Principles of Microeconomics: Demand, Supply, and Market Equilibrium

Cost-Benefit Principle

Evaluate all costs and benefits for any choice you face, and pursue the choice if the benefits are at least as large as the costs.

Economic surplus

Benefit - cost.

Opportunity Cost Principle

The true cost of something is the (value of the) next best alternative you give up in order to get it.

Sunk cost

Costs that have already been incurred and cannot be recovered.

Marginal Principle

For quantity decisions, need to consider marginal benefits and marginal costs.

Marginal benefit

The additional benefit received from consuming one more unit.

Marginal cost

The additional cost incurred from producing one more unit.

Diminishing marginal returns

The principle that as more of a good is consumed, the additional satisfaction gained from each additional unit decreases.

Interdependence Principle

Your best choice depends on your own choices, choices of others, dependencies between markets, and past and future decisions/expectations about the future.

Individual Demand

The demand for one person.

Quantity demanded

The amount of a good that buyers are willing and able to purchase at a given price.

Demand curve

A graphical representation of the relationship between price and quantity demanded.

Law of demand

As the price of a good decreases, the quantity demanded increases, and vice versa.

Market Demand

The total quantity demanded by all consumers in the market at each price.

Factors That Shift the Demand Curve

Factors that cause the demand curve to shift right (increase in demand) or left (decrease in demand).

Normal goods

Goods for which demand increases as income increases.

Inferior goods

Goods for which demand decreases as income increases.

Substitutes

Goods that can replace each other; an increase in the price of one leads to an increase in demand for the other.

Complements

Goods that are consumed together; an increase in the price of one leads to a decrease in demand for the other.

Individual Supply

The supply for one firm/business.

Supply curve

A graphical representation of the relationship between price and quantity supplied.

Law of supply

As the price of a good increases, the quantity supplied increases, and vice versa.

Shifts of supply curve

Factors that cause the supply curve to shift either to the right (increase in supply) or to the left (decrease in supply).

Input prices

The costs of the resources used to produce goods and services, which can affect supply.

Technology and productivity

Advancements and efficiencies in production processes that can increase supply.

Prices of related outputs

The prices of goods that are related to the production of the main good, which can impact supply (not covered on the exam).

Substitutes in production

Alternative goods that producers can create using the same resources, affecting supply decisions.

Complements in production

Goods that are produced together, where the supply of one affects the supply of the other.

Producer expectations of future prices

Producers' predictions about future market prices that can influence their current supply decisions.

Type and number of sellers

The variety and quantity of sellers in the market, which can affect overall market supply.

Market equilibrium

The point where the supply and demand curves intersect, indicating the equilibrium price and quantity.

Equilibrium price

The price at which the quantity of goods supplied equals the quantity of goods demanded.

Equilibrium quantity

The quantity of goods supplied and demanded at the equilibrium price.

Excess supply/surplus

A situation where the quantity supplied exceeds the quantity demanded at a given price.

Excess demand/shortage

A situation where the quantity demanded exceeds the quantity supplied at a given price.

Elasticity

The measure of how much one variable responds to changes in another variable, calculated as the ratio of two percentage changes.

Price Elasticity of Demand

The responsiveness of the quantity demanded to a change in price, typically expressed as a negative value.

Inelastic demand

Demand where the quantity demanded changes less than proportionately to a change in price (|E| < 1).

Elastic demand

Demand where the quantity demanded changes more than proportionately to a change in price (|E| > 1).

Perfectly inelastic demand

Demand where quantity demanded does not change regardless of price changes (E = 0).

Perfectly elastic demand

Demand where quantity demanded changes infinitely with any change in price (E = ∞).

Unit elastic demand

Demand where quantity demanded changes exactly proportionately to a change in price (|E| = 1).

Revenue

The total income generated from sales, calculated as price multiplied by quantity sold.

Effect of price changes on revenue

If demand is inelastic, raising price will increase revenues; if demand is elastic, raising price will decrease revenues.

Maximizing revenue

Occurs when demand is unit elastic, meaning that changing the price does not affect total revenue.