ECN 201: Microeconomics Final Review

Capitalism

An economic system based on private property, markets, and firms producing goods for profit.

Key features of capitalism

Private property, markets, and firms.

Private property

Gives owners the right to use and exchange assets and provides investment incentives.

Markets

Coordinate production through prices and voluntary exchange.

Firms

Organize labor and production to maximize profit.

Nominal values

Measured in current prices; real values are adjusted for inflation.

Economic growth

Driven by innovation, competition, specialization, and secure institutions.

Hockey stick growth curve

Shows centuries of stagnation followed by rapid growth during the Industrial Revolution.

Comparative advantage

Producing a good at a lower opportunity cost than another producer.

Government roles

Protect property rights, enforce contracts, correct market failures, and provide public goods.

Optimal choice condition

MRS = MRT (Marginal Rate of Substitution equals Marginal Rate of Transformation).

Technological progress

The ability to produce more with the same input.

Isoquant

Shows all combinations of inputs that produce the same output.

Diminishing marginal product of labor

Each additional worker adds less output than the previous.

Creative destruction

Describes how new technologies replace older, less efficient ones.

Employment rent

The difference between the utility of having a job and being unemployed.

Principal-agent problem

Occurs because employers cannot perfectly observe worker effort.

Efficiency wage theory

Higher wages lead to higher effort and lower turnover.

Pareto efficiency

No one can be made better off without making someone else worse off.

Gini coefficient

Measures inequality as A divided by (A + B).

Deadweight loss

Measures lost total surplus from inefficiency due to taxes or monopolies.

Public goods

Non-rival and non-excludable goods causing free riding.

Externalities

Side effects that affect others outside a transaction.

Negative externalities

Occur when MSC > MPC, leading to overproduction.

Positive externalities

Occur when MSC < MPC, leading to underproduction.

Adverse selection

Hidden information before a contract (e.g., risky insurance buyers).

Moral hazard

Hidden actions after a contract (e.g., risky behavior after insurance).

Market failure

Occurs when equilibrium is not Pareto efficient.

Critical question of intertemporal choice

Deciding how much to consume now versus later.

Interest rate

The reward for saving or cost of borrowing.

Discount rate

Measures impatience; a higher rate means more present-focused.

Future Value formula

Future Value = PV(1 + r).

Present Value formula

Present Value = FV / (1 + r).

Optimal output condition

Firms maximize profit where marginal revenue equals marginal cost.

Increasing returns to scale

Output rises more than input.

Constant returns to scale

Output doubles when inputs double.

Decreasing returns to scale

Output rises less than input.

Isocost equation

C = wL + rK.

Tax burden rule

Less elastic side bears more of the tax burden.

Basic profit formula

Profit = TR – TC.

Total Revenue formula

Total Revenue = P × Q.

Marginal Cost formula

Marginal Cost = ΔTC / ΔQ.

Marginal Revenue formula

Marginal Revenue = ΔTR / ΔQ.

Elasticity formula

Elasticity = %ΔQ / %ΔP.

Equilibrium condition for profit maximization

MR = MC.

Higher markup indicator

More market power and less elastic demand.

The difference between MSC and MPC

MSC includes external costs.

Gains from trade

Equal the sum of consumer and producer surplus.

Income vs Wealth

Income is a flow; wealth is a stock.

Example: Julia's situation with interest rates

Julia is worse off when the interest rate increases.

Example: Marco's situation with interest rates

Marco benefits by lending at 10 percent instead of storing grain.

Example: Higher interest rate effects

Higher r shrinks borrowing options and expands lending options.

Example: Negative externality

Pollution is a negative externality causing overproduction.

Example: Positive externality

Vaccines are a positive externality causing underproduction.

Example: Pigouvian tax purpose

Sets MPC = MSC.

Example: Function of voluntary exchange

Voluntary exchange increases fairness compared to coercion.

Example: Optimal choice scenario

The optimal choice occurs where MRS = MRT.

Example: Pareto efficiency occurrence

Pareto efficiency occurs when MRS = MRT.

Example: High employment rent impact

High employment rent means employers have more power.

Example: The slope of the budget line

Represents the opportunity cost between two goods.

Example: Nash equilibrium in prisoner’s dilemma

Both players defect.

Example: Fairness influences in ultimatum game

Responders reject unfair offers.

Example: Pareto efficient combinations in Angela and Bruno model

All Pareto efficient combinations of work and consumption.

Example: Economic models utility

Simplified frameworks used to explain and predict behavior.

Example: Efficiency concerns vs fairness concerns

Efficiency maximizes total output while fairness concerns equality.

Example: How does unemployment affect worker effort

Higher unemployment raises effort because job loss is costly.