Microeconomics

Market

comprised of all the buyers and sellers of a particular good or service

Highly competitive markets

has many buyers and sellers, no one buyer or seller can influence the price or quantity sold, sellers have no incentive to change the price they charge

Perfectly competitive markets

product sold is highly standardized, number of buyers and sellers is large, all participants are well informed about the market price

Law of demand

there is a negative relationship between a good’s price and the quantity demanded

Demand schedule

table listing the quantity of a good that is demanded at different prices

Demand curve

graph showing the relationship between price of a product and the quantity demanded

Market demand schedule

demand schedule based on the combined quantity demanded by every consumer in a market

Demand

the entire demand curve

Factors that affect demand

income, price of related goods, tastes, expectations, number of buyers

Normal goods

goods for which the demand rises when income rises and vice versa

Inferior goods

goods for which demand falls as income rises

Substitutes

goods for which a decline in the price of one good causes a reduction in the demand for another

Complements

goods for which a lower price for one good causes demand for the other good to increase

Law of supply

there is a positive relationship between price and quantity supplied

Factors that affect supply

input prices, technology, expectations, number of sellers

Inputs

anything suppliers have to purchase to supply a product

Equilibrium

state in which no participant in a market has any reason to alter their behavior, defined by where the supply and demand curves intersect

Competitive markets

gravitates toward equilibrium, effective method of allocating resources, price conveys important information to both suppliers and consumers

Marginal buyer

buyer who is indifferent between buying or not buying a good at a certain price

Height of the market demand curve

represents the marginal buyers willingness to pay

Consumer surplus

the benefit consumers receive from buying a product at a price lower than the maximum they would be willing to pay

Total consumer surplus

area below the demand curve and above the market price, measure of how much benefit all the buyers in a market receive from participating in it

Marginal seller

seller who would leave the market if the price were any lower; their willingness to supply is represented by the height of the supply curve

Height of the supply curve

represents the marginal seller’s willingness to supply or the opportunity cost to the marginal seller

Producer surplus

benefit suppliers receive from selling products at a price higher than the minimum they would be willing to sell at

Total producer surplus

area above the supply curve and below the market price

Total surplus

combination of consumer surplus and producer surplus

Price elasticity of demand

how much the quantity demanded responds to a change in price; percent change in quantity demanded over percent change in price

Elastic

1 percent change in price results in a change in quantity demanded greater than 1 percent

Inelastic

1 percent change in price results in a less than 1 percent change in quantity demanded

Unit elastic

1 percent change in price results in 1 percent change in quantity demanded

Factors that affect price elasticity of demand

substitutes, necessities, market definition, time horizon

Effect of substitutes on price elasticity of demand

goods with close substitutes have higher price elasticities because it is easy for consumers to switch to another product

Effect of necessities on price elasticity of demand

necessary items have lower price elasticities

Effect of market definition on price elasticity of demand

the broader the market definition, the fewer close substitutes there will be and the lower the elasticity will be

Effect of time horizon on price elasticity of demand

the longer the time horizon is the greater elasticity will be because adjusting to changes in prices takes time

Elasticity of supply

reflects the ease with which suppliers can alter the quantity of production; percent change in quantity supplied over percent change in price

Factors that affect the price elasticity of supply

ease of entry and exit, scarce resources, time horizon

Effect of ease of entry and exit on price elasticity of supply

supply will be more elastic if it is easier for businesses to begin supplying a product or to leave the market

Effect of scarce resources on price elasticity of supply

supply will be inelastic if the input required to produce a good is scarce

Total revenue

equilibrium price times equilibrium quantity; P*Q

Price ceilings

upper limit on prices imposed by the government

Effects of rent controls on total surplus

total surplus is reduced because some beneficial transactions don’t take place; increase in the consumer surplus of some renters decrease the producer surplus of landlords

Effects of rent controls on allocation of housing

landlords can select tenants, so apartments may not go to people who value them most highly, resulting in inefficiency

Effect of rent controls on supply and demand

supply and demand become more elastic, supply decreases due to cutting costs, demand increases due to lower price

Price floor

lower limit on price imposed by the government

Effects of price floors

lower demand, surplus supply, reduction of consumer and producer surplus

Effects of taxes

leftward shift in demand/supply curve, lower equilibrium quantity, price received by suppliers falls, total surplus decreases

Price wedge

difference between amount consumers pay and the amount suppliers receive, reduces market quantity

Deadweight loss

reduction in social welfare, represented by triangle to the right of the new equilibrium quantity and between the supply and demand curves

Distribution of tax burden

less elastic demand causes greater burden on buyers; the less elastic supply/demand curves are, the lower the deadweight loss is

Production Possibility Frontier

graph showing how many of two products an economy can produce

Absolute Advantage

ability to produce more of a good than others given the same amount of resources

Comparative Advantage

having a lower opportunity cost to produce a certain product

Reason a country becomes an exporter

country’s cost of supply is below the world price

Equilibrium with international trade

occurs where the world price intersects a country’s market supply curve

Effects of exporting on surplus

consumer surplus falls because price rises while producer surplus increases; overall social welfare increases

Effects of importing on surplus

social welfare increases, consumers benefit, producers suffer losses

Firms

economic actors who are responsible for supplying goods and services

Economic costs

includes opportunity costs of all resources required for production

Accounting costs

includes only actual monetary expenditures

Fixed costs

costs that do not depend on the quantity produced and cannot be changed in the short run

Variable costs

costs that can be varied in the short run

Marginal cost

increase in costs that occurs when producing an additional unit of output; increase in total costs divided by increase in quantity produced

Diminishing returns to scale

increasing marginal costs as output increases; use of more resources produces less and less additional output

Marginal revenue

the additional revenue a supplier receives from producing an additional unit of output

Addition of producers

shifts market supply curve to the right, causes equilibrium price to fall

Entry of producers into a market

continues as long as there are positive economic profits to be earned in a market, stops when economic profits reaches zero

Exit of producers in a market

happens when economic profits fall below zero

Economic profits in a competitive market

producers earn zero economic profits, but do earn their opportunity wage

Allocation of productive resources

if prices exceed production costs in one activity, positive economic profits signal that additional resources should be deployed to increase production

Imperfectly competitive markets

markets with only one or a few suppliers

Firms in imperfectly competitive markets

can’t assume that the quantity they supply does not affect price, faces a downward sloping demand curve (if supply increases, price goes down)

Market power

ability to choose market prices, possessed by firms facing a downward sloping demand curve

Monopoly

when a market has one supplier, arises due to barriers to entry

Barriers to entry

ownership of a key resource, government created monopolies, natural monopolies

Government created monopolies

when the government gives the rights to supply a product to a single company; ex. patent, copyright law

Natural monopolies

when a single firm can supply the market at a lower cost than could two or more firms; happens when there are large fixed costs that cause the average costs to fall as production increases

Impact of monopolies on social welfare

transfers consumer surplus to the monopoly, reduction in social well-being (restriction of supply)

Profit maximization

increase supply until marginal cost equals marginal revenue

Sherman Anti-Trust Act

1890 law used to increase market competition; large mergers and acquisitions must be reviewed by government regulators

Price discrimination

charging different prices to different customers, makes the marginal revenue curve closer to the market demand curve, moves market closer to socially efficient quantity

Oligopoly

market with only a few sellers

Oligopolies vs. monopolies

oligopolies must also consider the choices other suppliers make

Cartel

suppliers in an oligopoly agree to cooperate and behave like a monopolist to maximize profits, illegal under US anti-trust law

Problems faced by cartels

marginal revenue will be greater than marginal cost for each firm, creating temptation to increase production, which lowers market price and negatively impacts other members of cartel

Organization of Petroleum Exporting Companies (OPEC)

caused oil prices to increase sharply during the COVID-19 pandemic by reducing oil output

Monopolistic competition

markets in which firms produce similar but differentiated products; ex. books, restaurants, clothes

Firms in monopolistically competitive markets

faces a downward sloping demand curve, chooses output the same way a monopoly does

Entry and exit in monopolistically competitive markets

entry will continue until economic profits reach zero because there are no barriers to entry

Welfare properties of monopolistically competitive markets

there is some social inefficiency because price exceeds marginal costs, but consumers benefit from the increased range of choices

Economic profits

additional payment above and beyond the compensation that can be earned in the next best alternative activity

Entrepreneurs

individuals who take on the risk of attempting to create new products or services, establish new markets, or develop new methods of production

Rewards of entrepreneurship

economic profits that can be earned by being the first to market with a new product

Innovation

helps to create barriers to entry that reward the innovator, breaks down existing market imperfections by encouraging efforts to invent around existing barriers to entry

Creative Destruction

the impact of entrepreneurs; development of new and improved products causes long-run improvements in well-being

Market failures

circumstances in which competitive markets fail to produce socially desirable outcomes

Externality

arises when the actions of one person affect the well-being of someone else but neither party pays or is paid for these effects

Positive externality

externality that has a beneficial effect

Negative externality

externality that has a harmful effect