Comprehensive Economics Study Guide: Microeconomics, Market Models, and Game Theory

Opportunity Cost

The true cost of an item is its opportunity cost—what must be given up to obtain that item. Sunk costs are not opportunity costs.

Marginal Analysis

When deciding 'how much' of something to consume or produce,

Gains from Trade

When individuals specialize and trade, they can consume more than they could without trade.

Efficiency of Competitive Markets

A situation is efficient if resources cannot be reallocated to make at least one person better off without making anyone else worse off.

PPP Adjustments

When comparing economic data across countries, such as GDP per person, Purchasing-Power Parity (PPP) adjustments are used.

Production Possibilities Frontier (PPF)

graph that illustrates the tradeoffs involved in production using limited resources.

Efficient Outcomes

The PPF describes all efficient outcomes.

Slope as Opportunity Cost

The slope of the PPF indicates how much of the good on the vertical axis must be given up to produce one more unit of the good on the horizontal axis.

Curved vs. Straight Line PPF

A straight-line PPF indicates constant opportunity cost, while a bowed-out (curved) PPF indicates increasing opportunity cost.

Economic Growth

Economic growth is represented by an outward shift of the PPF.

Absolute Advantage

A person or country has an absolute advantage if they are capable of producing more of a good than another person or country.

Comparative Advantage

A person or country has a comparative advantage if their opportunity cost of producing a good is lower than another's.

Specialization and Trade

Individuals (or countries) should specialize and trade according to comparative advantage.

Applicability to International Trade

The principles of comparative advantage apply directly to international trade, allowing countries to move to consumption possibilities outside their original PPF.

Strategic Interaction

Game theory analyzes settings where one player's action affects another player's decision.

Setting up a Game

A game is defined by Players, available Actions (strategies), and Payoffs (or utility) associated with each combination of actions.

Best Responses

Analysis often begins by identifying the best response for one player, assuming a particular action by the other player.

Dominant and Dominated Strategies

Dominant strategies are actions chosen regardless of what the other player does, while dominated strategies are actions never chosen.

Nash Equilibrium (NE)

An NE is a situation where each player's choice is a best response to the other players' choices.

Prisoners' Dilemma

This classic game demonstrates that when rational individuals make independent decisions, the resulting outcome can be inefficient.

Coordination Games

These games have multiple equilibria, making prediction difficult, though sometimes one equilibrium is clearly better than the other.

Chicken Games

These games also feature multiple Nash Equilibria, often with disastrous consequences if players fail to coordinate.

Competitive Markets

These markets are characterized by a huge number of buyers and sellers and a standardized product.

Demand Curves (D)

The demand curve shows the quantity consumers are willing to buy at any price. It generally slopes downwards (Law of Demand).

Supply Curves (S)

The supply curve shows the quantity producers are willing to supply at any price. It slopes upwards because firms require a higher price to cover the increasing variable costs of producing additional units.

Movement vs. Shift

A change in the price of the good causes a movement along the curve; a change in an external factor causes a shift of the entire curve.

Demand Curve Shifts (Causes)

Changes in the prices of substitutes or complements, changes in income, changes in tastes, changes in expectations, changes in the number of buyers.

Supply Curve Shifts (Causes)

Changes in input prices, changes in expectations, changes in technology, changes in the number of sellers.

Equilibrium Price and Quantity

The equilibrium price is the price at which the quantity demanded equals the quantity supplied.

Excess Supply (Surplus)

Occurs when the price is above equilibrium, leading to unsold goods.

Excess Demand (Shortage)

Occurs when the price is below equilibrium, creating upward pressure on prices.

Shifts in Equilibrium

Shifts in supply and demand curves lead to new equilibrium prices and quantities.

Willingness to Pay (WTP)

WTP is the maximum amount a consumer is willing to pay for a good.

Consumer Surplus (CS)

The difference between a consumer's WTP and the price they actually pay.

Producer Surplus (PS)

The difference between the price received and the seller's cost of producing the good.

Total Surplus (TS)

The sum of consumer surplus and producer surplus.

Competitive Equilibrium is Efficient

The outcome of a free competitive market is typically efficient because it maximizes total surplus.

Deadweight Loss (DWL)

DWL is the loss in total surplus that results from government intervention.

Price Ceiling (Maximum Price)

To make the good affordable to the poor; creates a shortage if binding.

Price Floor (Minimum Price)

To help producers; creates a surplus if binding.

Quota (Quantity Limit)

To restrict quantity; limits the quantity traded, creating a wedge between the demand price and the supply price.

Excise Tax Impact

A tax changes market incentives, shifting supply or demand.

Tax Wedge

The tax creates a wedge between the price consumers pay and the price producers receive.

Government Revenue

Tax revenue is calculated by multiplying the tax amount by the quantity traded in equilibrium after the tax.

Tax Burden (Incidence)

The tax burden depends on the elasticity of supply and demand.

Deadweight Loss and Elasticity

Taxes create Deadweight Loss, larger when demand or supply curves are more elastic.

Excise Tax

A tax on a unit of a good sold that changes market incentives and allows the market to arrive at a new equilibrium.

Wedge

The difference between the price consumers pay (P_C) and the price producers receive (P_P) due to a tax.

Equilibrium Outcome

The final economic outcome, including equilibrium quantity, price paid by consumers, and price received by producers, remains the same regardless of whether the tax is imposed on consumers or producers.

Supply Curve Shift

When producers are taxed, the supply curve shifts up by the amount of the tax.

Demand Curve Shift

When consumers are taxed, the demand curve shifts down by the amount of the tax.

New Equilibrium Calculation

To solve for the new equilibrium after a tax, if consumers are taxed T, replace P with P+T in the demand curve equation.

Tax Burden

The way the tax burden is split between producers and consumers, depending on the elasticities of supply and demand.

Elasticity

Price sensitivity of supply and demand; affects how the tax burden is shared.

Revenue Generation

One of the primary reasons for taxes, aimed at generating income for the government.

Negative Externalities

Costs that producers ignore, which can be addressed by taxing them to internalize these costs.

Monopoly

An industry where a single seller, the monopolist, is the only producer of a good with no close substitutes.

Market Power

The ability of a monopolist to raise prices without losing all quantity demanded.

Barriers to Entry

Factors that prevent new firms from entering a market, such as economies of scale and government-created barriers.

Marginal Revenue (MR)

The additional revenue gained from selling one more unit, which a monopolist equates to Marginal Cost (MC) to maximize profit.

Price Discrimination

The practice of charging different prices to different consumers based on their willingness to pay.

Natural Monopoly

A market condition where a single firm can supply the entire market at a lower cost than multiple firms due to high economies of scale.

Deadweight Loss in Monopoly

The loss of total surplus due to a monopolist restricting output to maximize profit.

Regulating Monopoly

Efforts by regulators to maximize surplus, potentially through public ownership or price ceilings.

Externalities

Situations where an individual's action imposes costs or benefits on others that are not accounted for.

Macroeconomics

The branch of economics that focuses on economy-wide measures like inflation and growth.

Gross Domestic Product (GDP)

The market value of all final goods and services produced within a country in a given period.

Nominal GDP

GDP measured using current prices.

Real GDP

GDP measured using base year prices to avoid misinterpreting inflation.

Credit Markets

Markets where the core issue is the enforcement problem, as payments are made after credit is consumed.

Moral Hazard

A situation in credit markets where the lender cannot monitor loan use.

Adverse Selection

A situation in credit markets where the lender cannot distinguish credit-worthy borrowers.

Microfinance

Innovative methods like group lending and progressive lending used to solve issues in credit markets.

Behavioral Economics

The study of phenomena where human decision-making deviates systematically from pure economic rationality.