MICROECONOMICS FINAL EXAM

What is Capitalism?

an economic system characterized by private property, markets, and firms.

What does the 'Hockey-stick growth curve' illustrate?

This curve illustrates how income and productivity sharply increased after 1700.

What drives long-term economic growth?

is driven by technological progress and capitalist institutions.

What are economic institutions?

the 'rules of the game' that determine incentives and economic outcomes.

What does GDP measure and what doesn't it account for?

measures income/output but does not account for income distribution or overall well-being.

How does growth depend on incentives?

It depends on incentives for innovation and cooperation.

What are the dual effects of Capitalism on productivity and inequality?

Capitalism increases productivity but can also generate inequality.

Why do economists use economic models?

The models simplify reality to explain behavior.

What do production functions show?

They show the maximum output possible given a set of inputs.

Define 'diminishing marginal product'.

It means each additional input adds a smaller increase in output than the previous one.

What is 'opportunity cost'?

It is the value of the next best alternative that is forgone when a choice is made.

What is a 'feasible set'?

It includes all options that are available or achievable given constraints.

What do Utility/Indifference curves represent?

displays curves that show preferences and tradeoffs between different goods or outcomes, representing combinations that yield the same level of utility.

What is the primary tradeoff people face when maximizing utility?

People maximize utility subject to constraints such as time, income, and technology.

What is the 'labor–leisure tradeoff'?

This refers to the decision-making process where individuals allocate their scarce time between working (to earn income) and leisure activities.

What is a 'best response' in economic decision-making?

This is the optimal choice made by an individual or firm, given their constraints and expectations about others' actions.

How do work and production choices relate to marginal gains and opportunity costs?

Work and production choices are made by considering marginal gains and opportunity costs associated with each decision.

What is a 'reservation option'?

This is what someone gets if they do not take a job or engage in a particular economic interaction; it represents their fallback position.

How is optimal labor supply determined graphically?

It is determined by the intersection of the feasible frontier (representing time vs. income) and indifference curves (representing preferences).

What factors influence how much people work?

People may work more or less depending on wages, their preferences, and various constraints they face.

What is 'strategic interaction'?

This occurs when the payoff for one individual depends on the actions of others.

What is 'Game theory' used for?

a framework used to analyze situations of cooperation and conflict among interacting agents.

What is a 'Nash equilibrium'?

This is a set of strategies where no player can improve their outcome by unilaterally changing their own strategy, assuming other players' strategies remain unchanged.

What is the 'Prisoner's Dilemma'?

This is a game theory scenario where dominant strategies for individual players lead to an outcome that is worse for all players involved than if they had cooperated.

How do 'social preferences' influence decisions?

Social preferences, such as altruism, fairness, and reciprocity, influence individuals' decisions beyond just their self-interest.

What is 'strong reciprocity'?

This is the willingness to punish unfairness or uncooperative behavior, even if it comes at a personal cost.

Why do markets rely on trust, fairness norms, and repeated interactions?

Markets effectively function and thrive when participants operate with trust, adhere to fairness norms, and engage in repeated interactions.

What do private property and contracts enable in markets?

Private property and enforceable contracts are essential for enabling market exchange.

Define 'Pareto efficiency'.

A situation is this if no one can be made better off without making someone else worse off.

How do markets allocate resources?

Markets allocate resources primarily through voluntary exchange.

What is 'surplus' in market transactions?

This is the difference between an individual's willingness to pay (WTP) and the actual price paid (for consumers) or the price received and the cost of production (for producers).

What is 'deadweight loss'?

This is the value of total surplus (consumer + producer) that is lost when markets fail to achieve an efficient allocation or are distorted by interventions like taxes or monopolies.

What is a major insight regarding market efficiency and fairness?

Markets can be efficient in allocating resources, but they do not guarantee fairness in the distribution of outcomes.

What is the primary function of firms?

they transform inputs into outputs with the aim of earning a profit.

What is the 'principal–agent problem' in firms?

This issue arises because owners (principals) cannot perfectly monitor workers (agents), leading to potential conflicts of interest or misaligned incentives.

What are 'incomplete contracts' in the context of employment?

This refers to employment contracts where a worker's effort or aspects of their job performance cannot be fully specified or enforced, necessitating other incentives.

What is an 'efficiency wage'?

This is a wage paid by firms above the worker's reservation wage to motivate higher effort and productivity, reducing shirking.

What does the 'labor discipline model' suggest about worker effort?

It suggests that worker effort increases when unemployment is higher (making job loss costly) or when the wage offered is higher (increasing the value of keeping the job).

What does the 'wage–effort curve' represent?

Otherwise known as the best response function, it shows the maximum effort level a worker will provide for each given wage, determined by their motivation and the cost of job loss.

How do firms set wages and employment compared to competitive markets?

Firms set wages and employment strategically, not competitively, taking into account worker motivation and the principal-agent relationship.

What does the 'demand curve' represent?

This graph represents the willingness to pay of consumers and the marginal benefit they receive from consuming an additional unit of a good.

What does the 'supply curve' represent?

This graph represents the marginal cost of production for firms for each additional unit of a good.

What is 'market equilibrium'?

This is the point where the quantity demanded by consumers equals the quantity supplied by producers, resulting in a stable price and quantity.

What does 'elasticity' measure in economics?

This measures the responsiveness of quantity demanded or supplied to changes in price or other market factors.

How does the 'price mechanism' function in markets?

This system allocates goods and transmits information between buyers and sellers in a market.

What types of surplus are maximized at market equilibrium?

Equilibrium maximizes consumer surplus, producer surplus, and thus total surplus (in the absence of distortions).

What factors cause a 'demand shift'?

It can be caused by changes in income, consumer tastes and preferences, or the prices of substitute/complementary goods.

What factors cause a 'supply shift'?

it can be caused by changes in technology, input costs (like labor or raw materials), or producers' expectations about future prices.

What is 'market power'?

This is the ability of a firm to set its price above its marginal cost of production without losing its customers.

At what point do firms maximize profit?

Firms maximize profit at the output level where marginal revenue (MR) equals marginal cost (MC).

What determines a firm's 'markup'?

Decided by the percentage by which price exceeds marginal cost is inversely related to the elasticity of demand for its product.

List the types of price discrimination.

Price discrimination types include: 1. First-degree (perfect): Charging each customer their maximum willingness to pay. 2. Second-degree: Charging different prices based on the quantity consumed (e.g., quantity discounts). 3. Third-degree: Charging different prices to different customer segments or groups.

How does market power relate to deadweight loss?

Market power reduces consumer surplus and total welfare, leading to deadweight loss due to monopolistic pricing, which results in a lower output and higher price than in a competitive market.

What is the insight regarding prices above marginal cost?

Prices above marginal cost distort resource allocation and reduce overall economic efficiency.