intermediate micro

demand

describes the relationship between the price of a good and the quantity a consumer is willing and able to purchase at that price

Law of demand

as price increases, quantity demanded falls, and vice versa (all else equal)

price elasticity of demand is measured by

percent change in quantity / change in price

a change in a determinant of supply (not price) causes

a shift in the supply curve - a new quantity supplied at each possible price

what happens on the demand curve when a price changes

a slide along the demand curve (change in quantity demanded)

supply

describes the relationship between the price of a good and the quantity a producer is willing and able to supply at that price

law of supply

as price increases, quantity supplied rises, and vice versa (all else equal)

what happens on the supply curve when price changes

a slide along the supply curve (change in quantity supplied)

price elasticity is measured by

percent change in quantity / percent change in price

market equilibrium

a market condition in which the intentions of consumers match the intentions of producers

costs (in production)

a primary determinant of how much a producer is willing to supply at each possible selling price

short run (SR)

a period of time in which at least one factor of production cannot be changed

long run (LR)

a period of time in which all factors of production can be changed

opportunity cost

the cost of using inputs, measured by the value of their next best alternative use

perfectly competitive market

many sellers of a standardized product, with each firm having no market power

imperfectly competitive market

few firms selling a standard or differentiated product, battling for market share

monopoly

one firm producing the entire market share of a product, with considerable market power

normal profits

the level of profit that just covers the opportunity costs of resources invested in the firm

economic profit

profits in excess of normal profit

microeconomics

the study of choices and of how well the resulting market outcomes meet basic human needs

production possibility frontier (PPF)

the various amounts of two goods that an economy can produce during some period

what did Ricardo call the general phenomenon of increasing costs

Law of diminishing returns - Ricardo’s discovery that increasing costs is a general phenomenon

at the point where P* and Q* intersect, what is P*

P* is the equilibrium price - the price where quantity demanded and quantity supplied intersect

model (in economics)

a simple theoretical description that captures the essentials of how the economy or a market works

what are the four implications of the PPF model

resources are scarce; scarcity involves opportunity costs; opportunity costs are increasing; efficiency means using all resources to produce the maximum possible

what does inefficiency involve, according to the PPF model?

real costs - foregone output from not using all available resources

supply and demand model

a model describing how a good’s price is determined by the behavior of the individuals who buy it and the firms that sell it

in the supply and demand model, demand is determined by

consumer preferences for a good

in the supply and demand model, supply is determined by

the cost of producing a good

how do changes in determinants differ from changes in price in supply/demand language?

a change in a determinant shifts the schedule (curve); a change in price changes quantity demanded/supplied (movement along the curve)

Marshallian supply and demand model

prices are simultaneously determined by demand and supply together

what does the “scissors model” analogy illustrate?

you cannot say that either demand or supply alone determines price - like scissors, both blades act together

marshallian cross

the familiar supply and demand graph

rationality (in consumer/producer theory)

knowing one’s self-interest and making choices accordingly

what are the core assumptions shared by the consumer theory and price theory

consumers act rationally to maximize utility, and producers act rationally to maximize profit, both given their constraints

in the simplest utility theory model with one consumer and two goods, how is utility expressed?

U = f(X,Y) - utility as a function of the consumption of two goods

preferences are complete - what does this mean

a consumer can rank any two bundles: strictly preferred, indifferent, or weakly preferred

preferences are transitive - what does this mean?

if (x1,y1) > (x2,y2) and (x2,y2) > (x3,y3), then (x1,y1) _> (x3,y3)

indifference curve

all the combinations of two goods (bundles) that provide the same level of utility

can indifference curves representing distinct levels of utility cross?

they cannot cross

what’s the difference between testing assumptions and testing predictions

testing assumptions examines the premises a model is based on; testing predictions checks whether the model correctly predicts real-world events

what do many economists say about the positive-normative distinction?

the line between what is (positive) and what should be (negative) is not always clear-cut

what does the economic theory of choice begin with?

by describing people’s preferences

what question are we asking when drawing an indifference curve

if we add a little more of one good, how much do we need to change the other good to keep the consumer indifferent between the old and new bundle

perfect substitutes: what shape are the indifference curves

straight lines - the consumer only cares about the total amount of two goods combined

perfect complements: what shape are the indifference curves

L-shaped (right angle) curves, kinked at the fixed proportion the goods are always consumed together in

economic “bads”: what do indifference curves look like when one good is disliked

upward sloping - more of the disliked good requires more of the liked good to keep utility constant

neutral good: what do the indifference curves look like?

a straight vertical or horizontal line - changing the amount of the neutral good doesn’t affect utility

“Bliss” or satiation point: what do indifference curves look like?

Concentric circles (or ellipses) around a single ideal “bliss point” bundle

what does the slope of an indifference curve represent

Marginal rate of substitution (MRS) - the rate at which the consumer is willing to trade one good for the other

since indifference curves are curves, what does this mean for the MRS?

the MRS is different at every point along a (curved) indifference curve, with a few exceptions

how does having more of a good affect the marginal rate of substitution?

the MRS diminishes - the more you have of a good, the less of the other good you’re willing to give up for more of it

budget constraint (with prices Px, Py, and income m)

PxX + PyY _< m - total spending on goods x and y cannot exceed income m

what does PxX + PyY = mean represent?

the set of bundles that cost exactly m - the budget line

how do you draw a budget constraint?

find how much of good y could be bought spending all income on y (y-intercept), and how much of good x spending all income on x (x-intercept), then connect the two points

what does the slope of the budget constraint represent?

the rate at which the market is willing to “substitute” good x for good y (the price ratio)

how does a change in income affect the budget constraint?

it shifts the intercepts (outward if income grows, inward if it falls) but leaves the slope unchanged

if only the price of one good changes (the other stays the same), what happens to the budget constraint?

the intercept for the unchanged good’s axis stays the same, but the intercept for the good whose price changed shifts - changing the slope

what happens to the budget constraint when both prices change at the same time?

it depends - the effect varies based on whether the prices changes move in the same or opposite directions , by the same or different magnitudes, and whether income also changes

choice theory combines which two concepts?

indifference curves plus budget constraints - combining what a consumer prefers with what they can afford to find the optimal choice

at the optimal bundle, what is the relationship between the MRS and the budget line?

MRS = slope of the budget line - the consumer’s willingness to trade matches the market’s rate of exchange

what happens if the exchange rate is anything other than where MRS equals the budget line’s slope?

the budget line would cut through the indifference curve, meaning the consumer could move to amore preferred, still-affordable bundle

what are the three questions chapter 4 asks about demand?

why does demand shift when income changes? why does the law of demand work? how downward-sloping is the demand curve (elasticity)?

why does the demand function shift when income changes?

because the budget constraint shifts, making a new, different indifference curve attainable

why exactly does the law of demand work?

because price ratios change, shifting the budget constraint and requiring a move to a new point of tendency - composed of the substitution effect and the income effect.

what’s the confusing warning about the term “income effect”?

the income effect is NOT caused by a change in income - it’s caused by a change in price, and it explains a slide along the demand curve, not a shift

demand (formal definition)

a schedule showing the various amounts of a product a consumer is willing and able to purchase at each specific price over a range of possible prices

what are some determinants of demand?

tastes and preferences, income, and prices of related goods

how does a change in income affect the consumer’s optimal bundle?

teh optimal bundle changes because the budget constraint’s intercept changes when income (m) changes

exactly how the budget intercept changes with income depends on what?

whether the good is normal or inferior

substitution effect

how much consumption of x changes because the consumer reevaluates their mix of x and y due to the relative price change

income effect (in the context of a price change)

how much consumption of x changes because the price change altered the consumer’s real income (purchasing power)

when the price of good x changes, what two distinct effects does the consumer respond to?

the substitution effect and the income effect, and the overall response depends on which one dominates

what determines how steep or flat the demand curve is?

elasticity - it measures how responsive quantity demanded is to a change in price