Microeconomics - Final Exam Review

A comprehensive set of practice flashcards covering microeconomic concepts including consumer theory, production, market structures, and market failures based on lecture transcripts.

Certainty Equivalent

The amount of certain income that provides a consumer with the same level of utility as the expected utility of a risky lottery.

Risk Aversion

A consumer preference characterized by a concave expected utility function where the consumer is willing to pay to avoid a lottery.

Risk Seeking

A consumer preference characterized by a convex expected utility function where the consumer is willing to pay to participate in a lottery.

Axiom of Completeness

A postulate stating that a consumer is capable of comparing all consumption baskets according to their utility.

Axiom of Transitivity

The logic that if basket A is preferred to B, and B to C, then A is preferred to C, implying that indifference curves of a single consumer cannot intersect.

Axiom of Non-satiety

The assumption that for goods with positive preferences, the consumer always prefers a larger quantity to a smaller quantity.

Indifference Curve (IC)

A curve representing all combinations of goods X and Y that yield the consumer a constant level of utility.

Budget Constraint

A line representing all combinations of goods X and Y for which the consumer spends their entire disposable income, mathematically expressed as $I = Px \times X + Py \times Y$.

Marginal Rate of Substitution ($MRSc$)

The ratio at which a consumer is willing to trade one good for another, given by the ratio of marginal utilities: $\frac{MUx}{MUy}$.

Marginal Rate of Exchange ($MRSe$)

The ratio at which goods can be exchanged on the market, determined by the ratio of their prices: $\frac{Px}{Py}$.

Consumer Optimum

The point where the consumer maximizes utility given their budget, occurring where $MRSc = MRSe$, or $\frac{MUx}{Px} = \frac{MUy}{Py}$.

Price Elasticity of Demand ($epd$)

A measure of the sensitivity of quantity demanded to price changes, calculated as the percentage change in quantity divided by the percentage change in price; demand is elastic if $|epd| > 1$.

Income Elasticity of Demand ($eid$)

The ratio of the percentage change in quantity demanded to the percentage change in income; positive for normal goods and negative for inferior goods.

Cross-Price Elasticity of Demand ($ecd$)

A measure of how quantity demanded of one good reacts to a price change of another; positive results indicate substitutes, while negative results indicate complements.

Substitution Effect (Consumer)

The change in consumption resulting from a change in relative prices, where a good becomes relatively cheaper or more expensive compared to others.

Income Effect (Consumer)

The change in consumption resulting from a change in real income (purchasing power) caused by a price fluctuation.

Marshallian Demand

A demand curve that includes both the substitution and income effects of a price change, where nominal income is held constant and utility varies.

Hicksian Demand

A demand curve that includes only the substitution effect of a price change, where utility is held constant and income varies.

Law of Diminishing Marginal Returns

The principle stating that as units of a variable factor (labor) are added to fixed factors, the marginal product of that variable factor eventually begins to decline.

Isoquant

A curve showing all combinations of labor ($L$) and capital ($K$) that produce the same total volume of output.

Isocost

A line representing all combinations of labor and capital that can be purchased for a given total cost at specific factor prices ($w$ and $r$).

Marginal Rate of Technical Substitution ($MRTS$)

The ratio at which capital can be replaced by labor while keeping output constant, calculated as the ratio of marginal products: $\frac{MPL}{MPK}$.

Cost Optimum (Production)

The point where a firm produces a given output with the lowest costs, occurring where the slope of the isoquant equals the slope of the isocost ($MRTS = \frac{w}{r}$).

Increasing Returns to Scale

A situation where a proportional increase in all inputs leads to a more than proportional increase in total output.

Lerner Index ($L$)

A measure of monopoly power calculated as $L = \frac{P - MC}{P}$, where values closer to 1 indicate higher monopoly power.

Natural Monopoly

A market structure where a single firm can satisfy total market demand at a lower cost than multiple firms due to significant economies of scale and decreasing average costs ($AC$).

Monopolistic Competition

A market structure with many firms, differentiated products, and small barriers to entry, where firms have limited power to set prices above marginal cost ($MC$).

Cournot Model

An oligopoly model where firms choose their output levels simultaneously based on their reaction functions, each obvserving the other's volume.

Stackelberg Model

An oligopoly model where a lead firm has an informational advantage and sets its production volume first, knowing the reaction function of the follower.

Sweezy Model (Kinked Demand)

An oligopoly model explaining price stability where firms assume competitors will follow price cuts but not price increases, resulting in a discontinuous marginal revenue ($MR$) curve.

Dominant Firm and Competitive Fringe

A market structure where one large firm sets the price for the entire industry based on its own profit maximization ($MR = MC$), and smaller firms (the fringe) accept this price.

Substitution Effect (Labor)

The household reaction where an increase in the real wage rate makes leisure relatively more expensive, leading the household to work more hours.

Income Effect (Labor)

The household reaction where an increase in the real wage rate increases purchasing power, potentially leads to a higher demand for leisure and fewer hours worked.

Marginal Revenue Product of Labor ($MRPL$)

The additional revenue a firm earns by hiring one additional unit of labor, calculated as $MR \times MPL$.

Marginal Factor Cost of Labor ($MFCL$)

The additional cost incurred by a firm when hiring an additional unit of labor, which equals the wage rate ($w$) in a competitive market.

Moral Hazard

An information asymmetry problem where an agent (e.g., a manager or tenant) maximizes their own benefit at the expense of the principal (e.g., the owner), often by mismanaging resources.

Adverse Selection

A market failure resulting from asymmetric information where higher-quality products are pushed out of the market by lower-quality ones.

Negative Externality

An unintended cost imposed on third parties during production or consumption for which the producer or consumer does not pay (e.g., neighbor's dog barking).

Positive Externality

An unintended benefit received by third parties for which they do not pay (e.g., a neighbor's dog scaring away a thief from your garden).