ECON 1103 EXAM 1 GUIDE

Principles of Microeconomics  

1. Economics : study of satisfying our unlimited wants with limited resources 

   1. Unlimited wants: there is always someone else wants what you don’t, wants change overtime 

2. Microeconomics: making decisions for themselves; small picture activities; balancing trade-offs between resources to use 

3. Macroeconomics: making decisions for others as a group 

Factors of production  

1. Four factors: 

   1. Land 

   2. Labor 

   3. Capital 

   4. Entrepreneurship  

2. Every choice has a cost – economists only worry about the chosen thing and the runner up 

   1. Opportunity cost — the cost of the next best option not chosen 

      1. Calculation: sacrifice / gain

PPF

1. Production possibilities frontier: possibilities of production using given, limited resources  

   1. Bows out because of increasing opportunity costs 

   2. As we use our resources more efficiently, curve bows out because opportunity costs change as quality changes 

2. Points on PPF 

   1. Point under curve = inefficient (A) 

   2. Point on curve - efficient (B) 

   3. Point outside curve = unattainable ( C ) 

Determinants of PPF  

1. Machinery 

2. Trade 

3. Labor  

Allocative efficiency: resources allocated maximize happiness of consumers 

1. Balance between marginal utility and marginal cost of one more unit 

2. MU = MC 

   1. MC = change in costs / change in quantity  

   2. MU = change in utility / change in quantity 

Circular Flow Model  

1. Major components 

Factor market: resources businesses use to produce goods or services 

1. Households = suppliers (labor) 

2. Firms = consumers

Product market  

1. Households = consumers 

2. Firms = suppliers  

Economic systems: 

1. Free market: supply and demand, competition determine market outcomes 

2. Centrally planned economy: government allocates resources; restrictions 

3. Mixed: free market with government regulations for fair trade 

Demand  

1. Law of demand   

   1. Price and quantity demanded have inverse relationship 

   2. Reasons for this law 

      1. Substitution Effect: as price rises, you may choose to buy from a different market 

      2. Income effect: as the price rises and your income doesn’t, you can buy less and less of the good 

2. Determinants of Demand  

   1. Price of related goods 

      1. Substitutes 

      2. Complements 

   2. Expected future price 

      1. If you expect the future price to rise, demand for today increases 

      2. If you expect the future price to fall, demand for today lowers (waiting to purchase)  

   3. Income 

      1. Normal goods: income rises, demand rises  

      2. Inferior goods: income rises, demand falls 

   4. Population 

      1. Population increases, demand increases 

   5. Preferences of buyers 

      1. Changes in favor → demand increases 

      2. Change against → demand decreases 

3. Change in Demand vs. Change in Quantity Demanded 

   1.  Change in demand = movement of the curve (determinants change) 

   2. Change of quantity demanded = movement along the curve (happens because of price change) 

Supply  

1. Law of Supply: ceteris paribus, as the price of a good increases, quantity supplied of the good will increase 

2. Determinants of Supply  

   1. Price of factor of production 

      1. as increases, supply decreases 

   2. Price of related goods 

      1. Price of related goods increase (more profit), supply decreases  

   3. Expected future price 

      1. If the price is expected to increase, supply today decreases 

      2. If price expected to decrease, supply today increases 

   4. Number of suppliers in the market 

      1. Number of suppliers increase, supply increases 

      2. Supply = horizontal sum of individual firm’s supply 

   5. Technology  

3. Change in Supply vs. Change in Quantity Supplied  

   1. Change in supply = movement of curve (determinants change) 

   2. Change in quantity supplied = movement along curve (price change) 

Elasticity 

1. Price Elasticity of Demand  

   1. Measure of how much quantity demand changes with price change  

      1. E_D = %Δ Q_D / %ΔP 

      2. Midpoint formula: 

Types: 

1. Perfectly Inelastic: quantity demanded doesn’t change with price change 

   1. Usually for necessities (gas, medication) 

   2. Elasticity = 0 

2. Perfectly Elastic: extremely responsive to price changes 

   1. Elasticity = ∞ 

3. Unit elastic: quantity demanded is perfectly responsive to change in price 

   1. Elasticity = 1 

4. Elastic: quantity demanded changes a lot because of price change 

   1. Elasticity > 1 

5. Inelastic: quantity demanded doesn’t change much because of changes in price  

   1. 0 < Elasticity < 1

Relationship between Elasticity and Total Revenue  

1. Total revenue: P * Q  

2. More elasticity = more revenue 

3. More inelastic = less revenue  

4. Unit elastic = no change in revenue 

Other types of Elasticity 

1. Income Elasticity: how responsive demand is with change in income 

   1. E_I = %Δ Q / %ΔI

2. Cross Price elasticity: how responsive the demand for a  product is to a change in price of another 

   1. E_C = %Δ Q Product A / %Δ P Product B  

   2. Negative = complement 

   3. Positive = substitute 

3. Price Elasticity of Supply - same as Demand but with Quantity Supplied  

Advantage  

1. Absolute advantage  

   1. Ability to produce more of a good or service than another using the same amount of resources 

2. Comparative advantage  

   1. Producing a good at a lower opportunity cost compared to another, even if the other can produce more of both goods in absolute terms 

   2. Whoever has lower opportunity cost specializes in producing product