ECN 201: Microeconomics Final Review
CHAPTER 1 – CAPITALISM AND GROWTH
Capitalism is an economic system based on private property, markets, and firms producing goods for profit.
Key features of capitalism are private property, markets, and firms.
Private property gives owners the right to use and exchange assets and provides investment incentives.
Markets coordinate production through prices and voluntary exchange.
Firms organize labor and production to maximize profit.
Nominal values are measured in current prices; real values are adjusted for inflation.
Economic growth is driven by innovation, competition, specialization, and secure institutions.
The hockey stick growth curve shows centuries of stagnation followed by rapid growth during the Industrial Revolution.
Comparative advantage is producing a good at a lower opportunity cost than another producer.
Governments protect property rights, enforce contracts, correct market failures, and provide public goods.
Which of the following is a defining feature of capitalism?
Economic growth in capitalist systems results mainly from innovation and competition.
Why is real GDP used instead of nominal GDP when comparing over time? Real adjusts for inflation.
The ability to produce more with the same input is called technological progress.
Example: Increased ability to provide light, grow food, and communicate represents technological progress.
CHAPTER 2 – TECHNOLOGY AND PRODUCTION
Economic models are simplified frameworks used to explain and predict behavior.
The isocost line shows combinations of inputs that have the same total cost.
Equation for isocost: C = wL + rK.
The slope of an isocost line is the ratio of input prices, –(w/r).
An isoquant shows all combinations of inputs that produce the same output.
The production function Q = f(L,K) shows the relationship between inputs and output.
Diminishing marginal product of labor means each additional worker adds less output than the previous.
Technological progress shifts isoquants downward, meaning more efficient production.
Creative destruction describes how new technologies replace older, less efficient ones.
What does an isoquant represent? Combinations of labor and capital that yield equal output.
What is the slope of an isocost line? The ratio of input prices.
If a technology produces more with fewer inputs, it dominates other technologies.
When technology improves, output increases for the same level of inputs.
Example: Technology C dominated by A.
Example: Technology B optimal when input prices fall.
CHAPTER 3 – TRADE-OFFS AND OPTIMIZATION
The feasible set or budget constraint shows combinations of goods a consumer can afford.
Indifference curves represent bundles of goods that give equal satisfaction.
Indifference curves slope downward and are bowed inward.
The optimal choice occurs where the indifference curve is tangent to the budget line.
The condition for optimal choice is MRS = MRT.
Opportunity cost is the value of the next best alternative forgone.
What happens to the feasible set when income rises? It shifts outward.
The slope of the budget line represents the opportunity cost between two goods.
At equilibrium, MRS equals MRT.
Example: The optimal choice occurs where MRS = MRT.
CHAPTER 4 – GAME THEORY AND SOCIAL INTERACTION
Game theory studies strategic interactions where outcomes depend on others’ actions.
A Nash equilibrium occurs when no player benefits by changing their strategy alone.
A dominant strategy is the best option regardless of the other player’s choice.
The prisoner’s dilemma shows how rational self-interest can lead to a worse collective outcome.
In the prisoner’s dilemma, mutual defection (D,D) is the Nash equilibrium but not Pareto efficient.
The public goods game shows how people tend to free ride on others’ contributions.
The equilibrium of the public goods game is under-contribution.
The ultimatum game shows that fairness influences decisions; people reject unfair offers.
In sequential games, one player moves first and the other responds; analyzed by backward induction.
In the prisoner’s dilemma, what is the Nash equilibrium? Both players defect.
What defines a dominant strategy? It yields the best payoff regardless of others’ actions.
Why is the Nash equilibrium in the prisoner’s dilemma Pareto inefficient? Because both would be better off cooperating.
In the ultimatum game, why might a responder reject an offer? Because of fairness concerns.
What happens in the public goods game when people act selfishly? Everyone contributes less and total welfare decreases.
Which of the following is an example of social preferences? Rejecting an unfair offer.
Example: (C,C) is Pareto efficient but not the Nash equilibrium.
Example: Responders reject unfair offers in the ultimatum game.
CHAPTER 5 – INEQUALITY AND FAIRNESS
Institutions are formal and informal rules that shape incentives and behavior.
Pareto efficiency means no one can be made better off without making someone else worse off.
Efficiency maximizes total output while fairness concerns equality.
The Angela and Bruno model shows how bargaining power determines distribution of surplus.
The Lorenz curve shows the cumulative share of income distribution.
The Gini coefficient measures inequality as A divided by (A + B).
A Gini coefficient of 0 means equality, 1 means complete inequality.
What is the difference between Pareto efficiency and fairness? Efficiency focuses on total output; fairness on distribution.
What does the Lorenz curve show? The distribution of income or wealth.
If the Gini coefficient equals 0.5, inequality is moderate.
In the Angela and Bruno model, if Bruno’s bargaining power increases, his share of output increases.
Example: Voluntary exchange increases fairness compared to coercion.
Example: Pareto efficiency occurs when MRS = MRT.
CHAPTER 6 – FIRMS, WAGES, AND INCENTIVES
Firms coordinate production using authority; markets coordinate through prices.
Employment rent is the difference between the utility of having a job and being unemployed.
The no-shirking condition requires wages high enough to motivate effort.
The principal-agent problem occurs because employers cannot perfectly observe worker effort.
The efficiency wage theory states that higher wages lead to higher effort and lower turnover.
What is employment rent? The value of a job relative to unemployment.
How does unemployment affect worker effort? Higher unemployment raises effort because job loss is costly.
What is the efficiency wage hypothesis? Paying above equilibrium wage increases productivity.
What problem arises because employers cannot observe worker effort? The principal-agent problem.
Example: Higher unemployment increases profits by reducing worker bargaining power.
Example: High employment rent means employers have more power.
Example: Employment rent equals the cost of job loss.
CHAPTER 7 – FIRMS AND MARKETS
Firms maximize profit where marginal revenue equals marginal cost.
Increasing returns to scale: output rises more than input.
Constant returns to scale: output doubles when inputs double.
Decreasing returns to scale: output rises less than input.
Markup equals price minus marginal cost and increases with market power.
Isoprofit curves show combinations of price and quantity with the same profit.
At the profit-maximizing level of output, MR = MC.
If price is greater than average cost, the firm earns positive profit.
A higher markup indicates less elastic demand.
Example: P > AC means positive profit.
Example: Market power leads to higher markup.
Example: Constant returns mean doubling inputs doubles output.
Example: Producing beyond Q* reduces profit.
CHAPTER 8 – PERFECT COMPETITION AND TAXES
Perfect competition has many firms producing identical products.
Firms are price takers with P = MC = MR.
Consumer surplus is the area under demand above price.
Producer surplus is the area above supply below price.
Deadweight loss measures lost total surplus from inefficiency.
Tax incidence depends on elasticity of demand and supply.
The less elastic side bears more of the tax burden.
In the long run, supply is more elastic.
Gains from trade equal the sum of consumer and producer surplus.
In perfect competition, what condition holds? P = MC = MR.
What happens to tax incidence when demand is inelastic? Consumers pay more of the tax.
What does deadweight loss represent? Lost total surplus due to inefficiency.
Who bears more of a tax burden? The less elastic side of the market.
Example: Gains from trade = A + B + D + F.
Example: Firm output occurs where MC = P.
CHAPTER 9 – INTERTEMPORAL CHOICE
Intertemporal choice is deciding how much to consume now versus later.
The interest rate is the reward for saving or cost of borrowing.
The discount rate measures impatience; a higher rate means more present-focused.
Income is a flow; wealth is a stock.
Equilibrium condition: MRS = MRT → 1 + r = 1 + ρ.
Formula: Future Value = PV(1 + r).
Formula: Present Value = FV / (1 + r).
What happens to the feasible set when the interest rate increases? It rotates, making borrowing more costly.
Who benefits when interest rates rise? Lenders.
Who is worse off when interest rates rise? Borrowers.
Example: Julia is worse off when the interest rate increases.
Example: Marco benefits by lending at 10 percent instead of storing grain.
Example: Higher r shrinks borrowing options and expands lending options.
CHAPTER 10 – MARKET FAILURES AND GOVERNMENT POLICY
A market failure occurs when equilibrium is not Pareto efficient.
Externalities are side effects that affect others outside a transaction.
Negative externalities occur when MSC > MPC, leading to overproduction.
Positive externalities occur when MSC < MPC, leading to underproduction.
Asymmetric information occurs when one party knows more than the other.
Adverse selection is hidden information before a contract (example: risky insurance buyers).
Moral hazard is hidden actions after a contract (example: risky behavior after insurance).
Public goods are non-rival and non-excludable, causing free riding.
A Pigouvian tax or subsidy corrects externalities by aligning private and social costs.
Formula: MSC = MPC + MEC.
What is the difference between MSC and MPC? MSC includes external costs.
What happens with negative externalities? Overproduction and inefficiency.
What policy corrects a positive externality? A subsidy.
Why do markets underprovide public goods? Because of free riding.
What distinguishes moral hazard from adverse selection? Moral hazard involves hidden actions after a deal.
Example: Pollution is a negative externality causing overproduction.
Example: Vaccines are a positive externality causing underproduction.
Example: Pigouvian tax sets MPC = MSC.
HIGH-YIELD FORMULAS AND DEFINITIONS
Profit = TR – TC
Total Revenue = P × Q
Marginal Cost = ΔTC / ΔQ
Marginal Revenue = ΔTR / ΔQ
Elasticity = %ΔQ / %ΔP
Gini Coefficient = A / (A + B)
Future Value = PV(1 + r)
Present Value = FV / (1 + r)
Isocost Equation = C = wL + rK
MSC Equation = MSC = MPC + MEC
Optimal Choice = MRS = MRT
Efficiency Condition = P = MC
Tax Burden Rule = Less elastic side bears more of the tax burden
Pareto Efficiency = No reallocation can improve one person without harming another
COMMON OLD-FINAL QUESTION TYPES
Which of the following is true about the prisoner’s dilemma? Mutual defection is the Nash equilibrium but not Pareto efficient.
In the ultimatum game, why might a responder reject an offer? Fairness preferences cause rejection of low offers.
In the Angela and Bruno model, what does the Pareto frontier show? All Pareto efficient combinations of work and consumption.
If the Lorenz curve bows further from the 45-degree line, inequality increases.
Which of the following reduces deadweight loss? A Pigouvian tax equal to the external cost.
When the interest rate rises, borrowers are worse off because borrowing becomes more expensive.
Why do firms pay efficiency wages? To increase worker effort and reduce shirking.
Which side bears more tax burden when demand is inelastic? Consumers.
What is the equilibrium condition for profit maximization? MR = MC.
What does a higher markup indicate? More market power and less elastic demand.
What does the slope of the isocost line represent? The ratio of input prices.
What is the key feature of a perfectly competitive firm’s demand curve? Perfectly elastic at market price.
What type of externality leads to overproduction? Negative externality.
Why are public goods underprovided by markets? Free rider problem.
What happens to employment rent when unemployment falls? It decreases because outside options improve.