MICROECONOMICS MIDTERM EXAM #2 NOTES
Scare resources might be allocated by:
- Market price
- Majority rule
- First-come, first-served
- Sharing equally
- Personal characteristics
Market Price: When a market allocates a scarce resource, the people who get the
resource are those who are willing to pay the market price.
Command System: allocates resources by the order (command) of someone in
authority. Example: if you have a job, most likely someone tells you what to do. Your
labour time is allocated to specific tasks by command.
Majority Rule: allocates resources in the way the majority of voters choose
Contest: A contest allocates resources to a winner (or group of winners)
First-come, first-served: allocates resources to those who are first in line
Lottery: allocate resources to those with the winning number, draw the lucky cards,
or come up lucky on other gaming system
Personal Characteristics: allocate resources to those with the “right”
characteristics. Example: people choose marriage partners on the basis of personal
Force: Force plays a role in allocating resources. Example: war has played an
enormous role historically in allocating resources.
Value is what we get, price is what we pay. The value of one more unit of a good or
service is its marginal benefit. We measure value as the maximum price that a
person is willing to pay. But willingness to pay determines demand. A demand
curve is a marginal benefit curve.
The relationship between the price of a good and the quantity demanded by
one person is called individual demand.
The relationship between the price of a good and the quantity demanded by all
buyers in the market is called market demand.
1 MICROECONOMICS MIDTERM EXAM #2 NOTES
Consumer Surplus: the excess of the benefit received from a good over the amount
paid for it. We can calculate consumer surplus as the marginal benefit (or value)
of a good minus its price, summed over the quantity bought.
- Consumer Surplus = (MB – price) / quantity bought
- In business to make profit
- To make profit, firms must sell their output for a price that exceeds the
cost of production
Cost is what the producer gives up; price is what the producer receives. The cost of
one more unit is its marginal cost. Marginal cost is the minimum price that a
firm is willing to accept. A supply curve is a marginal cost curve.
The relationship between the price of a good and the quantity supplied by one
producer is called individual supply
The relationship between the price of a good and the quantity supplied by all
producers in the market is called market supply
Producer Surplus: the excess of the amount received from the sale of a good over
the cost of producing it. (The producer surplus is the value of the pizza sold in
excess of the cost of producing it)
- Producer Surplus = (price received – marginal cost) / quantity sold
Competitive Market efficiency:
When production is:
- Less than equilibrium quantity, MSB > MSC
- Greater than the equilibrium quantity MSC > MSB
- Equal to the equilibrium quantity, MSC = MSB (most efficient, meaning
total surplus is maximized)
The Invisible Hand: Idea proposed by Adam Smith which states that competitive
markets send resources to their highest valued use in society. Consumers and
producers pursue their own self-interest and interact in markets.
Market Failure: arises when a market delivers in inefficient outcome. Market
failure can occur because too little of an item is produced (underproduction), or too
much of an item is produced (overproduction)
Sources of Market Failure:
- Price and quantity regulations
- Taxes and subsidies
- Public goods and common resources
2 MICROECONOMICS MIDTERM EXAM #2 NOTES
- High transactions costs
Price and Quantity Regulations: - price regulations sometimes put a block of the
price adjustments and lead to underproduction.
- Quantity regulations that limit the amount that a farm is permitted to produce also
leads to underproduction.
Taxes and Subsidies: - Taxes increase the prices paid by buyers and lower the
prices received by sellers. Taxes decrease quantity produced and lead to
- Subsidies lower the prices paid by buyers and increase the prices received by
sellers. So subsidies increase the quantity produced and lead to overproduction.
Externalities: a cost or benefit that affects someone other than the seller or the
buyer of a good.
Public Goods and Common Resources: - A public good benefits everyone and no
one can be excluded from its benefits. It’s in everyone’s self-interest to avoid paying
for a public good (called the free-rider problem), which leads to underproduction.
- A common resource is owned by no one but can be used by everyone. It’s in
everyone’s self-interest to ignore the costs of their own use of a common resource
that fall on others (called tragedy of the commons). Leads to overproduction.
Monopoly: a firm that has sole provider of a good or service.
High Transaction Costs: the opportunity cost of making trades in a market. Some
markets are just too costly to operate. When transaction costs are high, the market
might under produce.
Is the Competitive Market Fair? Can be divided into two groups:
- It’s not fair if result isn’t fair.
- It’s not fair if the rules aren’t fair
It’s Not Fair if the Result Isn’t Fair: idea that only equality brings efficiency is
Utilitarianism: “Greatest good for the greatest amount of people”
It’s Not Fair if the Rules Aren’t Fair: idea that’s based on the symmetry principle.
Symmetry Principle: the requirement that people in similar situations be treated
similarly. In economics, this principle means equality of opportunity, not equality of
3 MICROECONOMICS MIDTERM EXAM #2 NOTES
A price ceiling or price cap is a regulation that make