Econ notes – Midterm 2
Chapter 9 – Budget line/ indifference curves
A household’s budget line describes the limits to its consumption choices
A divisible good is one that can be bought in any quantity.
An indivisible good is one that must be bought in units.
Affordable quantities are quantities on the budget line and inside it.
Unaffordable quantities are quantities outside the budget line and cannot be
obtained with the current income.
Equation of budget line: Qy= Income/Py – Px/Py •Qx or
Qy=real income of y – relative • Qx
Example: Income = 40, Py = 10 Px = 2, budget line is Qy= 4-5Qx
- When the price of the good on the X increases, budget line becomes steeper
- When the price of the good on the X decreases, budget line becomes flatter
- When the price of the good on the Y increases, budge line becomes flatter
- When the price of the good on the Y decreases, budget line becomes steeper
- When income increases, budget line shifts rightward
- When income decreases, budget line shifts leftward
Preference and Indifference Curves
An indifference curve is a line that shows the combination of goods among which a
consumer is indifferent. Consumers always prefer higher difference curves and
don’t prefer lower difference curves. They are indifferent to any point along the
same indifference curve.
The marginal rate of substitution is the rate at which someone will give up good y to
get an additional unit of x while remaining indifferent. If the indifference curve is
steep, a person is willing to give up a lot of y to get one additional unit of x and
remain indifferent. If the indifference curve is flat, a person is willing to give up
small amounts of y for large amounts of x and remain indifferent. This is measured
as the line tangent to points on the indifference curve.
Diminishing rate of substitution is the tendency of people to give up less y with
the more x they have, while remaining indifferent.
Perfect substitutes have indifference curves that are diagonal because they their
marginal rate of substitution is constant. Perfect compliments have indifference curves that are L-Shaped, because no
matter how much of y you have, you are still indifferent with each unit of x, and vice
The best affordable point is the point on the indifference curve that has a
marginal rate of substitution with the same slope as the budget line. In other words,
it is the highest attainable indifference curve with a given budget line.
Because a change in price results in either a steepening or flattening of the
budget line, the best affordable point changes with a change in price. By
mapping the change in price and the resulting best affordable points, we get
the individual’s demand curve.
Because a change in income shifts the budget line, a new best affordable point can
be attained on a different indifference curve. This is why the demand curve shifts
when income changes.
Chapter 10 – Markets and the Competitive Environment
Four Firm Concentration ration – sum of the sales from the 4 largest firms/ the total
sales of the market X 100%
- If the number is close to 0, the market is in perfect competition
- If the number is close to 100, the market is a monopoly
- If the number is low, it is a monopolistic competition
- If the number is high, it is an oligopoly.
Herfindahl-Hirschman Index – The sum of the squares of the market share of the top
50 firms in the market (or all the firms if less than 50).
- If less than 100, it is a perfectly competitive market
- If 10000 it is a monopoly
- If it is between 101 and 999 it is monopolistic competition
- If it is over 1000 it is an oligopoly
Chapter 11 – Output and costs
Short run – at least one fixed factor of production (usually plant)
Long run – any factor of production can be changed. However, you can’t easily
change them. i.e: Sunk costs on factory equipment
Total product = the maximum amount of product you can produce with the given
Average product = the total product divided by the labour units
Marginal product = the change in total product divided by the change in labour units
Increasing marginal returns is the occurrence of increasing marginal product with
an increase in labour units.
Diminishing marginal returns is the occurrence of decreasing marginal product
with and increase in labour units. A.K.A – Law of diminishing returns. When Marginal Product is greater than average product, average product is
increasing. When marginal product = average product, it is maximum average
product. When marginal product is less that average product, marginal product is
Total cost = total variable cost + total fixed cost (TC=TFC+TVC)
Marginal cost = the change in total cost/ change in output
- ATC = Total cost/ output
- AVC = TVC/output
- AFC = TFC/ output
- Or ATC= AFC+AVC
When marginal cost is less than average total cost, average total cost is
When marginal cost is = to average cost, that is minimum average cost.
When marginal cost is greater than average cost, average cost is increasing.
MP is at a max when MC is at a min. AP is at a max when AVC is at a min.
Increase in fixed factors of production shifts the TFC and AFC curves up.
Increases in wages or fuel shifts TVC and AVC up.
Diminishing returns – even in LRAC, the marginal product decreases with more
Diminishing marginal product of capital – Measuring the product produced at the
same labour with different capital shows increasing inefficiency.
LRAC is the relationship between the lowest attainable average total cost and output
when the firm can change both labour and plant.
Economies of scale – ATC decreases with production until it reaches minimum
Diseconomies – ATC increases as it moves away from the minimum efficient scale
Constant returns to scale – LRAC is horizontal
Minimum efficient scale – the smallest output at which LRAC reaches its lowest
Chapter 12 – Perfect Competition
- many firms sell identical products to many buyers
- there are no restrictions on entry into the market
- established firms have no advantage over new ones