Microeconomics Study Notes
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices,
outputs, and income distributions in markets through supply and demand.
Opportunity cost is the value of a product forgone to produce or obtain another product.
Production possibility frontier (PPF)
boundary between unattainable and attainable production possibilities
shows maximum combinations of outputs given resources and technology
A bowed outward (concave) PPF has nonhomogeneous resources, increasing opportunity cost->
opportunity cost of good as quantity produced
opportunity cost on PPF of additional X is amount Y forgone
no opportunity cost moving from point inside PPF to point on PPF
A linear (straight line) PPF has, homogeneous resources and constant opportunity costs
Marginal Cost (MC)
o opportunity cost of producing 1 more unit
o increasing marginal cost
Marginal Benefit (MB)
o benefit from consuming 1 more unit
o decreasing marginal benefit
Allocative efficiency (efficient use of resources) where MC = MB
Preferences and Marginal Benefit
o Preferences are a description of a persons likes and dislikes.
o To describe preferences, economists use the concepts of marginal benefit and the marginal benefit
o The marginal benefit of a good or service is the benefit received from consuming one more unit of it.
o We measure marginal benefit by the amount that a person is willing to pay for an additional unit of a
good or service.
Efficient Use of Resources
o When we cannot produce more of any one good without giving up some other good, we have
achieved production efficiency, and we are producing at a point on the PPF.
o When we cannot produce more of any one good without giving up some other good that we value
more highly, we have achieved allocative efficiency, and we are producing at the point on the PPF
that we prefer above all other points.
The expansion of production possibilitiesand increase in the standard of livingis called economic growth.
Two key factors influence economic growth:
o Technological change: the development of new goods and of better ways of producing goods and
o Capital accumulation: the growth of capital resources, which includes human capital.
The Cost of Economic Growth
o To use resources in research and development and to produce new capital, we must decrease our
production of consumption goods and services.
Gains from trade
Production from specialization according to comparative advantage
o comparative advantage
can produce good at lower opportunity cost
o specialized production according to comparative advantage and exchange gains from trade
o specialization and exchange allow consumption at points outside PPF
o A person has a comparative advantage in an activity if that person can perform the activity at a lower
opportunity cost than anyone else. o Absolute advantage: When one person is more productive than another person in several or even all
To demonstrate gains from trade, compare:
o self-sufficiency --
each individual consumes only what
o specialization and trade --
each individual specializes in producing comparative advantage good,
trades for other goods
Specialization and trade
o each individual can consume
at point outside PPF
o solution to paradox that
individually we would each be poor
but collectively we are well-off
Mutual advantage to trade between countries
o Learning-by-doing occurs when a person (or nation) specializes and by repeatedly producing a
particular good or service becomes more productive in that activity and lowers its opportunity cost of
producing that good over time.
Dynamic comparative advantage occurs when a person (or nation) gains a comparative advantage from learning-
Chapter 3: Demand and Supply
A market is any arrangement that enables buyers and sellers to get information and do business with each
A competitive market is a market that has many buyers and many sellers so no single buyer or seller can
influence the price.
The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time
period, and at a particular price.
o Market Demand Curve
o aggregation of all individual demands
o relation between price ( P ) and quantity demanded (DQ )
The law of demand states:
o Other things remaining the same, the higher the price of a good, the smaller is the quantity
The law of demand results from:
o Substitution effect
o Income effect
o Substitution effectwhen the relative price (opportunity cost) of a good or service rises, people seek
substitutes for it, so the quantity demanded decreases.
o Income effectwhen the price of a good or service rises relative to income, people cannot afford all
the things they previously bought, so the quantity demanded decreases.
When any factor that influences buying plans other than the price of the good changes, there is a change in
demand for that good.
Six main factors that change demand are:
1. The prices of related goods
2. Expected future prices
4. Expected future income
For increase in: o preferences D shifts rightward
o population D shifts rightward
o expected future prices D shifts rightward
o income (normal good) D shifts rightward
an inferior good is a good that decreases in demand when consumer income rises, unlike
normal good,for which the opposite is observed.
o income (inferior good) D shifts leftward
For increase in:
o price substitute D shifts rightward
(A substitute is a good that can be used in place of another good.)
o price complement D shifts leftward
(A complement is a good that is used in conjunction with another good.)
The quantity supplied of a good or service is the amount that producers plan to sell during a given time period
at a particular price.
Resources and technology determine what it is possible to produce. Supply reflects a decision about which
technologically feasible items to produce.
Market Supply Curve
o aggregation of all individual firm supply curves
o relation between price (P) and quantity suppliSd (Q )
For an increase in
o technology S shifts rightward
o number suppliers S shifts rightward
o expected future prices S shifts leftward
o prices productive resources
S shifts leftward
o prices substitutes in production
S shifts leftward
o prices complements in production
S shifts rightward
A substitute in production for a good is another good that can be produced using the same resources.
o The supply of a good increases if the price of a substitute in production falls.
Goods are complements in production if they must be produced together.
o The supply of a good increases if the price of a complement in production rises.
Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the
price balances the plans of buyers and sellers.
o The equilibrium price is the price at which the quantity demanded equals the quantity supplied.
o The equilibrium quantity is the quantity bought and sold at the equilibrium price.
o Price regulates buying and selling plans.
o Price adjusts when plans dont match.
o Price Ceiling-Shortage
o Floor pricing- Surplus
At equilibrium price, quantity demanded equals quantity supplied
o below equilibrium price, shortage P
o above equilibrium price, surplus P
o at equilibrium price, no tendency for change
o equilibrium quantity
quantity bought and sold at equilibrium P
The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a
good to a change in its price when all other influences on buyers plans remain the same.
o The price elasticity of demand is calculated by using the formula:
Percentage change in quantity demanded/Percentage change in price To calculate the price elasticity of demand:
o We express the change in price as a percentage of the average pricethe average of the initial and