Economics Flashcards
Microeconomics
Factor Market
As opposed to goods market, a market for factors of production such as labour, capital or raw materials.
Demand for the factors is derived demand since it derives from the ability to produce goods for a goods market.
Microeconomics
Aggregate Demand/Supply
The total amount of demand or supply at a given price level across the whole market (i.e. all buyers or suppliers).
Microeconomics
Market Equilibrium
Unstable Equilibrium
Market equilibrium is the point at which demand and supply clears in the market. Markets generally tend towards equilibrium as sellers adjust price and quantity available to satisfy the demand in the market.
An unstable equilibrium is when an external shock to the market equilibrium does not stabilise back to equilibrium.
Microeconomics
Consumer Surplus
The area below the demand curve but above the market price of the goods (top left triangle).
The buyers in this area were willing to pay above the market price, the area represents the total amount they were willing to pay less what they actually paid (market price) collectively.
Reflects the gain to buyers of the market exchange.
Microeconomics
Producer Surplus
The area above the supply curve line and below the market price.
Represents the revenue achieved above marginal cost (the price at which 1 unit will be supplied to the market, i.e. intersection with y axis) by all suppliers due to market price being above the marginal cost of the goods.
Microeconomics
Total Surplus
What is it?
When is it maximised?
The sum of consumer and producer surplus.
Maximised at market equilibrium where market price = marginal value to consumer = marginal cost to producer.
Microeconomics
Utility Theory
Definition of Utility
Utility Theory
The total satisfaction received by a person from consuming a good or service.
Utility theory is a quantitive model of consumer preferences, represented by an ordinal function U = f(Qx1, Qx2, …, Qxn)
Ordinal means it provides a ranking not a value (as in cardinal functions). The function shows the relationship between utility and every possible bundle of goods.
Microeconomics
Axioms of Utility Theory
Completeness: A person can compare any two bundles A & B such that either A>B (ie A is preferred to B), A=B or A
Transitivity: If A>B and B>C then A>C.
Nonsatiation: If A has more than B of all positive factors then A is preferred to B.
Microeconomics
Indifference Curves
Show combinations of amounts of two goods which provide the same amount of utility.

Microeconomics
Indifference Curves
Features
Which curves are better?
Shape of each curve and reason
Number of curves in existence
More goods always preferred to less so curves to north-east of chart are better.
The value of a good reduces as more is consumed, which causes the convex shape of the curve. The slope of the curve is the marginal rate of substitution.
Indifference curves are everywhere dense (can draw one through any point) and will never cross.
Microeconomics
Opportunity Set
A consumer buys X items of good x at price Px, and Y of good y at Py. If they have income of M then X * Px + Y * Py <= M is their budget constraint. A graph of this is a downward sloping diagonal line showing the combination of x and y within budget.
So the opportunity set is the set of combinations of goods they can buy given the budget constraint.
Companies have production opportunity sets and investment opportunity sets which show possible combinations of 2 goods to produce or 2 investments to make.
Microeconomics
Maximising Consumer Utility
Using opportunity sets and indifference curves to maximise utility
Choose the point on the budget line which lies on the furthest out (ie highest utility) indifference curve.

Microeconomics
Effect of consumer equilibrium of price changes
(in the 2-product substitution model)
Name and define the two “effects” of a price change
Substitution Effect: If the price of one good decreases the slope of the budget line changes so (typically) more of this good will now be purchased relative to the alternative.
Income Effect: In addition the “real income” of the consumer has increased, therefore higher utility can be achieved (although this could lead to lower consumption of an “inferior” good.
Microeconomics
Effects of price change on consumer equilibrium
(in the 2 product substitution model)
For a normal good, what does price change (fall in price of one good) look like on chart?
Which part of increase in quantity of that product is income effect and which is substitution effect?
Price of product B has fallen.
Draw a dotted line parallel to the new budget line going through the original indifference curve. Increase in QB is substitution effect. The rest of the increase is income effect.

Microeconomics
Effects of price change on consumer equilibrium
(for 2 product substitution model)
For an inferior good, what does the change in price look like on the chart?
For inferior goods the substitution effect leads to an an increase in quantity, but the income effect is negative. The substitution effect is the larger of the two.

Microeconomics
Effects of price change on consumer equilibrium
(for 2 product substitution model)
For an Giffen good, what does the change in price look like on the chart?
For an inferior good with a price decrease, if the income effect outweighs the substitution effect it is called a Giffen good. This is rarely the case.

Microeconomics
Effects of price change on consumer equilibrium
Type of good for which price increase = quantity increase
Veblen Good
Microeconomics
Effects of price change on consumer equilibrium
Behaviour of Substitutes and Complements
If price of product B falls, quantity demanded of product B usually increases, but what about product A?
If A and B are complements then the quantity of A demanded will also increase.
However if they are substitutes, then fewer of quantity A will be purchased, the consumer will “switch” from A to B.
Microeconomics
Accounting Profit
Accounting Profit = Total Revenue - Total Accounting Costs
Microeconomics
Economic Profit
Economic Profit = Total Revenue - Total Opportunity Costs
Same as accounting profit but considers additional opportunity costs of resources used.
For an entrepreneur this could include their salary if they worked instead of running the business.
For a corporation this is the required return on equity capital.
Microeconomics
Normal Profit
This is the accounting profit earned when economic profit is zero.
AP = EP + NP
Alternatively this is the total implicit opportunity cost.
Alternatively it is the normal amount of profit expected to be achieved from the resources available (eg required return on equity for a corporation).
Microeconomics
Economic Rent
Definition
Effect of elastic/inelastic supply
This is the income received by an owner of a factor of production ABOVE the opportunity cost.
Inelastic supply ⇒ Income mostly economic rent
Elastic supply ⇒ Income mostly opportunity cost

Microeconomics
Marginal Revenue
Definition
Perfect/Imperfect competition
The change in TOTAL revenue from selling 1 extra unit.
In perfect competition firms are price takers, every unit sold at market price (P) so MR = P.
In imperfect competition (ie monopoly) an extra unit sold requires a price decrease, so extra revenue from the unit is offset by lost revenue on all other units sold. As such TR is maximised at the quantity where MR = 0.
Microeconomics
Chart of costs vs quantity produced
Marginal Cost, Average Variable Cost,
Average Fixed Cost, Average Total Cost
Note: MC always crosses AVC at its lowest point
MC falls at first due to economies of scale but eventually increases due to diminishing returns.

