Microeconomics Review Session

Hosted by JP on IBO Discord

Schedule

• Tuesday: Macro
• Wednesday: International Economics
• Thursday: Higher Level Theory of the Firm

Foundations of Economics

• Scarcity: Unlimited wants, limited fulfillment
• PPC Curve (Production Possibilities Curve): Illustrates trade-offs (e.g., schools on y-axis, motorcars on x-axis)
  • Curve shape due to limited resources

Factors of Production

• Natural resources (land, oil)
• Labor (human input)
• Capital (machinery, buildings)
• Entrepreneurship

Fundamental Economic Questions

• What to produce?
• How much to produce?
• For whom to produce?
• Answer: Mixed market economy (combines government and market decision-making)

Market Dynamics

• Market: Where buyers and sellers meet, governed by demand and supply
• Invisible Hand: Adam Smith’s concept

Demand

• Willingness and ability to pay
• Demand Curve: Downward sloping due to:
  • Wealth effect (feeling richer when price is lower)
  • Principle of marginal returns (diminishing satisfaction)
  • Substitution effect (opting for cheaper alternatives)
• Law of Demand: Inverse relationship between price and quantity demanded
• Shifts in Demand: Due to non-price determinants (public perception, income, substitutes, complements)

Supply

• Willingness and ability to produce
• Supply Curve: Upward sloping due to:
  • Profit motivation
  • Entry of more firms at higher prices
• Law of Supply: Direct relationship between price and quantity supplied
• Shifts in Supply: Due to costs of production, technology, government intervention

Market Equilibrium

• Point where supply equals demand
• No inefficiencies at this point
• Calculated by setting quantity demanded equal to quantity supplied

Elasticities

• Price Elasticity of Demand (PED): Responsiveness of demand to price changes
  • Elastic (>1): Quantity changes more than price
  • Inelastic (<1): Quantity changes less than price
• Special Cases: Perfectly Elastic, Unit Elastic, Perfectly Inelastic
• Determinants of PED: Substitutes, necessity, cost of switch, time period
• Cross Price Elasticity (XED): Responsiveness of good X demand to good Y price change
  • Substitutes (>0), Complements (<0), Unrelated (0)
• Income Elasticity (YED): Responsiveness of demand to income changes
  • Normal Goods (>0), Inferior Goods (<0)
• Price Elasticity of Supply (PES): Responsiveness of supply to price changes

Government Intervention

Taxes

• Indirect Tax: Fixed amount (specific) or percentage amount (ad valorem)
• Leads to inefficiencies (deadweight loss)

Subsidies

• Subsidies: Per-unit payment by government
• Encourages behavior, reduces prices
• Effects on stakeholders: Government costs, consumer benefit, producer revenue

Price Controls

• Price Floors: Minimum price, often above equilibrium (e.g., minimum wage)
  • Result: Excess supply
• Price Ceilings: Maximum price, often below equilibrium (e.g., rent control)
  • Result: Shortages

Market Failure

• Caused by inefficient resource allocation
• Externalities: Costs or benefits affecting third parties
  • Negative Externalities: Over-supply of harmful goods, e.g., cigarettes
  • Positive Externalities: Under-supply of beneficial goods, e.g., healthcare
• Public Goods: Non-rivalrous, non-excludable (e.g., national defense)

Upcoming Topics

• Tuesday: Macro
• Wednesday: International Economics
• Thursday: Higher Level Theory of the Firm