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Microeconomics flashcards

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1 Introduction to microeconomics

Scarcity and the basic economic problem: Scarcity: unlimited wants set against limited resources. The basic economic problem: scarcity forces choices over what to make, how to make it and who gets it.
Economic good vs free good: Economic good: uses scarce resources to supply, so it has a cost of provision. Free good: needs no resources to supply, so it has no price. A good free at the point of use (paid for by taxes) is still an economic good.
Positive vs normative statement: Positive: describes or predicts; evidence can check it. Normative: expresses an opinion on what ought to happen (a value judgement).
The margin and rationality: The margin: the point of deciding on one more or one less unit. Rationality: acting consistently to maximise a goal using the information available.
Opportunity cost vs trade-off: Opportunity cost: the value of the best option passed over when choosing. Trade-off: the relationship of accepting less of one thing to get more of another.
PPF: movement along vs shift: Movement along: a choice between the two goods (reallocation). Shift: a change in the economy's capacity (outward from more or better resources or technology). Any point on the frontier is productively efficient.
Specialisation vs division of labour: Specialisation: concentrating on a narrow range of goods or services; can apply to a person, firm, region or country. Division of labour: splitting a production process into tasks, a separate worker on each.
Why does specialisation need money rather than barter?: Barter needs a double coincidence of wants. Money, generally accepted as a medium of exchange, makes trading surpluses easy, so specialisation becomes worthwhile.
Market, planned and mixed economies: Market: private decisions coordinated by prices; private ownership. Planned: a central authority decides allocation; mostly state ownership. Mixed: market and government both allocate, in varying proportions.
Sustainability: Using resources to satisfy today's needs in a way that leaves future generations able to satisfy their own.

2 The role of markets

Contraction of demand vs decrease in demand: Contraction: a movement along the demand curve after a rise in the good's own price. Decrease: a leftward shift caused by anything else (lower income for a normal good, a cheaper substitute).
A shop cuts price from £20 to £19 and sales rise from 250 to 270. PED, and what happens to revenue?: Price −5%, quantity +8%. PED = 8 ÷ −5 = −1.6, elastic. Revenue rises from £5,000 to £5,130.
Inferior good vs necessity (YED): Inferior: YED below 0 (demand falls as income rises). Necessity: YED between 0 and 1 (normal but income inelastic). Luxury: YED above 1.
Consumer surplus and producer surplus: Consumer surplus: the most buyers would pay minus the price paid; area beneath demand, above price. Producer surplus: price received minus the least sellers would accept; area above supply, below price.
Joint supply vs competitive supply: Joint: one production process yields two or more products (beef and leather). Competitive: producers can switch inputs between products, so the goods compete for resources.
Why are agricultural prices volatile?: Supply shifts with weather and harvests, and both demand and short-run supply are price inelastic, so a small shift in supply causes a large change in price.
Productive, allocative and economic efficiency: Productive: output at the lowest possible average cost (MC = AC). Allocative: resources go to what society values most (P = MC; with externalities, MSB = MSC). Economic efficiency: both together.
Externality, and the social cost and benefit identities: A cost or benefit that lands on someone outside the transaction and is left out of the price. MSC = MPC + MEC. MSB = MPB + MEB. Negative externalities give over-production; positive give under-production.
Public good (OCR description): Non-excludable and non-rival (non-diminishable), also non-rejectable, with a zero marginal cost of an extra user. Free riders mean it cannot be sold profitably, so the market may not provide it.
Merit good vs public good: A merit good can be bought and sold in a market but is under-consumed because consumers undervalue its benefits. A public good cannot be sold profitably at all.
Buffer stock scheme: An agency buys when the price falls to the floor (adding to stocks) and sells when it reaches the ceiling (releasing stocks), to keep the price within a band. It fails if the floor is above the long-run price, because stocks keep growing.
Cost-benefit analysis: the main stages: Identify all private and external costs and benefits, put money values on them (including shadow prices for unpriced items), discount future values to present values, compare, and test the sensitivity of the result.
Environmental Kuznets curve: An inverted U: environmental damage per head rises with income per head, peaks, then falls as richer societies demand and can afford cleaner production.

3 Business objectives

Fixed costs £150 a day; at 30 jars TVC is £210. Find TC, AC, AFC and AVC.: TC = £360. AC = 360 ÷ 30 = £12.00. AFC = 150 ÷ 30 = £5.00. AVC = 210 ÷ 30 = £7.00. Check: 5.00 + 7.00 = 12.00.
Diminishing returns vs negative returns: Diminishing returns: the marginal product of the variable factor falls. Negative returns: total product falls (MP below zero).
Output with 1 to 5 cleaners is 5, 14, 22, 27, 29 cars an hour. When do diminishing returns begin?: MP is 5, 9, 8, 5, 2. It peaks at the second cleaner and falls from the third, so diminishing returns begin with the third cleaner.
LRAC, internal and external economies of scale: LRAC: the lowest cost per unit at each output when every factor can change; the envelope of SRAC curves. Internal economy: a movement along LRAC as the firm grows. External economy: LRAC shifts down as the industry grows.
Minimum efficient scale (MES): The smallest output at which LRAC reaches its lowest level. Market size ÷ MES gives roughly how many firms the market can support at lowest cost.
MR for a straight-line demand curve, and MR in terms of PED: If P = a − bQ, then MR = a − 2bQ (same intercept, twice the slope). MR = P(1 + 1/PED), so MR is zero where PED = −1.
Accounting profit vs economic profit: Accounting profit: TR minus explicit costs. Economic profit: TR minus explicit and implicit (opportunity) costs. Normal profit is included within total cost.
Profit, revenue and sales maximisation (OCR): Profit maximisation: MR = MC, with MC cutting MR from below. Revenue maximisation: MR = 0. Sales volume maximisation: the largest output with price at least equal to average cost.
Satisficing, utility maximisation and growth maximisation: Satisficing: aiming for a satisfactory profit, then pursuing other goals. Utility maximisation: decision makers pursue their own pay, status and leisure. Growth maximisation: expanding long-run size.
Principal-agent problem: The agent's (managers') aims differ from the principal's (shareholders'), and information is unequal, so managers may not maximise profit.
Corporate social responsibility and social welfare objectives: CSR: voluntary action for stakeholders beyond legal requirements. Social welfare objective: putting society's gain first, often covering costs only (common in public and not-for-profit organisations).
Short-run shutdown vs break-even: Shut down when price is below AVC. Break even (normal profit) when price equals AC.

4 Market structures

Perfect competition: long-run equilibrium and efficiency: Supernormal profit attracts entry until price equals minimum AC: normal profit only. P = MC (allocatively efficient) and output at lowest AC (productively efficient).
Monopolistic competition: long-run outcome: Entry removes supernormal profit, so AR is tangent to AC: normal profit, with excess capacity (output below minimum AC) and P above MC.
Oligopoly and interdependence: A market shared by a few big sellers whose choices affect one another: one firm's best action depends on how rivals respond. Rivalry is often through non-price competition.
Dominant strategy vs Nash equilibrium: Dominant strategy: a choice that is best whatever the rival does. Nash equilibrium: neither player can gain by changing alone, given the other's choice.
Concentration ratio: CRn: the combined market share of the n largest firms. A high ratio suggests oligopoly or monopoly, but says nothing about how firms behave.
Monopoly: profit, deadweight loss and efficiency: Output at MR = MC, price from AR. Supernormal profit is the rectangle (P − ATC) × Q. The deadweight loss is the triangle between AR and MC from the monopoly output to the P = MC output. P above MC: allocatively inefficient.
Natural monopoly: An industry in which average cost is still falling at the size of the whole market, so a single firm supplies most cheaply. Setting P = MC would make a loss.
Price discrimination: Different prices for the same product, not explained by cost differences. Needs market power, groups with different PED, and markets kept separate. The less elastic group pays more.
Perfectly contestable market: Entry and exit are costless (no sunk costs), so the threat of hit-and-run entry disciplines incumbents whatever their number. A market with no legal barriers can still be uncontestable if entry needs unrecoverable spending.
Horizontal, vertical (backward, forward) and conglomerate integration: Horizontal: rivals at the same stage of one industry. Vertical: different stages; backward towards suppliers, forward towards customers. Conglomerate: unrelated industries.
Regulation vs competition policy: Regulation sets rules for a particular industry, such as a price cap of inflation minus X. Competition policy applies across industries: merger control, action on cartels and abuse of dominance, market investigations.
Monopsony in a product market: One (or a dominant) buyer able to push down the price it pays suppliers, for example a large supermarket buying from farmers.

5 The labour market

Derived demand and MRP: Labour is demanded because of demand for the output it produces. MRP = MPP × MR (= price if the product market is perfectly competitive). The MRP curve is the demand curve for labour.
Wage elasticity of demand for labour: formula and determinants: WED = % change in labour demanded ÷ % change in wage. More elastic when capital substitutes easily, product demand is elastic, labour is a large share of costs, and in the long run.
Wages rise 2% while prices rise 3%. Change in real wages?: 1.02 ÷ 1.03 − 1 = −0.97%. Real pay fell, although nominal pay rose.
Unit labour cost and productivity: ULC = total labour cost ÷ output (= wage ÷ output per hour). Productivity is output per worker or per hour. High productivity can come with high wages and still keep ULC low.
Monetary and non-monetary factors affecting labour supply: Monetary: wage, overtime, bonuses, cash benefits, tax. Non-monetary: job satisfaction, hours, risk, location, status, security, training.
Transfer earnings vs economic rent: Transfer earnings: the minimum payment needed to keep a worker in the job (what they could earn in the next best alternative). Economic rent: earnings above transfer earnings.
Substitution and income effects of a wage rise on hours worked: Substitution effect: leisure is dearer, so work more. Income effect: higher income means more leisure can be afforded, so work less. If the income effect dominates at high wages, the supply curve can bend backwards.
Monopsony employer: employment and wage: Employment where MCL = MRP; the wage is read from the supply curve (ACL) at that employment, below MRP and below the competitive wage.
Effect of a minimum wage under monopsony: A floor between the monopsony wage and the competitive wage makes MCL flat at the floor, so the firm can raise both the wage and employment. Set too high, employment falls.
Reasons for wage differentials: Differences in skills and productivity (MRP), training costs, non-monetary features of jobs, trade union and monopsony power, labour immobility, and discrimination.