Principles of Microeconomics: Final Exam Study Guide

Study Guide - Smart Notes

Tailored notes based on your materials, expanded with key definitions, examples, and context.

Exam Date: March 10th, Tuesday, 10am-12pm (in person).
Chapters Covered: Acemoglu, Laibson, List Chapters 1, 2, 3, 4, 5 (with appendix), 6 (with appendix), 7, 8, 9, 10, 12, 13, 14.
Exam Format: Multiple-choice, short-answer, and long-answer questions.
Allowed Materials: Pen, pencil, eraser, ruler, simple standard function calculator (not scientific).
Preparation Tips:
- Start studying early and review class notes.
- Redo all practice questions, quizzes, and past exams.
- Work in groups and compare answers.
- Get adequate rest before the exam.

Short-Run vs. Long-Run Equilibrium: In the short run, firms may earn profits or losses; in the long run, entry and exit drive profits to zero, and price equals minimum average total cost ().
Entry and Exit Dynamics: Positive demand shocks attract entry, negative shocks cause exit, leading to a horizontal long-run supply curve at .
Consumer Surplus (CS), Producer Surplus (PS), and Total Surplus (TS):
- Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay.
- Producer Surplus: The difference between the price received and the minimum price at which producers are willing to sell (not the same as profit).
- Total Surplus: ; maximized at competitive equilibrium.
Pareto Efficiency: An allocation is Pareto efficient if no one can be made better off without making someone else worse off.
Invisible Hand: Self-interested behavior in competitive markets leads to maximum total surplus and Pareto efficiency.
Market Failures: Market power, government intervention, externalities, public goods, and asymmetric information can prevent the Invisible Hand from maximizing welfare.

Taxes:
- Per-Unit Tax: A fixed amount per unit sold.
- Ad Valorem Tax: A percentage of the price.
- Tax Incidence: Determined by relative elasticities of supply and demand.
- Welfare Effects: Taxes reduce CS and PS, generate government revenue, and create deadweight loss (DWL).
Subsidies:
- Increase production, benefit buyers and/or sellers, but cause overproduction and government cost, leading to DWL.
Price Ceilings and Floors:
- Price Ceiling: Maximum legal price; binding if set below equilibrium, causing shortages.
- Price Floor: Minimum legal price; binding if set above equilibrium, causing surpluses.
- Both can alter CS and PS depending on allocation.

Externalities:
- Negative Externality: Social marginal cost () exceeds private marginal cost ().
- Positive Externality: Social marginal benefit () exceeds private marginal benefit ().
- Efficient Quantity: Where ; market outcome may differ.
- Deadweight Loss: Occurs when market quantity differs from efficient quantity.
- Policy Solutions: Taxes/subsidies can align private and social incentives.
- Coase Theorem: Private bargaining can solve externalities if property rights are clear and transaction costs are low.
Public Goods and Common Resources:
- Public Goods: Non-rival and non-excludable (e.g., national defense).
- Vertical Summation: Social marginal benefit curve is the sum of individual WTPs at each quantity.
- Tragedy of the Commons: Overuse of common resources due to lack of excludability; solutions include taxes, licenses, or cap-and-trade.

Monopoly vs. Perfect Competition:
- Monopolies have barriers to entry, are price makers, and face downward-sloping demand.
- Monopoly leads to underproduction, higher prices, and deadweight loss compared to competition.
Marginal Revenue (MR):
- For linear demand , .
- MR is always less than price for a monopolist.
Profit Maximization:
- Set to find monopoly quantity; price is found from demand curve.
- Profit is .
Natural Monopoly: Declining ATC justifies a single firm; regulation may involve price ceilings.
Price Discrimination:
- First-Degree: Perfect price discrimination; each unit sold at buyer's maximum WTP.
- Second-Degree: Price varies by quantity or product version.
- Third-Degree: Price varies by consumer group (e.g., student discounts).
- Prevention of resale and information requirements differ by type.

Production Possibilities Curve (PPC):
- Shows maximum output combinations given resources and technology.
- Slope represents opportunity cost; can be constant or increasing.
- Technological shifts move the PPC outward.
Comparative vs. Absolute Advantage:
- Absolute Advantage: Ability to produce more with the same resources.
- Comparative Advantage: Lower opportunity cost in producing a good.
- Specialization and trade allow consumption beyond individual PPCs.
Terms of Trade: Mutually beneficial if between opportunity costs of trading partners; gains from trade shrink as partners become more alike.
Small Open Economy Model:
- World price determines if a country imports or exports.
- Winners and losers identified by changes in CS and PS.
Tariffs:
- Raise domestic price, reduce imports, benefit producers, harm consumers, generate government revenue, and create deadweight loss.
- Deadweight loss arises from overproduction by inefficient domestic firms and underconsumption by consumers whose WTP exceeds the world price.

Game Structure: Defined by players, strategies, payoffs, and information; can be simultaneous or sequential.
Dominant Strategy: A strategy that is best regardless of what others do.
Nash Equilibrium: No player can benefit by unilaterally changing strategy.
Mixed Strategies: Randomization may be optimal; expected payoffs are calculated.
Sequential Games: Solved by backward induction; subgame perfect Nash equilibrium identifies credible strategies.
Credible vs. Non-Credible Threats: Only threats that are optimal to carry out are credible; commitment can affect outcomes (first-mover advantage/disadvantage).
Oligopoly and Strategic Environments: Use appropriate equilibrium concepts to predict outcomes.

Some explanations and formulas have been expanded for clarity and completeness.
Students are encouraged to review graphical analysis and practice drawing key diagrams (e.g., supply and demand, monopoly pricing, externalities, PPCs).