[Link] Hons Semester 1 Principles of Microeconomics: Detailed Notes (P.

36–509)

The notes cover material from the Appendix of Chapter 2 through the
introductory sections of Chapter 22.

PART I: Introduction

Chapter 2 Appendix: Graphing: A Brief Review (Starts p. 37)

• Purpose of Graphs: Economists use graphs to express relationships

between variables.

• Coordinate System: Used for showing relationships between two

variables: the -coordinate (horizontal location) and the -coordinate
(vertical location). The point with both coordinates at zero is the origin.

• Relationships between Variables:

◦ Negative Relationship: Variables move in opposite directions,

resulting in a downward-sloping curve (e.g., the Demand Curve).

◦ Positive Relationship: Variables move in the same direction,

resulting in an upward-sloping curve (e.g., the Supply Curve).

• Movement vs. Shifts (Crucial distinction):

◦ Movement Along a Curve: Caused by a change in one of the

variables measured on the axes (e.g., a change in the price of the good
itself).

◦ Shift of a Curve: Caused by a change in a variable not measured on

the axes (e.g., a change in income).

• Slope: Measures the responsiveness of the vertical variable () to a

change in the horizontal variable ().

Chapter 3: Interdependence and the Gains from Trade (p. 47–61)

• Core Principle: Trade can make everyone better off.

• Production Possibilities Frontier (PPF): Shows the various mixes of

output an economy can produce. For Frank and Ruby, the PPF is a straight
line because the trade-off between the two goods is constant.

• Absolute Advantage: The ability to produce a good using fewer

inputs than another producer. Ruby has an absolute advantage over
Frank in both meat and potato production.

• Opportunity Cost: Whatever must be given up to obtain an item.

• Comparative Advantage (Key Concept): The ability to produce a
good at a lower opportunity cost than another producer.

◦ Gains from trade are based on comparative advantage, not

absolute advantage.

◦ For trade to be mutually advantageous, the price must lie between

their two opportunity costs.

• Trade Terms: Imports are goods produced abroad and sold

domestically; exports are goods produced domestically and sold abroad.

PART II: How Markets Work

Chapter 4: The Market Forces of Supply and Demand (p. 65–87)

• Competitive Market: Many buyers and sellers dealing in identical

products, resulting in each being a price taker.

• Demand:

◦ Quantity Demanded: The amount of a good that buyers are willing

and able to purchase.

◦ Law of Demand: Quantity demanded falls as price rises (other

things being equal). The demand curve slopes downward.

◦ Shifts in Demand (Key Determinants): Income (Normal/Inferior

Goods), Prices of Related Goods (Substitutes/Complements), Tastes,
Expectations, and Number of Buyers.

◦ Normal Good: Demand rises when income rises.

◦ Inferior Good: Demand rises when income falls.

• Supply:

◦ Law of Supply: Quantity supplied rises as price rises (other things

being equal). The supply curve slopes upward.

◦ Shifts in Supply (Key Determinants): Input Prices, Technology,

Expectations, and Number of Sellers.

• Equilibrium: The point where the supply and demand curves intersect.

◦ Surplus (Excess Supply): Price is above equilibrium; QS > QD. Price

falls to clear the market.

◦ Shortage (Excess Demand): Price is below equilibrium; QD > QS.

Price rises to clear the market.
• Analyzing Changes (3 Steps): 1. Determine if event shifts S or D (or
both). 2. Determine the direction of the shift. 3. Use the diagram to find
the new equilibrium price and quantity.

• Role of Prices: Prices are the signals that allocate scarce resources in
market economies.

Chapter 5: Elasticity and Its Application (p. 89–109)

• Elasticity: Measures responsiveness of quantity demanded or supplied

to changes in its determinants.

• Price Elasticity of Demand: Percentage change in QD divided by the

percentage change in price.

◦ Elastic Demand: Elasticity > 1 (quantity responds substantially).

Luxuries tend to be elastic.

◦ Inelastic Demand (Crucial): Elasticity < 1 (quantity responds

slightly). Necessities tend to be inelastic.

• Total Revenue (TR): .

◦ If Demand is Inelastic: Price and TR move in the same direction.

◦ If Demand is Elastic: Price and TR move in opposite directions.

• Price Elasticity of Supply: Measures how much quantity supplied

responds to price changes. Supply is generally more elastic in the long
run.

• Application Insight: When the demand for basic foodstuffs (like

wheat) is inelastic, an increase in supply (due to new technology) causes
total revenue for farmers to fall.

Chapter 6: Supply, Demand, and Government Policies (p. 111–129)

• Price Ceiling: Legal maximum price. If set below equilibrium, it is

binding and creates a shortage. Examples: Rent control, gasoline lines.

• Price Floor: Legal minimum price. If set above equilibrium, it is

binding and creates a surplus. Example: Minimum wage.

• Tax Incidence (Crucial Concept): The burden of the tax is shared

among market participants. The tax burden falls more heavily on the side
of the market that is less elastic (less able to leave the market).

◦ A tax levied on buyers is equivalent to a tax levied on sellers.

• Taxes: Taxes drive a "wedge" between the price buyers pay and the
price sellers receive. They reduce the quantity sold.
PART III: Markets and Welfare

Chapter 7: Consumers, Producers, and the Efficiency of Markets (p. 133–

151)

• Welfare Economics: Study of how resource allocation affects economic

well-being.

• Consumer Surplus (CS): Willingness to Pay minus Price. Measured by

the area below the demand curve and above the price.

• Producer Surplus (PS): Price minus Cost of Production. Measured by

the area above the supply curve and below the price.

• Total Surplus (TS): CS + PS. Measures the total benefit received by

society.

• Efficiency: Maximizing total surplus from scarce resources.

• Market Efficiency Conclusion (Core Principle): The equilibrium of

supply and demand maximizes total surplus. The "Invisible Hand" ensures
goods go to buyers who value them most and are produced by sellers with
the lowest cost.

• Market Failure: Occurs if markets suffer from externalities or market

power.

Chapter 8: Application: The Costs of Taxation (p. 153–165)

• Deadweight Loss (DWL): The fall in total surplus resulting from a tax
because it distorts behavior and prevents mutually beneficial trades.

• Tax Cost: The loss in CS and PS usually exceeds the tax revenue
collected, resulting in DWL.

• Tax Revenue: Equals , the size of the tax times the quantity sold.

• Determinants of DWL (Crucial Point): DWL is greater when supply

and demand are more elastic because participants change their
behavior more dramatically in response to the tax.

• Laffer Curve: Shows that as a tax increases, DWL grows rapidly, while
tax revenue may eventually fall.

Chapter 9: Application: International Trade (p. 167–184)

• World Price (W.P.): The prevailing price in world markets.

• Trade Determination (Based on Comparative Advantage): A

country determines trade status by comparing its domestic price to the
W.P..
 ◦ If Domestic Price < W.P.: Country becomes an Exporter. Producers
gain; Consumers lose; Total surplus increases.

◦ If Domestic Price > W.P.: Country becomes an Importer.

Consumers gain; Producers lose; Total surplus increases.

• Tariff (Tax on Imports): Increases domestic price, reduces imports,

causes a deadweight loss, and reduces total surplus.

• Arguments for Restricting Trade: Include the Jobs Argument,

National-Security Argument, and Infant-Industry Argument, though
economists generally oppose trade restrictions.

PART IV: The Economics of the Public Sector

Chapter 10: Externalities (p. 189–208)

• Externality: Uncompensated impact of one person's action on a

bystander.

• Market Inefficiency:

◦ Negative Externality (e.g., pollution): Social cost > Private cost.

Market output is larger than the social optimum. Corrected using
corrective taxes (Pigovian taxes).

◦ Positive Externality (e.g., education, technology): Social value

> Private value. Market output is smaller than the social optimum.
Corrected using subsidies.

• Public Policies:

◦ Command-and-Control: Regulations (e.g., setting pollution limits).

◦ Market-Based Policies: Corrective Taxes/Subsidies; Tradable

Pollution Permits (sets the quantity of pollution efficiently).

• Private Solutions:

◦ Coase Theorem: If transaction costs are low, private parties can

bargain to solve the externality problem themselves and reach the
efficient outcome.

Chapter 11: Public Goods and Common Resources (p. 211–224)

• Goods Classification (Fundamental):

1. Excludability: Can people be prevented from using the good?.

2. Rivalry in Consumption: Does one person’s use diminish another’s

use?.
• Four Types of Goods: Private Goods (Excludable and Rival), Public
Goods (Neither Excludable nor Rival), Common Resources (Rival but Not
Excludable), Club Goods (Excludable but Not Rival).

• Public Goods and the Free-Rider Problem (Crucial): Public goods

are under-provided because non-excludability allows people to be free
riders (receiving benefit without paying).

• Common Resources and the Tragedy of the Commons: Common

resources are overused (depleted) because they are rival but not
excludable.

• Cost–Benefit Analysis: Government uses this to determine what public

goods to provide and in what quantities.

Chapter 12: The Design of the Tax System (p. 227–244)

• U.S. Tax Base: Federal government relies heavily on personal income

taxes and payroll taxes (Social Insurance Taxes). State/local governments
rely on sales and property taxes.

• Tax Efficiency: Costs imposed beyond the revenue collected:

Deadweight Loss (due to distorted incentives) and Administrative
Burden (compliance costs).

• Tax Equity (Fairness):

◦ Benefits Principle: People pay based on benefits received from

government services (e.g., gasoline tax funding roads).

◦ Ability-to-Pay Principle: People pay based on income/wealth.

▪ Vertical Equity: Higher income pays a larger fraction (Progressive

Tax).

▪ Horizontal Equity: Similar ability to pay, pay the same.

• Equity-Efficiency Trade-off (Important Point): Efforts to achieve

greater equity often reduce economic efficiency.

• Tax Incidence: The burden of the tax may fall on different people than
those legislated to pay it (the "flypaper theory" is often dangerous).

PART V: Firm Behavior and the Organization of Industry

Chapter 13: The Costs of Production (p. 247–264)

• Goal of the Firm: Maximize profit (Total Revenue - Total Cost).

• Costs (Economic vs. Accounting):

◦ Explicit Costs: Cash outlay required.

 ◦ Implicit Costs: Forgone opportunities (e.g., owner’s forgone wage).

◦ Economic Profit (Critical): TR - (Explicit + Implicit Costs).

◦ Accounting Profit: TR - Explicit Costs.

• Production Function (PF): Relates inputs (workers) to outputs.

• Marginal Product (MP): Increase in output from an extra unit of input.

• Diminishing Marginal Product: MP declines as the quantity of input

increases (causes the PF to flatten and the Total Cost curve to steepen).

• Cost Measures:

◦ Fixed Costs (FC): Do not vary with output.

◦ Variable Costs (VC): Vary with output.

◦ Average Total Cost (ATC): TC/Q. Typically U-shaped.

◦ Marginal Cost (MC): (cost of producing one extra unit).

• MC and ATC Relationship: The MC curve crosses the ATC curve at the
minimum of ATC (the efficient scale).

• Costs in Long Run:

◦ Economies of Scale: LRATC falls as output increases (specialization).

◦ Diseconomies of Scale: LRATC rises as output increases

(coordination problems).

Chapter 14: Firms in Competitive Markets (p. 267–285)

• Competitive Firm Revenue: Firm is a price taker, so (Marginal

Revenue equals Price).

• Profit Maximization Rule: Produce where . For competitive firms, this

means . The MC curve is the firm's short-run supply curve.

• Short-Run Decisions:

◦ Shutdown Rule: Firm shuts down temporarily if (or ). Sunk costs

(FC) are irrelevant to this decision.

• Long-Run Decisions:

◦ Exit Rule: Firm exits permanently if (or ).

◦ Entry Rule: Firm enters if .

• Long-Run Equilibrium (Essential for Exams):

◦ Entry and exit drive economic profit to zero.

 ◦ Result: . Firms operate at their efficient scale.

Chapter 15: Monopoly (p. 289–316)

• Monopoly: Sole seller; a price maker.

• Barriers to Entry (Key Causes): Monopoly Resources, Government-

Created Monopolies (patents/copyrights), or Natural Monopoly
(economies of scale over entire market).

• Monopoly Revenue: Demand curve is downward sloping. .

• Profit Maximization: Set output where . Then set price using the
Demand curve. Result: .

• Welfare Cost: Monopolies produce less than the socially efficient

quantity (where Demand = MC), creating a deadweight loss.

• Price Discrimination: Selling the same good at different prices to

different customers.

◦ Perfect Price Discrimination: Eliminates deadweight loss but

transfers all consumer surplus to the producer (profit).

• Public Policy: Antitrust laws, Regulation (setting price), or Public

Ownership. If regulators set price equal to marginal cost for a natural
monopoly, the firm loses money and exits.

Chapter 16: Monopolistic Competition (p. 319–335)

• Characteristics: Many sellers, differentiated products, and free

entry/exit.

• Short Run: Acts like a monopoly; determines quantity, . Profit/loss

possible.

• Long-Run Equilibrium (Key for Exams): Entry/exit drives profit to

zero; the demand curve is tangent to the ATC curve. Result: (Zero Profit)
and (Market Power/Markup over MC).

• Inefficiencies Compared to Perfect Competition:

1. Excess Capacity: Firms produce less than the efficient scale

(minimum ATC).

2. Markup over MC: (price exceeds cost).

• Advertising: Used to signal quality and to introduce brand names

(which ensure quality maintenance due to high reputation cost).

Chapter 17: Oligopoly (p. 337–357)

• Oligopoly: Market with only a few sellers; decisions are strategic.

• Collusion/Cartel: An agreement among firms to act in unison
(monopoly outcome). Cartels are unstable because of individual incentive
to cheat.

• Nash Equilibrium (Crucial Concept): Situation where each actor

chooses the best strategy given the choices of all other actors.

• Oligopoly Outcome: In Nash equilibrium:

◦ Quantity is greater than the monopoly quantity but less than the
competitive quantity.

◦ Price is lower than the monopoly price but greater than the
competitive price.

• The Prisoners’ Dilemma: Illustrates why, even when cooperation is

mutually beneficial, self-interest drives actors toward a worse (less
profitable for the firms) non-cooperative Nash equilibrium.

• Public Policy: Antitrust laws (e.g., Sherman Act) are used to prevent
collusion, as cooperation among oligopolists is undesirable for society.

Chapter 18: The Markets for the Factors of Production (Starts p. 361)

• Derived Demand: Demand for a factor (like labor, land, or capital) is

derived from the firm's decision to produce a good.

• Profit Maximization: A competitive firm hires factors up to the point

where the factor's price (e.g., wage ) equals the Value of the Marginal
Product (VMP) of that factor.

• VMPL: Marginal Product of Labor () times the price of the output (). The
VMPL curve is the firm's labor-demand curve.

• Factor Income: Wages, rent, and capital income are determined by

supply and demand, and in equilibrium, each factor earns the value of its
marginal contribution.

• Productivity and Wages: Technological change typically raises the

marginal product of labor, increasing labor demand and equilibrium
wages.

Chapter 19: Earnings and Discrimination (Starts p. 383)

• Compensating Differentials: Differences in wages that arise to offset

the non-monetary characteristics of different jobs (e.g., dangerous jobs
pay more).

• Human Capital: Accumulation of investments in people, such as

education and training.
• Signaling Theory: Education might not raise productivity but merely
signal a worker’s high ability to employers.

• Superstar Phenomenon: Occurs when every customer wants the

service of the best producer, and technology allows the best producer to
serve millions cheaply (e.g., actors, athletes).

• Efficiency Wages: Above-equilibrium wages paid by firms to increase

worker productivity and reduce turnover.

• Discrimination: In a competitive market, employers who discriminate

(if skills are equal) will face higher costs and lower profits, causing them to
be driven out of the market by non-discriminating firms (the profit motive
is an antidote to employer discrimination).

Chapter 20: Income Inequality and Poverty (Starts p. 401)

• Poverty Rate: Percentage of the population below the poverty line.

• Measurement Problems: Standard income measures ignore in-kind

transfers (goods/services instead of cash), variations over the life cycle,
and differences between transitory and permanent income.

• Political Philosophy of Redistribution:

◦ Utilitarianism: Goal is to maximize total utility (happiness) across

society. Suggests government should redistribute income because the
marginal dollar of utility gained by the poor outweighs the loss by the rich,
but limited by the efficiency cost (the "leaky bucket").

◦ Liberalism (Rawls): Advocates the maximin criterion: maximizing

the well-being of the worst-off person.

◦ Libertarianism (Nozick): Government should enforce property

rights; equality of opportunity/process is more important than equality of
outcome.

• Policies to Reduce Poverty: Minimum-wage laws, Welfare, Negative

Income Tax (reduces work disincentive compared to welfare), and In-Kind
Transfers.

Chapter 21: The Theory of Consumer Choice (Starts p. 425)

• Budget Constraint: Shows consumption bundles a consumer can

afford. Its slope equals the relative price of the two goods.

• Indifference Curves: Show combinations of goods yielding equal

satisfaction. Their slope is the Marginal Rate of Substitution (MRS).
Higher curves are preferred.
• Optimization: The consumer maximizes utility by choosing the point
where the highest indifference curve is tangent to the budget
constraint. At this point, MRS = Relative Price.

• Price Change Effects (Decomposition):

◦ Substitution Effect: Change in consumption due to the price change

making the good relatively cheaper (movement along the same
indifference curve).

◦ Income Effect: Change in consumption due to the price change

altering the consumer's purchasing power (movement to a new
indifference curve).

• Giffen Good: A rare inferior good where the income effect is so large
that it outweighs the substitution effect, causing quantity demanded to
rise when price rises (violates Law of Demand).

Chapter 22: Frontiers of Microeconomics (Starts p. 451)

• Asymmetric Information: When one party knows more than the other.

◦ Moral Hazard: Arises from hidden actions (e.g., less effort after
getting insurance).

◦ Adverse Selection: Arises from hidden characteristics (e.g., high-

risk people buying insurance—the "lemons problem").

◦ Solutions: Signaling (informed party reveals information, e.g.,

education, thoughtful gifts); Screening (uninformed party induces
information revelation).

• Political Economy: Application of economic analysis to government

behavior.

◦ Median Voter Theorem: Majority rule yields the outcome preferred

by the median voter.

• Behavioral Economics: Integrates psychology, acknowledging that

people are often not fully rational, care about fairness, and exhibit
inconsistent preferences over time.