Melbourne ECON10004 - Principles of Microeconomics: Supply, Demand & Market Structure Flashcards

Question 1

Price Elasticity of Demand (PED)

Accepted Answer

Measures the responsiveness of quantity demanded to a change in price.

$$
E_d = \frac{\% \Delta Q_d}{\% \Delta P}
$$

- Elastic: $|E_d| > 1$
- Inelastic: $|E_d| < 1$
- Unitary Elastic: $|E_d| = 1$

Question 2

Midpoint Method for Elasticity

Accepted Answer

Calculates the percentage change relative to the average of initial and final values to ensure consistency regardless of direction:

$$
E_d = \frac{(Q_2 - Q_1) / [(Q_1 + Q_2)/2]}{(P_2 - P_1) / [(P_1 + P_2)/2]}
$$

Question 3

Cross-Price Elasticity of Demand (XED)

Accepted Answer

Measures how quantity demanded of Good A responds to a price change in Good B:

$$
E_{AB} = \frac{\% \Delta Q_A}{\% \Delta P_B}
$$

- $E_{AB} > 0$: Substitutes
- $E_{AB} < 0$: Complements
- $E_{AB} = 0$: Unrelated goods

Question 4

Income Elasticity of Demand (YED)

Accepted Answer

Measures how quantity demanded changes relative to a change in consumer income:

$$
E_y = \frac{\% \Delta Q_d}{\% \Delta Y}
$$

- $E_y > 0$: Normal Good ($E_y > 1$ for Luxury Good)
- $E_y < 0$: Inferior Good

Question 5

Consumer Surplus (CS)

Accepted Answer

The economic gain to consumers, measured as the difference between maximum willingness to pay and the actual price paid. Graphically, it is the area below the demand curve and above the market price line.

Question 6

Producer Surplus (PS)

Accepted Answer

The economic gain to producers, measured as the difference between the price received and the minimum willingness to sell (marginal cost). Graphically, it is the area above the supply curve and below the market price line.

Question 7

Deadweight Loss (DWL)

Accepted Answer

The loss in total surplus (allocative inefficiency) that results when a market produces at an output level where marginal benefit does not equal marginal cost ($MB 
eq MC$), often caused by taxes, price controls, or market power.

Question 8

Utility Maximization Condition

Accepted Answer

Consumers maximize utility subject to a budget constraint when the marginal utility per dollar spent is equal across all goods:

$$
\frac{MU_x}{P_x} = \frac{MU_y}{P_y}
$$

Alternatively, where the Marginal Rate of Substitution equals the price ratio: $MRS_{x,y} = \frac{P_x}{P_y}$.

Question 9

Marginal Rate of Substitution (MRS)

Accepted Answer

The rate at which a consumer is willing to give up good Y for an additional unit of good X while maintaining the same level of total utility. Graphically, it is the negative slope of the indifference curve:

$$
MRS_{x,y} = \frac{MU_x}{MU_y}
$$

Question 10

Budget Constraint Equation & Slope

Accepted Answer

Represents all combinations of goods a consumer can afford with income $I$:

$$
I = P_x X + P_y Y
$$

Rearranged for Y: $Y = \frac{I}{P_y} - \left(\frac{P_x}{P_y}\right) X$.
Slope $= -\frac{P_x}{P_y}$ (the relative price ratio).

Question 11

Golden Rule of Profit Maximization

Accepted Answer

Firms maximize profits (or minimize losses) by producing where Marginal Revenue equals Marginal Cost:

$$
MR = MC
$$

- If $MR > MC$, increase production.
- If $MR < MC$, decrease production.

Question 12

Perfect Competition: Key Characteristics

Accepted Answer

1. Many buyers and sellers (price takers).
2. Homogeneous/identical products.
3. Free entry and exit in the long run.
4. Perfect information.
5. Firm's demand curve is horizontal ($P = MR = AR$).

Question 13

Perfect Competition: Long-Run Equilibrium

Accepted Answer

In the long run, entry/exit drives economic profit to zero ($TR = TC$):

$$
P = MR = MC = 	ext{Min } ATC
$$

Achieves both **allocative efficiency** ($P = MC$) and **productive efficiency** ($P = 	ext{Min } ATC$).

Question 14

Short-Run Shutdown Rule

Accepted Answer

A firm should temporarily shut down in the short run if total revenue is less than total variable cost, or equivalently:

$$
P < AVC
$$

In this state, the firm pays fixed costs but avoids variable costs.

Question 15

Long-Run Exit Rule

Accepted Answer

A firm should permanently exit the market in the long run if total revenue is less than total cost, or equivalently:

$$
P < ATC
$$

Question 16

Monopoly: Key Characteristics

Accepted Answer

1. Single seller (price maker).
2. High barriers to entry (patents, economies of scale, control of resources).
3. Downward-sloping demand curve ($P > MR$).
4. No close substitutes.

Question 17

Monopoly Inefficiency & Welfare Loss

Accepted Answer

Because a monopoly charges $P > MC$, it produces less than the allocatively efficient output ($P = MC$). This creates a **Deadweight Loss (DWL)**, transferring consumer surplus to the producer and creating total economic inefficiency.

Question 18

Price Discrimination

Accepted Answer

Selling the same good at different prices to different consumers for reasons not based on cost differences.

- **1st Degree (Perfect)**: Charges each buyer their maximum WTP; converts all CS to profit; $DWL = 0$.
- **2nd Degree**: Price depends on quantity bought (e.g., bulk discounts).
- **3rd Degree**: Segments market by elasticity (higher price for inelastic group).

Question 19

Tax Incidence and Elasticity

Accepted Answer

The burden of a tax falls more heavily on the side of the market that is **more inelastic**.

- If demand is more inelastic than supply, consumers bear most of the tax burden.
- If supply is more inelastic than demand, producers bear most of the tax burden.

Question 20

Economic Profit vs. Accounting Profit

Accepted Answer

- **Accounting Profit** $= 	ext{Total Revenue} - 	ext{Explicit Costs}$
- **Economic Profit** $= 	ext{Total Revenue} - (	ext{Explicit Costs} + 	ext{Implicit Costs})$

Economic profit includes opportunity cost. Normal profit occurs when Economic Profit $= 0$.

Melbourne ECON10004 - Principles of Microeconomics: Supply, Demand & Market Structure

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