Guide to Microeconomics
Key Concepts in Microeconomics
What Is the difference between microeconomics and macroeconomics?
Microeconomics focuses on economic decisions made by individuals and single firms. Macroeconomics focuses on economic decisions and phenomena on a regional, national, or global scale.
Which factors determine the elasticity of demand of a good?
While numerous factors can affect demand elasticity, there are two common ones. The first is availability of substitute goods. If there are easily available substitutes for a good, then demand will be very elastic, as consumers will just switch to the substitutes rather than pay more. Demand will be more or less elastic depending on whether consumers can go without a good. A luxury good may be something that consumers can forgo if prices increase, but essentials like medical care or food are required for a person to live.
What is the difference between the income effect and the substitution effect?
The income effect is when a person changes their purchasing patterns based on how much money they make. For example, a person may buy a luxury sports car if their income goes up, rather than a family sedan. The substitution effect is when a person substitutes one god for another when the price of that good changes. For example, if one brand of snack food goes up in price, a person may purchase another brand.
What's the difference between diminishing marginal returns and returns to scale?
Returns to scale describe how much production of a good or service increases for a particular increase in fixed inputs, such as machinery, usually in the long term. Diminishing marginal returns is when variable inputs, such as raw materials, are changed and you get an increasingly small increase in production.
What are some examples of the Law of Demand?
One example of the law of demand is how a store may sell more items when they go on sale, because the decrease in price increases demand. Another example is how when the price of gas goes up, people will drive less to buy less gas, as demand goes down as price increases.
Law of Demand
The law of demand is a principle in economics that states that the demand for a good or service is inversely proportional to its price. This means as the price of a good goes up, demand for it drops, all else being equal. This principle, along with the law of supply, forms one of the foundations of economics.
Comparative advantage is when a firm or country produces a good at a lower opportunity cost than its competitors. This does not mean it has to produce it at a lower absolute cost, just relative to other goods it could be producing. This principle is what allows trade to enrich all participants.
Demand describes the amount of a good desired at a particular price. The demand for a good is inversely proportional to its price, all things being equal.
Microeconomics is the study of economic decisions and phenomena at the level of an individual person or firm. This is in contrast with macroeconomics, which looks at economic decisions and phenomena on a larger scale, such as a whole country or the world.
An indifference curve is a graph that shows the array of combinations of two goods or services a person would be equally happy with. Curves are almost always concave, due to the diminishing marginal utility of most goods.
Marginal Rate of Substitution (MRS)
The marginal rate of substitution is the amount of one good that would be required to satisfy their demand for one additional unit of a substitute good. This rate defines an indifference curve between two goods, which shows the range of combinations of goods a person would be equally happy with.
Tragedy of the Commons
The tragedy of the commons is when a resource that everyone can access but no one owns is damaged or destroyed due to overexploitation. This is because no one feels responsible for maintaining the resource, as others can benefit from it for free, and therefore insufficient investment goes into maintaining it.
Utility is the technical term for happiness or enjoyment. One of the main basis of entry-level economics is that people will attempt to rationally maximize their own utility.
Marginal utility is the additional happiness or satisfaction that a consumer gets from one additional unit of a good or service. Marginal utility usually diminishes, as, for example, going from not having a car to having one car significantly expand one's ones’ opportunity, but going from one to two does not have nearly as large an impact on the consumer’s life.
Economies of Scale
Economies of scale are when a firm increases the efficiency of its production the more it produces. Not all goods and services benefit from economies of scale, and production only scales to a particular level before it reverses and each unit produced decreases efficiency. This is known as a diseconomy of scale.