Microeconomics, Markets, Firms, and Consumers
Microeconomics studies how individuals and firms make decisions and how markets allocate resources. These flashcards cover essential micro concepts you need to master.
Supply and Demand Fundamentals
Supply and demand form the foundation of microeconomics. Demand shows the inverse relationship between price and quantity demanded. Supply shows the direct relationship between price and quantity supplied. At equilibrium, quantity supplied equals quantity demanded, determining market price and quantity.
When price rises above equilibrium, you get a surplus (excess supply). When price falls below equilibrium, you get a shortage (excess demand). Understanding these relationships is critical for every economics course.
Demand and Supply Shifters
Demand shifters move the entire demand curve left or right. These include income changes, prices of related goods, tastes, number of buyers, and future price expectations. An increase in demand shifts the curve right. A decrease shifts it left. Important: a change in the good's own price causes movement along the curve, not a shift.
Supply shifters similarly affect the entire curve. Input prices, technology, number of sellers, expectations, and government policies all shift supply. Better technology or lower input costs shift supply right. Rising costs shift supply left. Again, the good's own price creates movement along the curve, not a shift.
Price Elasticity and Consumer Welfare
Price elasticity of demand (PED) measures how responsive quantity demanded is to price changes. Calculate it as: % change in quantity demanded divided by % change in price. Elastic demand (absolute value greater than 1) means quantity is very responsive to price. Inelastic demand (absolute value less than 1) means quantity is less responsive.
Consumer and producer surplus represent economic welfare. Consumer surplus is the difference between what buyers are willing to pay and what they actually pay. Producer surplus is the difference between the actual price and sellers' willingness to sell. Deadweight loss occurs when market inefficiency reduces total surplus.
Market Structures and Competition
Perfect competition features many firms selling identical products. Firms are price takers in the short run and long run. The profit-maximizing rule is: produce where marginal revenue equals marginal cost. In the long run, free entry and exit eliminate economic profit.
Monopoly has one seller of a unique product. The monopoly is a price maker, not a price taker. It produces less output and charges a higher price than perfect competition. This creates deadweight loss and allocative inefficiency. Natural monopolies (like utilities) have continuously declining average costs and may face regulation.
Monopolistic competition combines elements of monopoly and perfect competition. Many firms sell differentiated products, giving each firm some pricing power. Short-run profits attract new entrants. Long-run equilibrium occurs where price equals average total cost, but price exceeds marginal cost (creating inefficiency).
Oligopoly involves a few large, interdependent firms. Game theory explains oligopoly behavior. The prisoner's dilemma shows why firms tend to cheat on collusion agreements. A cartel forms when competitors collude to act like a monopoly. Nash equilibrium occurs when no firm can improve by unilaterally changing its strategy.
Production and Costs
Marginal analysis is the decision-making framework of economics. Do an activity as long as marginal benefit exceeds marginal cost. Optimal quantity occurs where marginal benefit equals marginal cost. This principle applies to production, consumption, hiring, and virtually every economic decision.
Costs of production include fixed costs (rent, insurance) and variable costs (labor, materials). Total cost equals fixed costs plus variable costs. Average total cost divides total cost by quantity. Marginal cost is the additional cost of producing one more unit. Marginal cost intersects average total cost at its minimum point. Economies of scale occur when average total cost decreases as output increases.
Trade and Market Failures
Comparative advantage explains why both parties benefit from trade. A country has comparative advantage in a good if it can produce it at lower opportunity cost than another country. Even if one party has absolute advantage in everything, both gain by specializing based on comparative advantage.
Externalities are costs or benefits affecting third parties. Negative externalities (pollution) create overproduction. Solutions include Pigouvian taxes, regulation, or tradable permits. Positive externalities (education) create underproduction. Solutions include subsidies or public provision. Public goods are non-rivalrous and non-excludable (national defense, street lights). Free-rider problems cause underproduction in private markets.
Consumer Choice and Utility
Utility maximization means consumers allocate income so marginal utility per dollar is equal across all goods. If the marginal utility per dollar for good A exceeds good B, buy more of A. The law of diminishing marginal utility states that each additional unit provides less satisfaction than the previous unit. This principle underlies downward-sloping demand curves.
| Term | Meaning |
|---|---|
| Supply and Demand | Demand: inverse relationship between price and quantity demanded (law of demand). Supply: direct relationship between price and quantity supplied (law of supply). Equilibrium: where supply equals demand, determining market price and quantity. Surplus: price above equilibrium (Qs > Qd). Shortage: price below equilibrium (Qd > Qs). |
| Demand Shifters | Factors that shift the entire demand curve (not movement along it): income (normal vs. inferior goods), prices of related goods (substitutes and complements), tastes and preferences, number of buyers, expectations of future prices. Increase in demand: curve shifts right. Decrease: shifts left. A change in the good's own price causes movement along the curve. |
| Supply Shifters | Factors shifting the supply curve: input/resource prices, technology, number of sellers, expectations, government policies (taxes, subsidies, regulations). Decrease in input costs or better technology: supply shifts right (more supplied at every price). Increase in costs: shifts left. A change in the good's own price causes movement along the curve. |
| Price Elasticity of Demand (PED) | PED = % change in Qd / % change in P. Elastic (|PED| > 1): quantity very responsive to price (luxuries, many substitutes). Inelastic (|PED| < 1): quantity less responsive (necessities, few substitutes). Unit elastic (|PED| = 1). Perfectly elastic: horizontal demand. Perfectly inelastic: vertical demand. Total revenue test: elastic = P up, TR down; inelastic = P up, TR up. |
| Consumer and Producer Surplus | Consumer surplus: difference between willingness to pay and actual price (area below demand, above price). Producer surplus: difference between actual price and willingness to sell (area above supply, below price). Total surplus = CS + PS, maximized at equilibrium. Deadweight loss: reduction in total surplus from market inefficiency (taxes, price controls, monopoly). |
| Price Ceilings and Floors | Price ceiling: max legal price, below equilibrium (e.g., rent control). Creates shortage (Qd > Qs). Price floor: min legal price, above equilibrium (e.g., minimum wage). Creates surplus (Qs > Qd). Both create deadweight loss and can lead to black markets or inefficient allocation. |
| Perfect Competition | Many firms, identical products, price takers, free entry/exit, perfect information. P = MR = MC at profit-maximizing output. Short run: firms can earn economic profit or loss. Long run: economic profit = 0 (entry/exit drives price to minimum ATC). Allocatively efficient (P = MC) and productively efficient (P = min ATC) in long run. |
| Monopoly | Single seller, unique product, price maker, high barriers to entry. Profit max: MR = MC, price from demand curve above. P > MC (allocatively inefficient). Produces less and charges more than perfect competition. Creates deadweight loss. Natural monopoly: ATC continuously declining (utilities). May be regulated: P = ATC (fair return) or P = MC (socially optimal, may need subsidy). |
| Monopolistic Competition | Many firms, differentiated products (brand loyalty), easy entry/exit. Short run: like monopoly (can earn economic profit). Long run: entry eliminates profit, tangency point where P = ATC but P > MC. Excess capacity: produces less than efficient scale. Product differentiation through advertising, branding, quality differences. |
| Oligopoly | Few large firms, interdependent decision-making. Barriers to entry exist. Key models: game theory (prisoner's dilemma shows why firms tend to cheat on collusion), kinked demand curve (explains price rigidity), cartel model (like OPEC, firms collude to act as monopoly). Nash equilibrium: no player can improve by unilaterally changing strategy. |
| Marginal Analysis | Key decision rule in economics: an activity should be increased as long as marginal benefit > marginal cost. Optimal quantity: where MB = MC. Applies to: firm production (produce where MR = MC), consumer purchases (buy where MU/P is equal across goods), hiring (hire where MRP = wage). Foundation of rational economic decision-making. |
| Comparative Advantage | A country/individual has comparative advantage in producing a good if they can produce it at a lower opportunity cost. Even if one party has absolute advantage in everything, both benefit from specialization and trade based on comparative advantage. Basis for gains from trade. Opportunity cost = what you give up / what you get. |
| Externalities | Costs or benefits that affect third parties not involved in the transaction. Negative externality (pollution): social cost > private cost, overproduction. Solutions: tax (Pigouvian), regulation, tradable permits. Positive externality (education): social benefit > private benefit, underproduction. Solutions: subsidy, public provision. Market failure occurs when externalities are not internalized. |
| Public Goods | Non-rivalrous (one person's use doesn't reduce availability) and non-excludable (can't prevent people from using). Examples: national defense, street lights, clean air. Free-rider problem: people consume without paying, so private markets underprovide. Typically provided by government. Common resources are rivalrous but non-excludable (overfishing, tragedy of the commons). |
| Utility Maximization | Consumers maximize total utility by allocating income so that the marginal utility per dollar is equal across all goods: MUa/Pa = MUb/Pb = ... = MUn/Pn. Law of diminishing marginal utility: each additional unit provides less additional satisfaction. If MUa/Pa > MUb/Pb, buy more of good A. |
| Costs of Production | Fixed costs (FC): don't change with output (rent, insurance). Variable costs (VC): change with output (labor, materials). Total cost: TC = FC + VC. Average total cost: ATC = TC/Q. Marginal cost: MC = change in TC / change in Q. MC intersects ATC and AVC at their minimum points. Economies of scale: ATC decreases as output increases. |
Macroeconomics, GDP, Policy, and International Trade
Macroeconomics studies the economy as a whole including output, employment, price levels, and government policies. These flashcards cover essential macro concepts.
Measuring Economic Output and Employment
Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a country in one year. The expenditure approach calculates GDP as: consumption plus investment plus government spending plus net exports (exports minus imports). Never count intermediate goods, used goods, or financial transactions in GDP.
Nominal GDP uses current prices. Real GDP adjusts for inflation using base year prices. GDP per capita divides total GDP by population to show average output per person. Understanding these measurements is essential for comparing economies over time and across countries.
Unemployment rate equals unemployed workers divided by the labor force, multiplied by 100. The labor force includes employed and actively unemployed workers. Frictional unemployment is temporary (between jobs). Structural unemployment reflects skill mismatches and lasts longer. Cyclical unemployment results from recessions. The natural rate of unemployment includes frictional and structural unemployment only.
Inflation and Price Levels
Inflation is a sustained increase in the general price level. Measure it using the Consumer Price Index (CPI) or GDP deflator. Demand-pull inflation occurs when too much money chases too few goods. Cost-push inflation results from rising production costs. Calculate inflation rate as: (new CPI minus old CPI) divided by old CPI, multiplied by 100.
Inflation hurts fixed-income earners, savers, and lenders. It helps borrowers who repay loans with less valuable dollars. Understanding inflation's effects is crucial for evaluating economic policy and personal financial planning.
Aggregate Demand and Supply
Aggregate demand is total spending at each price level. It equals consumption plus investment plus government spending plus net exports. The curve slopes downward due to three effects: the wealth effect (higher prices reduce purchasing power), the interest rate effect (higher prices increase money demand and rates), and the net export effect (higher prices make exports expensive).
Aggregate demand shifters include changes in consumption, investment, government spending, or net exports. For example, consumer optimism increases consumption and shifts aggregate demand right.
Short-run aggregate supply (SRAS) slopes upward because higher prices lead to more production when wages and prices are sticky. Long-run aggregate supply (LRAS) is vertical at full-employment GDP. Output depends on resources and technology, not price level. Long-run equilibrium occurs where aggregate demand intersects both SRAS and LRAS.
Fiscal and Monetary Policy
Fiscal policy uses government spending and taxation to influence the economy. Expansionary fiscal policy increases government spending or decreases taxes to fight recession and increase aggregate demand. Contractionary fiscal policy decreases spending or increases taxes to fight inflation and decrease aggregate demand.
The multiplier effect amplifies initial spending changes. The spending multiplier equals 1 divided by (1 minus the marginal propensity to consume). Automatic stabilizers like unemployment insurance reduce economic fluctuations without deliberate policy changes.
Monetary policy involves Federal Reserve control of the money supply to influence interest rates and economic activity. The Fed uses three main tools: open market operations (buying or selling bonds), the discount rate (interest rate for emergency lending), and reserve requirements (percentage of deposits banks must hold).
Expansionary monetary policy increases money supply and decreases interest rates. The Fed buys bonds, lowers the discount rate, or lowers reserve requirements. Contractionary monetary policy decreases money supply and increases interest rates. The federal funds rate is the key target rate for overnight bank lending between banks.
Money Creation and Banking
The money multiplier equals 1 divided by the reserve requirement ratio. If banks must hold 10% in reserves, the multiplier is 10. A $1,000 deposit can create up to $10,000 in new money through repeated lending. Excess reserves equal total reserves minus required reserves.
In practice, the multiplier is smaller due to leakages. People keep some cash outside banks, and banks hold excess reserves for safety. Understanding money creation is essential for understanding monetary policy transmission.
Employment, Inflation, and Economic Growth
The Phillips Curve shows a short-run inverse relationship between inflation and unemployment. Lower unemployment correlates with higher inflation as the economy overheats. The long-run Phillips Curve is vertical at the natural rate of unemployment. Stagflation (high inflation and high unemployment simultaneously) challenged this relationship in the 1970s during supply shocks.
The business cycle includes expansion (rising GDP, falling unemployment), peak, contraction or recession (falling GDP for two consecutive quarters), and trough. Leading indicators like stock market performance predict turns. Lagging indicators like unemployment rate confirm turns after they occur.
International Economics
The balance of payments includes the current account (trade in goods and services) and capital account (foreign investment flows). A current account deficit means a country imports more than it exports. This deficit is financed by a capital account surplus (foreign investment in domestic assets).
Exchange rates in floating systems are determined by supply and demand for currencies. Currency appreciation occurs when demand increases due to foreign investment, high interest rates, or strong economic growth. Appreciation makes exports more expensive and imports cheaper. Currency depreciation has opposite effects.
In the loanable funds market, supply comes from savings and demand comes from borrowing for investment. The real interest rate balances supply and demand. Government budget deficits increase demand for loanable funds, raising interest rates. This may crowd out private investment by making borrowing more expensive.
In the money market, the money supply is vertical (set by the Fed). Money demand slopes downward. When the Fed increases money supply, interest rates fall. When money demand increases from higher GDP or prices, interest rates rise. A liquidity trap occurs when interest rates near zero and monetary policy becomes ineffective.
Comparative advantage and trade create mutual gains even when one country dominates another in all goods. Countries should specialize in goods with lowest opportunity cost. Tariffs and quotas reduce trade, creating deadweight loss domestically but protecting specific industries from foreign competition.
| Term | Meaning |
|---|---|
| Gross Domestic Product (GDP) | Total market value of all final goods and services produced within a country in a year. Expenditure approach: GDP = C + I + G + (X-M). Not counted: intermediate goods, used goods, financial transactions, household production. Nominal GDP: current prices. Real GDP: adjusted for inflation (base year prices). GDP per capita = GDP / population. |
| Unemployment | Unemployment rate = (unemployed / labor force) x 100. Labor force = employed + unemployed (actively seeking). Types: frictional (between jobs, normal), structural (skills mismatch, longer-term), cyclical (due to recession). Natural rate of unemployment: frictional + structural (no cyclical). Full employment exists at the natural rate. |
| Inflation | Sustained increase in general price level. Measured by CPI (consumer price index) and GDP deflator. Demand-pull: too much money chasing too few goods. Cost-push: rising production costs. Inflation rate = (CPI_new - CPI_old) / CPI_old x 100. Hurts: fixed-income earners, savers, lenders. Helps: borrowers (repay with less valuable dollars). |
| Aggregate Demand (AD) | Total spending in the economy at each price level. AD = C + I + G + (X-M). Downward sloping due to: wealth effect (higher prices reduce purchasing power), interest rate effect (higher prices increase money demand and interest rates), and net export effect (higher prices make exports expensive). AD shifters: changes in C, I, G, or net exports. |
| Aggregate Supply (Short-Run and Long-Run) | SRAS: upward sloping (higher prices lead to more production in short run due to sticky wages/prices). Shifts: input prices, productivity, expectations. LRAS: vertical at full-employment GDP (potential output). In the long run, output is determined by resources and technology, not price level. Long-run equilibrium: AD intersects SRAS intersects LRAS. |
| Fiscal Policy | Government use of spending and taxation to influence the economy. Expansionary: increase G or decrease T to fight recession (increases AD). Contractionary: decrease G or increase T to fight inflation (decreases AD). Multiplier effect: initial spending creates rounds of additional spending. Spending multiplier = 1/(1-MPC). Tax multiplier = -MPC/(1-MPC). Automatic stabilizers: unemployment insurance, progressive taxes. |
| Monetary Policy (Federal Reserve) | Fed controls money supply to influence interest rates and economic activity. Expansionary: buy bonds (open market operations), lower discount rate, lower reserve requirement, increases money supply, decreases interest rates, increases AD. Contractionary: sell bonds, raise rates, decreases money supply, increases interest rates. Federal funds rate: key target rate for overnight bank lending. |
| Money Multiplier | Money multiplier = 1 / reserve requirement ratio. If RR = 10%, multiplier = 10. A $1,000 deposit can create up to $10,000 in new money through repeated lending. Excess reserves = total reserves - required reserves. In practice, multiplier is smaller due to leakages (cash held outside banks, banks holding excess reserves). |
| Phillips Curve | Short-run: inverse relationship between inflation and unemployment. Lower unemployment = higher inflation (economy overheating), and vice versa. Long-run: vertical at natural rate of unemployment. Stagflation (1970s) challenged the short-run Phillips Curve (both high inflation and high unemployment from supply shocks). Expectations-augmented Phillips Curve accounts for inflation expectations. |
| Business Cycle | Recurring fluctuations in economic activity: expansion (GDP rising, unemployment falling), peak, contraction/recession (GDP falling for 2+ consecutive quarters), trough. Leading indicators (stock market, building permits) predict turns. Lagging indicators (unemployment rate) confirm turns. Coincident indicators (GDP, industrial production) move with the cycle. |
| Balance of Payments | Current account: trade in goods and services, investment income, transfers. Capital/financial account: foreign investment flows (FDI, portfolio investment). Current account deficit = capital account surplus (and vice versa). The US runs a persistent current account deficit (imports > exports) financed by capital inflows (foreign investment in US assets). |
| Exchange Rates | Floating: determined by supply and demand for currencies in forex markets. Currency appreciates when demand increases (foreign investment, high interest rates, strong economy). Depreciates when demand falls. Appreciation: exports more expensive (decrease), imports cheaper (increase). Depreciation: opposite. Fixed exchange rates: government intervenes to maintain target rate. |
| Loanable Funds Market | Determines real interest rate. Supply: savings (upward sloping, higher interest rate encourages saving). Demand: borrowing for investment (downward sloping, lower interest rate encourages borrowing). Government budget deficit: increases demand for loanable funds (government borrowing), raises interest rates, may crowd out private investment. |
| Money Market | Determines nominal interest rate. Money supply: vertical (set by Fed). Money demand: downward sloping (lower interest rate increases quantity demanded). Fed increases money supply: interest rate falls. Money demand increases (higher GDP or prices): interest rate rises. Liquidity trap: interest rates near zero, monetary policy becomes ineffective. |
| Crowding Out | When government borrowing (deficit spending) increases demand for loanable funds, raising interest rates, which reduces private investment spending. Limits the effectiveness of fiscal policy. Complete crowding out: government spending increase is fully offset by private investment decrease. More likely when economy is near full employment. |
| Comparative Advantage and Trade | Countries should specialize in goods where they have the lowest opportunity cost and trade for other goods. Both countries gain from trade even if one has absolute advantage in everything. Terms of trade: the rate at which goods are exchanged, must fall between each country's opportunity costs. Tariffs and quotas reduce trade, creating deadweight loss domestically but protecting specific industries. |
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- Review consistently, daily practice beats marathon sessions
- 1
Generate flashcards using FluentFlash AI or create them manually from your notes
- 2
Study 15-20 new cards per day, plus scheduled reviews
- 3
Use multiple study modes (flip, multiple choice, written) to strengthen recall
- 4
Track your progress and identify weak topics for focused review
- 5
Review consistently, daily practice beats marathon sessions
Why Flashcards Work Better Than Other Study Methods for economics
Flashcards aren't just for vocabulary. They're one of the most research-backed study tools for any subject, including economics. The reason comes down to how memory works. When you read a textbook passage, your brain stores information in short-term memory. Without retrieval practice, it fades within hours.
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The Testing Effect
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FSRS Algorithm and Optimal Scheduling
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