Microeconomics
Core Concepts
Microeconomics examines how individual agents-consumers, firms, and resource owners-make decisions and interact in markets. You must understand demand and supply, elasticity, consumer choice (utility, indifference curves, budget constraints), production and costs (short-run vs. long-run, returns to scale), market structures (perfect competition, monopoly, monopolistic competition, oligopoly), and welfare economics (consumer/producer surplus, deadweight loss). Factor markets and income distribution are also relevant.
Common Traps
- Confusing shifts in demand/supply with movements along the curve. A change in price causes movement; changes in income, tastes, prices of related goods, or expectations cause shifts.
- Misapplying elasticity: price elasticity of demand varies along a linear demand curve; revenue maximization occurs where elasticity equals 1, not where price is highest.
- Assuming perfect competition when there are barriers to entry or product differentiation.
- Forgetting that in the long run, perfectly competitive firms earn zero economic profit, but accounting profit may be positive.
- Mixing up economies of scale (cost per unit falls as output rises) with diminishing marginal returns (short-run phenomenon).
Worked Example / Rule of Thumb
Rule of thumb: For a linear demand curve P = a - bQ, total revenue is maximized at the midpoint where Q = a/(2b) and P = a/2. Marginal revenue is MR = a - 2bQ. Profit maximization for a monopolist occurs where MR = MC, not where price is highest.
Example: Suppose a monopolist faces demand P = 100 - 2Q and has constant marginal cost MC = 20. Set MR = 100 - 4Q = 20 → Q = 20. Then P = 100 - 2(20) = 60. Profit = (60-20)20 = 800. If the firm acted as a perfect competitor (P = MC), Q = 40, P = 20. The deadweight loss is the triangle between these outcomes: 0.5(60-20)*(40-20) = 400. This illustrates the welfare cost of monopoly.