CAPE Economics Unit 1 cheat sheet

Law of demand: quantity demanded falls as price rises, ceteris paribus; the demand curve slopes downward because of income and substitution effects.

Movement along a demand curve is caused only by a change in the good's own price; a shift is caused by non-price determinants (income, tastes, prices of substitutes and complements, expectations, population).

Supply shifts with input costs, technology, taxes and subsidies, number of firms, and expectations; a rise in price causes a movement along the supply curve, not a shift.

Equilibrium: set Qd = Qs. At a price above equilibrium a surplus exists and price falls; below equilibrium a shortage exists and price rises.

Price elasticity of demand PED = (% change in Qd)/(% change in price); use the midpoint formula to avoid direction bias. |PED| > 1 elastic, < 1 inelastic, = 1 unit elastic.

PED determinants: availability of substitutes, proportion of income spent, necessity vs luxury, time period, and breadth of definition. Elastic demand means a price cut raises total revenue.

Income elasticity YED = (% change in Qd)/(% change in income); YED > 0 normal good, YED < 0 inferior good, YED > 1 income-elastic luxury.

Cross elasticity XED = (% change in Qd of A)/(% change in price of B); XED > 0 substitutes, XED < 0 complements, XED near 0 unrelated goods.

Price elasticity of supply PES = (% change in Qs)/(% change in price); larger when spare capacity exists, factors are mobile, and the time period is longer.

Perfect competition assumptions: many buyers and sellers, homogeneous product, free entry and exit, perfect information, factor mobility; each firm is a price taker facing a horizontal demand curve where P = MR = AR.

Short-run profit maximisation rule for all structures: produce where MR = MC, provided P ≥ AVC; if P < AVC the firm shuts down. Long-run equilibrium in perfect competition occurs where P = MR = MC = minimum ATC.

Monopoly: single seller, no close substitutes, high barriers to entry; the firm faces the downward-sloping market demand curve so MR < AR and MR is twice as steep as a linear demand curve.

Monopoly output rule: set MR = MC, then read price off the demand curve; the result is P > MC and a deadweight loss relative to competitive output.

Price discrimination requires market separation, differing elasticities, and no resale; charge more in the inelastic market and less in the elastic market.

Monopolistic competition: many firms, differentiated products, low barriers; short-run profits attract entry, shifting each firm's demand left until normal profit in long run where P = ATC but P > MC.

Oligopoly: few large firms, interdependence, and strategic behaviour; the kinked demand curve predicts price rigidity because rivals match price cuts but ignore price rises.

Concentration ratio and Herfindahl-Hirschman Index measure market power; HHI sums the squares of market shares and rises with concentration.

Efficiency benchmarks: allocative efficiency requires P = MC; productive efficiency requires production at minimum ATC; perfect competition achieves both in long-run equilibrium, monopoly achieves neither.

Market failure exists when the free market's allocation is not allocatively efficient (P ≠ MC) or is inequitable; sources include externalities, public goods, merit and demerit goods, imperfect competition, and information failure.

Negative externality of production: marginal social cost exceeds marginal private cost; the free market overproduces relative to the social optimum, creating a deadweight loss triangle.

Positive externality of consumption: marginal social benefit exceeds marginal private benefit; the free market underproduces relative to the social optimum.

Public goods are non-rival and non-excludable, so the free-rider problem causes missing markets; quasi-public goods are partially rival or excludable.

Merit goods are underconsumed and demerit goods overconsumed because of information failure and undervaluation of private benefits or costs.

Indirect tax on a demerit good shifts supply up by the tax; the price rise is smaller than the tax when demand is elastic, and the tax is most effective when demand is inelastic.

Subsidy on a merit good shifts supply down, raising quantity; the cost to government equals subsidy per unit times quantity.

Pigouvian tax sets tax equal to marginal external cost; tradable permits cap total pollution and allow least-cost abatement; both internalise the externality.

Government failure: intervention may create deadweight loss through poor information, administrative cost, unintended consequences, or regulatory capture.

Factor demand is derived demand, dependent on demand for the final good; a firm hires a factor until marginal revenue product equals marginal factor cost (MRP = MFC).

Marginal revenue product MRP = marginal physical product × marginal revenue; under perfect competition MR = P, so MRP = MPP × P = value of marginal product.

Demand curve for labour is the downward-sloping MRP curve; it shifts with product price, labour productivity, and prices of substitute factors.

Supply of labour reflects the substitution and income effects of a wage change; the backward-bending supply curve occurs when the income effect dominates above a certain wage.

Competitive labour market equilibrium wage and employment are set where labour demand (MRP) equals labour supply; a binding minimum wage above equilibrium creates unemployment.

Monopsony: single buyer of labour faces an upward-sloping labour supply; marginal factor cost lies above the supply curve, so employment and wages are below competitive levels.

Wage differentials arise from compensating differentials, human capital differences, labour immobility, union power, discrimination, and government regulation.

Economic rent is payment above transfer earnings (the minimum needed to keep a factor in its current use); perfectly inelastic supply means all payment is rent.

Returns to capital and entrepreneurship: interest is the price of loanable funds; normal profit is the minimum return to keep a firm in the industry, supernormal profit is the residual above it.