Microeconomics: Consumer Theory, Producer Theory and Market Structure
The Microeconomics domain tests whether you can move fluently between preference-based consumer theory, cost-based producer theory and the equilibrium predictions of the canonical market structures, then carry that apparatus into the law-and-economics domains.
Consumer theory
A consumer maximises u(x₁,x₂) subject to p₁x₁+p₂x₂=m. At an interior optimum the marginal rate of substitution equals the price ratio, MRS = p₁/p₂, and the Lagrange multiplier is the marginal utility of income. Ordinary demand slopes downward through combined substitution and income effects; the Slutsky equation separates them. Own-price elasticity ε = (dQ/dP)(P/Q) drives revenue: demand is elastic (|ε|>1) exactly when a price cut raises total revenue. Elasticity is a ratio of proportional changes, not the slope of the demand curve.
Producer theory
Firms minimise cost subject to a production function. In the short run at least one factor is fixed and diminishing marginal returns set in; in the long run all factors vary and returns to scale is the relevant concept. Marginal cost is the cost of the last unit, and average cost falls while MC<AC. Economic cost includes the opportunity cost of owner capital and time, so economic profit lies below accounting profit and drives exit decisions.
Market structures
Perfect competition drives P=MC. A monopolist sets MR=MC and reads price off the demand curve, producing the Lerner index (P−MC)/P = 1/|ε|. Cournot rivals choose quantities simultaneously; Bertrand rivals choosing prices for homogeneous goods with equal costs compete price to marginal cost. Differentiation, capacity constraints and repeated interaction soften both results.
Worked example
Demand P=100−2Q, constant MC=20. Total revenue is 100Q−2Q², so MR=100−4Q. Setting MR=MC gives Q=20 and P=60. At that point |ε| = (1/2)(60/20) = 1.5, and the Lerner index is 40/60 = 2/3 = 1/1.5, confirming the markup formula. Competitive output is where P=MC, Q=40, so deadweight loss is ½ × (60−20) × (40−20) = 400.
Traps
Do not confuse a movement along a demand curve with a shift of it. Do not apply returns to scale to a short-run fixed-factor problem. Do not use accounting cost where the question asks for the shutdown or entry decision. Do not claim Cournot rivals collude - they earn positive but below-monopoly profits. Do not apply the Lerner formula to a firm that is not profit-maximising.