Spring 2013

Frequently Missed Concepts in Microeconomics (ECO 2023)

Studying Tips
 The best way to study is to do as many practice problems as possible. There are hundreds
of previous exam questions for you to practice on Sakai. If you understand the majority
of the exam questions, you will be perfectly prepared for what will be on the exam.
 One of the most common difficulties that students have with ECO2023 is staying up to
date with the lectures. As an online course that students don’t have to attend lecture for,
ECO2023 may be easy to forget. Try to avoid getting left behind by watching lectures
on time.

Midterm 1
 Opportunity Cost- Opportunity Cost is what is given up in exchange for increasing
something else. Opportunity cost is always in terms of the other good. If a factory
produces burgers and fries, the opportunity cost of producing more burgers is producing
less fries.
 Elasticity of Demand- Elasticity is people’s responsiveness to a change in price of a
good. If people respond a lot to a change in price of a good, that good is elastic. If people
don’t respond very much to a change in price of a good, that good is inelastic.
o Necessities have inelastic demand. (If a necessity, like water, increases in price,
people will not be responsive and will still buy water because they need it.)
o Luxuries have elastic demand. (If a luxury, like cruise ship tickets, increase in
price, people will be very responsive by being less likely to buy them. People
don’t need luxury goods and will settle for something cheaper.)
o Goods that require a large portion of one’s income have elastic demand. (If
your annual insurance expenses are 80% of what you make, you will be very
responsive to a change in the price of your insurance. On the other hand, a good
that requires a very small portion of your income has an inelastic demand. If you
spend 0.01% of your income on gum, you will not be responsive to a change in
price because it is very cheap.)
o As more time passes since a price change, the more elastic a good becomes.
(If it has been a long time since a price change, you will not be very responsive
because you will be able to find other substitutes during that period of time. In
contrast, if it has just been 10 minutes since a price change, and you truly need to
buy this particular good, you will be unresponsive to the price change (inelastic)
because you haven’t had enough time to find other substitutes.)
 Shifting Supply Curve and Demand Curve
o Supply Curve is shifted to the right/increased by:
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
Decreases in costs to produce a good/service (If it becomes cheaper to
produce computers, more computers will be made.)
 Increases in selling price of a good (If suppliers can sell a good at a
higher price, they will produce more of that good.)
 Increases in selling price of a complement in production. (A
complement in production is a byproduct that a supplier produces
naturally when making another good. For example, when farmers harvest
and process oatmeal, they also collect oat hulls that are removed and used
as a fuel. If farmers find out that they can sell oat hulls (the complement to
oatmeal) at a higher price, they will make more oatmeal to produce oat
hulls.)
 Increases in number of suppliers (As the number of farmers increase,
more agriculture products are produced.)
 Improvements in technology (If a manufacturing firm purchases more
advanced machines, they can produce more.)
 Improvements in weather (If weather conditions become more favorable
for farming, farmers can grow more crops.)
o Demand Curve is shifted to the right/increased by:
 Increases in price of a substitute (If train tickets increase in price, the
demand curve for bus tickets (a substitute for trains), increases. People
will buy the cheaper alternative.)
 Decreases in price of a complement (If hot dogs go down in price,
people will be more likely to buy hot dogs, along with hot dog buns (the
complement to hot dogs.))
 Increases in the expected future price of a good (If gas prices are
expected to rise tomorrow, today’s demand curve for gas will rise as
people take advantage of the cheaper price.)
 Increases in income, if it is a normal good.
 Decreases in income, if it is an inferior good.
 Improved preferences for the good (If more people become concerned
about being healthy, the demand for gym memberships will increase)

Midterm 2
 Costs: Average, Fixed, Variable
o Fixed Cost + Variable Cost = Total Cost
o Total Variable Cost/Quantity = Average Variable Cost
 Average Variable Cost X Quantity = Total Variable Cost
o Total Fixed Cost/Quantity = Average Fixed Cost
 Perfect Competition and Monopoly:
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o When Marginal Revenue = Marginal Cost, a firm is maximizing its profit. (Keep
in mind, however, that a firm may be losing money but still be maximizing their
profits in the best way possible.)
o Price < Average Total Cost  Economic loss
o Price > Average Total Cost  Economic profit
o Price = Average Total Cost  Normal profit, breakeven
o Perfect Competition
 Marginal Revenue curve = Demand curve for the firm = Price (fixed)
o Monopoly
 Price is above Marginal Revenue curve and Marginal Cost curve
 Only a monopoly can earn a profit in the long run. Other types of firms,
like perfectly competitive firms, can earn a profit in the short run, but are
unable to in the long run.

Final
 Game Theory: Sears and Walmart Example
o Game Theory involves comparing the different outcomes between two
alternatives. To illustrate game theory, we’ll use the following example.

In any game theory problem, the boxes represent the different outcomes of
decisions that Sears and Walmart can take. In the top left box below, Sears will
receive $10 million and Walmart will receive $5 million if they both set low
prices. In the top right box below, Sears will receive $1 million and Walmart will
receive $30 million if Sears sets high prices but Walmart sets low prices.

o A dominant strategy is when a company has one best decision that maximizes
profit. To determine if Sears has a dominant strategy, we need to compare two
decisions: setting low prices versus setting high prices. To do this, we look at the
table column by column. The left column shows the outcomes if Sears sets low
prices, and the right column shows the outcomes if Sears sets high prices. (If we
wanted to see if Walmart had a dominant strategy, we will not compare columns.
Rather, we would compare the rows. The top row is Walmart’s outcomes if they
set low prices. The bottom row is Walmart’s outcomes if they set high prices.)

In the left, unshaded column, Sears will get $10 million if Walmart sets low or
high prices.
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In the right, unshaded column below, if Sears sets high prices, it will receive
either $1 million or $20 million. It will receive $1 million if Walmart sets low
prices (top right box), but $20 million if Walmart sets high prices (bottom right
box).

Conclusion: Sears does not have a dominant strategy. If they set low prices (left
column), they can earn $10 million, but lose out on possibly earning $20 million
(right column). If they set high prices, they run the risk of earning only $1 million.
One way for Sears to have a dominant strategy is if the top right box had $20
million instead of $1 million. That way, setting high prices earns them more
money than setting low prices, regardless of Walmart’s decision.