Key Microeconomics Concepts: From Demand to Market Failure

Posted on Dec 1, 2025 in State Administration

Core Principles of Microeconomics

An increase in demand for an inferior good can be caused by a decrease in consumer income.
If the price of an input, such as salt for peanut butter, increases, the supply of the final product will decrease.
An excess supply (surplus) of labor can be caused by a wage set above the equilibrium level.
When a price decrease leads to an increase in total revenue, the demand for that good is considered elastic over that price range.

If the market price increases from $10 to $20, the producer surplus will increase by $150.
If a price ceiling of $10 is imposed, the consumer surplus is calculated to be 250.
When a country imposes a tariff on imports, domestic consumer surplus decreases while domestic producer surplus increases.

In economics, utility represents the satisfaction derived from an action or consumption.
If a consumer is indifferent between two bundles of goods, such as A and B, the utility derived from both bundles must be equal.
A consumer will choose to buy more of a good if its marginal utility per dollar is higher than that of other goods. For example, if the price of baking soda is $3 and its marginal utility is 12, while the price of vinegar is $5 and its marginal utility is 15, the consumer will buy more baking soda (MU/P of 4 vs. 3).

The magnitude of the slope of a budget constraint equals the opportunity cost of the good on the horizontal axis.
The labor-leisure budget constraint illustrates that the opportunity cost of leisure is determined by the wage rate.

When marginal product is decreasing, marginal cost (MC) is increasing.
The spreading effect describes how average fixed cost (AFC) decreases as output increases.
The diminishing returns effect describes how average variable cost (AVC) eventually increases as output increases.
The marginal cost (MC) curve necessarily crosses the average total cost (ATC) curve at the minimum point of the ATC curve.
When average total cost (ATC) is increasing, average variable cost (AVC) must also be increasing.
The average fixed cost (AFC) curve cannot increase as output increases because of the spreading effect.

A firm’s optimal quantity of output is determined by its production costs and market price. In one example, the optimal quantity is 15 units.
A firm should shut down in the short run if the market price is less than the minimum of its average variable cost (AVC).
A perfectly competitive firm’s short-run profits can be calculated as: Quantity × (Price – Average Total Cost). For example, Q × (P – ATC) = 170.

As long as the market price is above the shutdown price, a perfectly competitive firm maximizes its profits by producing the quantity where Price equals Marginal Cost (P = MC).

A natural monopoly is often a consequence of significant increasing returns to scale, which provide a cost advantage to a single large firm. They are typically characterized by high fixed costs.
A monopolist maximizes profit by choosing the quantity where Marginal Revenue equals Marginal Cost (MR = MC) and setting a price determined by the height of the demand curve at that quantity.
A policy that could decrease deadweight loss in a monopolized market is setting a price floor above the monopolist’s optimal price.
Product differentiation plays a crucial role in markets characterized by monopolistic competition.
In the long run, each firm in a monopolistically competitive industry will choose a quantity where price equals average total cost (P = ATC), resulting in zero economic profit.
In a monopolistically competitive market like restaurants, an increase in demand can lead to a short-run increase in the number of firms.
Because some beneficial transactions do not occur, monopolistically competitive markets result in deadweight loss.

In a payoff matrix, a dominant strategy is the best choice for a firm regardless of the other firm’s action. In one scenario, the dominant strategy for both firms is to produce a high output.
A Nash Equilibrium is an outcome where no player can benefit by changing their strategy while the other players keep theirs unchanged. In the “Arms Race Game,” both countries building nuclear weapons is a Nash Equilibrium.

In financial markets, demand represents the behavior of borrowers, and supply represents the behavior of savers.
An interest rate is a typical example of a financial rate of return.
During economic expansions, firms and consumers have a greater incentive to borrow, resulting in an increase in demand for financial capital.

Negative externalities exist when the marginal social cost of a good is greater than the marginal private cost. Goods with external costs tend to be over-provided by the market.
Positive externalities exist when the marginal social benefit of a good is greater than the marginal private benefit. Goods with external benefits tend to be under-provided by the market.
A Pigouvian tax, such as one on CO2 emissions, increases the private marginal cost to align it with the social marginal cost, correcting for negative externalities.
A Pigouvian subsidy is a policy tool used to correct for positive externalities by encouraging more production or consumption.