Ch10. Economics — Comprehensive Review & Master Formula Sheet

Microeconomics Formula Sheet

Supply and Demand:
  Price Elasticity of Demand (PED)
    = % ΔQd / % ΔP
  Price Elasticity of Supply (PES)
    = % ΔQs / % ΔP

Consumer Theory:
  Utility maximization: MUx/Px = MUy/Py
  Consumer equilibrium: MRS = Px/Py = MUx/MUy

Producer Theory:
  Profit maximization: MR = MC
  Total Cost: TC = TFC + TVC
  Marginal Cost: MC = ΔTC / ΔQ
  Average Total Cost: ATC = TC/Q = AFC + AVC

Market Structures:
  Perfect competition: P = MR = MC
    (long-run: P = ATC, economic profit = 0)
  Monopoly: MR = MC, P > MC → deadweight loss

Macroeconomics Formula Sheet

National Income:
  GDP = C + I + G + (X − M)
  GNP = GDP + Net factor income from abroad
  Real GDP = Nominal GDP / GDP Deflator × 100
  Growth rate
    = (Real GDP₁ − Real GDP₀) / Real GDP₀ × 100

Money and Finance:
  Money multiplier = 1 / reserve ratio
  MV = PQ (Quantity Theory of Money)

Fiscal Policy:
  Spending multiplier = 1/MPS = 1/(1−MPC)
  GDP increase = ΔG × multiplier
  Tax multiplier = −MPC / MPS

Exchange Rates and Trade:
  Current account surplus → upward currency pressure
  Exchange rate rises (USD appreciates) → exports ↓
  Comparative advantage: specialize in
    the good with the lower opportunity cost

Top Ten Exam Mistakes

① Opportunity cost = single best forgone option
   → Not the sum of everything forgone

② Never include sunk costs in a decision
   → Only compare future marginal costs and benefits

③ Price change → quantity demanded changes
   (movement along the curve)
   Non-price factor → demand shifts
   (curve moves left or right)

④ GDP includes only FINAL goods
   → Wheat (intermediate) excluded;
     bread (final good) included

⑤ Monopoly: MR ≠ P
   → Monopoly: MR < P
      Perfect competition: MR = P

⑥ Interest rates and bond prices are ALWAYS inverse
   → Rates up → bond prices down (no exceptions)

⑦ Dollar depreciation → exports rise
   → Weaker dollar = US goods cheaper abroad
      = export competitiveness improves

⑧ Comparative advantage ≠ absolute advantage
   → Comparative advantage = lower opportunity cost
   → A country can have comparative advantage
      even with no absolute advantage

⑨ Positive externality → under-production
   → Remedy: subsidize to increase output

⑩ Government spending multiplier > tax-cut multiplier
   → Spending multiplier = 1/MPS
   → Tax multiplier = MPC/MPS (smaller)

Market Structures — Final Comparison

Perfect Competition:
  P = MC = MR = ATC (long-run equilibrium)
  Economic profit = 0 in the long run
  Maximum allocative and productive efficiency

Monopoly:
  P > MC = MR at profit-max output
  Economic profit > 0 even in long run
    (protected by barriers to entry)
  Deadweight loss; subject to antitrust law

Monopolistic Competition:
  P > MC in short run (positive profit possible)
  P = ATC in long run (free entry erodes profit)
  Product differentiation → brand loyalty

Oligopoly:
  Price rigidity (kinked demand)
  Cartel incentive → unstable (Prisoner's Dilemma)
  Analyzed with game theory (Nash Equilibrium)
  Subject to Sherman Act § 1 (collusion per se illegal)

GDP Expenditure Approach ★★★★★ : C + I + G + (X − M). Imports are subtracted. Investment (I) = equipment + structures + inventory change. Memory hook: GDP = Consumers + Investment + Government + Net exports

Multiplier Formula ★★★★★ : Multiplier = 1/(1−MPC). MPC = 0.8 → multiplier = 5. A $1 increase in G raises GDP by$ 5 (absent crowding out). Memory hook: multiplier = 1 ÷ MPS = 1 ÷ (1−MPC)

Deadweight Loss (DWL) Conditions ★★★★☆ : Monopoly, taxation, price ceilings, and price floors all create a wedge where P ≠ MC → mutually beneficial trades don’t occur → DWL. Memory hook: P ≠ MC = inefficiency = deadweight loss

Comprehensive Practice Questions

Q. In an economy with MPC = 0.6, which produces a larger GDP increase — a $50 billion rise in government spending or a$ 50 billion tax cut?

Government spending wins. Spending multiplier = 1/(1−0.6) = 2.5 → GDP increase = $125 billion. Tax multiplier = 0.6/0.4 = 1.5 → GDP increase =$ 75 billion. The spending multiplier is always larger because every dollar spent directly enters the income stream, whereas a tax cut is partially saved.

Q. Why does P > MC at a monopolist’s profit-maximizing output?

The monopolist faces a downward-sloping demand curve. To sell additional units it must lower the price on all units, so marginal revenue (MR) is less than price (P) at every positive output level. Setting MR = MC to maximize profit therefore implies P > MC. The resulting gap is the source of deadweight loss — transactions that would be mutually beneficial at competitive prices do not occur.

Q. Even if a country has absolute advantage in producing every good, can it still benefit from international trade?

Yes — through comparative advantage. Even if Country A is more productive in every sector, it should specialize in the good where its opportunity cost advantage is greatest and trade for the rest. As long as opportunity costs differ across countries, specialization and trade expand the total output available to both nations. This is Ricardo’s fundamental insight: absolute productivity is irrelevant; relative opportunity costs determine the gains from trade.