Exam 1 study guide | Microeconomics

Capitalism + governments and institutions

You should understand…

…the components of the capitalist economic system: private property, markets, and firms
…what happens when any of these components gets distorted
…what makes public goods different from regular goods (see public goods game)
…what institutions are and how they coordinate action
…what GDP is, what it measures, what it doesn’t measure, what problems there are with it, what alternatives there are for it, and why it continues to be popular
…the difference between real and nominal values (and why we care)
…what a price index is
…what purchasing power parity (PPP) is (and also what the Big Mac Index is)
…the downsides of capitalism (inequality + environmental damage)
…why not everything should be a market
…why large groups suffer from free riding and how they work to behave like small groups
…how small factions threaten democracy, but also how they enable it
…how voting can suffer from failures (Condorcet’s paradox)

Important formulas:

Adjusting for inflation:

\[ \text{Real} = \frac{\text{Nominal}}{\text{Price Index / 100}} \]
Percent change:

\[ \text{% change} = \frac{\text{New} - \text{Old}}{\text{Old}} \]

or

\[ \text{% change} = \frac{\text{Current} - \text{Previous}}{\text{Previous}} \]
Compound annual growth rate (CAGR); periodic method (this assumes interest is compounded once a year; this is the harder method and you don’t really need to use it):

\[ r = \exp(\frac{\ln(\frac{\text{Price index}_{\text{new}}}{\text{Price index}_{\text{old}}})}{t}) - 1 \]
Compound annual growth rate (CAGR): continuous method (this assumes interest is compounded continuously; this is the easier method and you should generally use this):

\[ r = \frac{\ln(\frac{\text{Price index}_{\text{new}}}{\text{Price index}_{\text{old}}})}{t} \]

Guides:

Other helpful resources:

You should understand…

…that perfectly rational individual behavior can create irrational and inferior social outcomes
…how to use game theory to analyze social interactions. In particular, you should be able to define the following: game, zero-sum, Pareto efficiency, Nash equilibrium, pure strategy, mixed strategy, dominant strategy
…what social dilemmas, collective action problems, and tragedies of the commons are
…the difference between a stag hunt game and a prisoners dilemma game, why that difference is important, and why stag hunts are possibly a better metaphor for social dilemmas
…what factors prevent individuals from cooperating, such as uneven payoffs, lack of assurance, preference falsification, dishonesty, and selfishness
…how to fix collective action problems with altruism, repetition and iteration, infinitization, punishment, norms, and institutions
…how incentives can get crowded out and distorted when extrinsic rewards or punishments replace intrinsic motivation (i.e. don’t marketize important social relationships; pay enough or don’t pay at all)

Guides:

Other helpful resources:

You should understand…

…the difference between Pareto efficiency and fairness
…why Pareto efficiency is not necessarily the best standard for measuring the success of a policy
…how we can measure fairness with substantive standards, procedural standards, and Rawlsian standards
…how cultural perceptions of luck and fairness shape public policy
…how ideas of efficiency and fairness apply to international trade
…how public policy can be used to change the payoffs in games (e.g. making it more expensive to use water and deplete public goods)
…what elasticity measures (i.e. what it means for something to be inelastic vs. elastic)
…why good public policies should be a Nash equilibrium
…the difference between absolute and comparative advantage and how there can still be gains from trade if a part doesn’t have absolute advantage in a product

Guides:

You should understand…

…what opportunity costs are and how they influence decision making
…how to draw a budget line and what budget lines mean
…how utility is measured and what indifference curves are
…the difference between the marginal rate of substitution (slope of the indifference curve) and the marginal rate of transformation (slope of the feasible frontier)
…what it means when marginal product and marginal utility diminish
…how to find the utility-maximizing level of consumption given preferences and budget constraints
…the difference between normal and inferior goods
…what income effects and substitution effects are and how they’re related to government policies

Important formulas:

All the ways marginal utility (or marginal rate of substitution) can be written:

\[ MRS = \frac{dy}{dx} = \frac{\Delta y}{\Delta x} = \frac{\text{Price}_x}{\text{Price}_y} = \frac{MU_x}{MU_y} = \frac{\partial u / \partial x}{\partial u / \partial y} \]

Guides:

Other helpful resources:

You should understand…