TUTORIAL QUESTIONS AND ANSWERS: ECO 601

1: Introduction to Microeconomic Theory

What is microeconomics about? Microeconomics is the branch of economics that studies the
behavior of individual economic agents, such as households, firms, and individuals, and how
they make decisions in the face of scarcity. It examines how these individual decisions interact
to form markets and determine prices and quantities of goods and services.

Why is mathematics essential in microeconomic theory? Mathematics provides a precise and

rigorous language and set of tools to model, analyze, and predict economic behavior. It allows
economists to formalize theories, derive logical conclusions, and test hypotheses using data.
Concepts like optimization, calculus, and algebra are crucial for understanding and working with
microeconomic models.

2: Consumer Theory - Preferences and Utility

What is the difference between ordinal and cardinal utility?

 Ordinal utility suggests that consumers can rank their preferences for different bundles
of goods and services without assigning specific numerical values to the level of
satisfaction. They can say they prefer bundle A to bundle B, but not by how much.
 Cardinal utility assumes that consumers can assign numerical values to the level of
satisfaction they derive from consuming different bundles. This allows for comparisons
of the intensity of preferences. Modern microeconomics primarily relies on ordinal
utility.

How do consumers make purchasing decisions considering their income and prices?
Consumers make purchasing decisions by trying to maximize their utility (satisfaction) given
their budget constraint (income and the prices of goods and services). They will choose a
combination of goods and services that they prefer most and can afford. This involves
considering their preferences, the prices of available goods, and the total amount of money
they have to spend.

3: Consumer Theory - Demand and Elasticity

What is the income effect in consumer choice?

The income effect refers to the change in a consumer's consumption of a good that results from
a change in their purchasing power due to a change in their real income (even if nominal
income stays the same). For normal goods, an increase in income leads to an increase in
quantity demanded, while for inferior goods, an increase in income leads to a decrease in
quantity demanded.
 What does consumer surplus mean? Consumer surplus is the difference between the total
amount that consumers are willing and able to pay for a good or service and the total amount
that they actually do pay. It represents the net benefit or "extra value" that consumers receive
from purchasing a good or service at a price lower than their maximum willingness to pay.

4: Production Theory - Technology and Costs

What is the difference between short-run and long-run costs?

 Short-run costs are costs where at least one factor of production (usually capital) is
fixed, and the firm can only vary its output by changing the amount of variable inputs
(like labor and materials). There are both fixed costs (that do not change with output)
and variable costs (that do).
 Long-run costs are costs where all factors of production are variable. Firms can adjust
the scale of their operations and choose the most efficient combination of inputs for
any given level of output. There are no fixed costs in the long run.

What does the marginal rate of technical substitution (MRTS) mean?

The marginal rate of technical substitution (MRTS) is the rate at which a firm can substitute one
input (e.g., labor) for another input (e.g., capital) while keeping the level of output constant. It is
the absolute value of the slope of an isoquant curve at a particular point and reflects the trade-
off between inputs in the production process.

5: Profit Maximization and Supply Decisions

What are the key features of perfect competition? Main features of perfect competition
include:These features are also known as assumptions of the perfect competition.

 A large number of buyers and sellers.

 Homogeneous (identical) products.
 Free entry and exit into the market.
 Perfect information for all participants.
 Firms are price takers (they cannot influence the market price).
 Theirs is no preferential treatment
 Factors of production are perfectly mobile.

How is a firm's supply curve derived under perfect competition?

Under perfect competition, a firm's supply curve is derived from the portion of its marginal cost
(MC) curve that lies above its average variable cost (AVC) curve. A profit-maximizing firm will
produce at the level where marginal cost equals the market price (MC = P), as long as the price
is high enough to cover its average variable costs.
6: Market Equilibrium and Efficiency

What is the difference between partial and general equilibrium?

 Partial equilibrium analysis examines the equilibrium in a single market, taking the
conditions in other markets as given. It focuses on the interaction of supply and
demand in that specific market without explicitly modeling the interdependencies
with other markets.
 General equilibrium analysis considers the simultaneous equilibrium of all markets in
an economy. It recognizes the interrelationships between different markets and how
changes in one market can affect others. It aims to find a set of prices and quantities
that simultaneously clears all markets.

How do prices help allocate resources?

 Prices act as signals in a market economy, conveying information about the relative
scarcity and value of goods and services.
 Signaling function: High prices signal scarcity and encourage producers to increase
supply and consumers to reduce demand. Low prices signal abundance and encourage
the opposite.
 Incentive function: Prices provide incentives for producers to allocate resources to the
production of goods and services that are most valued by consumers (those with higher
prices). They also incentivize consumers to economize on the use of scarce resources.
 Rationing function: Prices ration scarce goods and services among consumers who are
willing and able to pay for them.

7: Monopoly and Market Power

What is price discrimination?

Price discrimination is a selling strategy where a seller charges different prices to different
buyers for the same good or service for reasons not associated to the cost of production.. This is
possible when the seller has some market power and can prevent arbitrage (resale by buyers
who paid a lower price). There are different degrees of price discrimination.

What role do governments play in regulating monopolies?

Governments regulate monopolies to prevent them from exercising their market power in ways
that harm consumers and reduce economic efficiency. Common regulatory measures include:

 Price controls: Setting maximum prices that a monopoly can charge.

 Antitrust laws: Preventing the formation of monopolies and breaking up existing ones.
  Regulation of services: Controlling the quality and availability of services provided by
natural monopolies.
 Promoting competition: Encouraging entry into markets dominated by monopolies.

8: Monopolistic Competition and Market Structure Comparisons

What are the key differences between monopolistic competition and perfect competition?

 Product differentiation: Monopolistically competitive firms sell differentiated products

(similar but not identical), while perfectly competitive firms sell homogeneous products.
 Market power: Monopolistically competitive firms have some degree of market power
and can influence their own prices to a limited extent, while perfectly competitive firms
are price takers.
 Under perfect market situation, the commodities are homogeneous while in monopoly
they are heterogeneous.
 The demand curve under PM Is perfectly elastic while in monopoly the demand curve
is fairly elastic.
 The monopoly earns abnormal profit both in long and short run while perfect market
profit is earned in the short run.
 Under monopoly, there is no free entry and exit because the maker is regulated while
in PM there free entry and exit.
 Under monopoly, we could observe government intervention known as regulated
monopoly while under PM there is no government intervention.
 In PM forms are price takers while in monopoly, the firm is a price maker.

1: Introduction to Microeconomic Theory

False: Microeconomics primarily deals with the behavior of individual economic agents
(households, firms) and their interactions in specific markets. Macroeconomics focuses on the
aggregate economy, including inflation and unemployment.

True: Positive economics deals with objective statements about "what is" and can be tested and
validated against real-world data.

Consumer Theory - Preferences and Utility

True: This describes the property of transitivity of preferences, a fundamental assumption in

consumer theory.

False: The Marginal Rate of Substitution (MRS) is the absolute value of the slope of the
indifference curve and it typically diminishes (decreases) as you move along a convex
indifference curve. This is because consumers are generally willing to give up less of one good to
obtain one more unit of another good they already have a lot of.
Consumer Theory - Demand and Elasticity

True: The Hicksian (or compensated) substitution effect isolates the impact of a price change on
quantity demanded by keeping the consumer's utility level constant.

False: A perfectly inelastic demand curve is vertical. This indicates that the quantity demanded
does not change regardless of the price. A horizontal demand curve represents perfectly elastic
demand.

Production Theory - Technology and Costs

False: Isoquants are downward-sloping curves. They show different combinations of inputs that
yield the same level of output.

True: In the long run, there are no fixed factors of production; all inputs can be varied by the
firm.

Profit Maximization and Supply Decisions

False: In perfect competition, firms are price takers and cannot influence the market price. They
must accept the prevailing market price.

True: Producer surplus is the difference between the market price that producers receive for
their goods and the minimum price they are willing to accept (their marginal cost). It is
represented by the area above the supply curve and below the market price.

Market Equilibrium and Efficiency

True: The First Welfare Theorem states that under certain conditions, a competitive equilibrium
will result in a Pareto efficient allocation of resources.

False: General equilibrium analysis examines the simultaneous equilibrium across multiple
interconnected markets in an economy, not a single market in isolation.

Monopoly and Market Power

True: A monopolist, like any profit-maximizing firm, will produce the quantity of output where
its marginal cost (MC) equals its marginal revenue (MR).

False: Price discrimination, if implemented successfully, generally increases a monopolist's

profits by allowing it to capture more consumer surplus.