EC1A5 Microeconomics Exam Revision Guide
Exam Writing Guide:
When answering a question mention these topics, for example:
Acronym: BIRDLIE
Demand & Supply, and the concepts that come with it:
o Elasticity (including cross price elasticity of demand), Market
Clearing price & quantity, and Producer & Consumer surplus
o Subsidies and Lump-sum. When mentioning tariffs, briefly
relate the price to the world price, pw, to state that the foreign
suppliers will only be willing to sell if the price is more or equal
to pw.
o Remember that the demand curve for an individual firm in
Perfect Competition is perfectly elastic. So the
MR=AR=Demand Curve.
o Let’s assume that there is an increase in tax paid by
employers on wages and the labour supply is perfectly
inelastic. In this case, if the y-axis is wage paid by the
employer, then the curves will not shift: the demand curve
won’t because it’s the wage paid by the employer, and the
supply curve won’t shift because it is completely inelastic.
However, if the y-axis was wage received by workers, then the
demand curve will shift down.
Budget Constraints (for two goods & home time vs consumption),
if the question is regarding income and consumers, this also
includes:
o Indifference Curves, the marginal rate of substitution, utility,
and whether the goods are complements or substitutes
o Whether the goods are normal, luxury, or inferior (this
includes Giffen goods). These topics are associated with
income elasticity of demand
o When mentioning goods, the substitution and income effect
must be mentioned. A positive Income effect is when demand
rises when income increases
Revenues and Costs:
o Monopolistic competition is one model of an oligopoly market
(not to be confused with monopoly)
U-shaped cost curves should be drawn, unless stated
otherwise
MR=MC is still the profit maximizing point
o Remember that Average revenue curve is also the demand
curve, Average revenue and Average costs are taken by
, EC1A5 Microeconomics Exam Revision Guide
calculation the slope of the line stretched from the origin to a
particular point. When there are constant returns to scale, the
Average and Marginal costs curves are equal and horizontal
(perfectly elastic)
o Returns to scale, whilst perfectly competitive markets have
constant returns to scale. Here, the firms produce at P = MC,
because in this case, MR = P, so it is the same as saying MR =
MC or P = MC (for profit maximization)
o A firm has decreasing returns to scale if MC > AC, and vice
versa
o Markup of price over marginal cost (Gap between Price and
MC)
o Marginal Revenue will always be below the Average Revenue
Curve (Demand curve, they are both the same). This also
means that when the MR = MC, the price must be higher,
because AR curve is always above MR curve
o Fixed Costs only affect Average Costs, not Marginal Costs
o Increasing returns to scale leads to Monopoly
o Profits can be written as R = Q x (P – AC). Even if the firm is
producing at MR = MC, we need to check whether P > AC,
otherwise the firm is making negative profits
o Also, if MR > MC, then it does not make sense to produce at
MR = MC, since MR is increasing and is more than MC.
However, this is unlikely
o Producer Surplus is the area between the Price and the MC
and the quantity, the Price is selected at MR = MC, and then
selecting the price at that quantity in the AR curve
o Finally, relate these facts with inequality, because in reality,
some firms may have price inequality. Which means that they
may charge different prices, depending on age, occupation
(student discounts), etc.
o Price charged by sellers are related to MC not AC, because,
sellers sell at the point where MR = MC, so an increase in AC
would only decrease profits but won’t have any effect on
quantity or price
o This is how Price and MC are related, the
lower the MC, the higher Price is compared to MC (if the
Elasticity is less than one, then there is no point of this
formula)
o The demand curve for an individual firm is perfectly elastic
