Theory of demand

Traps in Theory of demand

• Picks a closely related concept
  Learn related terms as contrasting pairs with one-line definitions, and identify which one the stem describes.
• Utility theory errors
  Marginal utility = change in total utility from one more unit; it diminishes. Total utility is maximum when MU = 0. Consumer equilibrium: MUa/Pa = MUb/Pb.
• Over-generalises a rule
  Economic laws hold 'other things being equal' and within limits. Be suspicious of options with always/never/all.
• Stops at a different economic quantity
  Underline what the question asks for and check the final number is THAT quantity, not a step on the way.
• Gives a number from the question as the answer
  If your answer appears in the question, check again: the question almost never asks you to copy a figure. Work out the required quantity from its definition.
• Confuses movement along and shift of the demand curve
  A change in the good's OWN price causes movement ALONG the curve. Changes in income, tastes, prices of related goods etc. SHIFT the curve.
• Confuses types of elasticity
  Income elasticity: + normal, − inferior. Cross elasticity: + substitutes, − complements. PED is usually negative; |PED| compared with 1.
• Applies the rule for the opposite case
  Before answering, name the case in the stem (inelastic? price floor ABOVE equilibrium? point INSIDE the PPC?) and recall the rule for that case only.
• Reverses the direction of the effect
  Trace the chain step by step (e.g. buying securities → banks gain cash → money supply rises) and check the sign at every link.
• Chooses a true but irrelevant statement
  Re-read the question's key term and test each option against it, not against whether it is true in general.
• Confuses a movement along a curve with a shift
  Own price changes → movement ALONG the curve. Any other factor (income, tastes, price of related goods, costs) → SHIFT of the curve.
• Picks another type in the same classification
  Learn each classification as a table of types with one defining feature each (monopoly: one seller; monopsony: one buyer; command economy: central planning).
• Uses the everyday meaning of a term
  Economic terms have precise definitions. Recall the textbook definition before matching.
• Confuses scale of preference, wants and choice
  Wants are unlimited; resources are scarce → choice. A scale of preference ranks wants in order of importance. Free goods (air) have no opportunity cost; economic goods are scarce and command a price.
• Uses the wrong arithmetic operation
  Write the definition in words first (TR = price × quantity; ATC = TC ÷ Q) and only then put in numbers. Check units: totals and averages cannot be added.
• Turns the formula upside down
  Learn the formula with its meaning: elasticity = responsiveness of QUANTITY, so %ΔQ is on top; k = 1/MPS = 1/(1 − MPC).
• Gives only part of the answer
  List every component in the definition (GDP = C + I + G + (X − M)) and tick them off before answering.
• Misreads price ceilings and floors
  A maximum price set BELOW equilibrium causes shortage (black markets); a minimum price ABOVE equilibrium causes surplus.