ECO 304K, Introduction to Microeconomics | University of Texas at Austin Source: Practice Mock Exam 2026 Difficulty: Introductory | Prerequisites: None
This material covers the building blocks of how markets work: what drives buyers and sellers, how prices form, and how consumers make choices with limited budgets. It sits at the core of any introductory microeconomics course and underpins nearly everything else you will study, from market structures to welfare economics.
You should already be comfortable with basic algebra (solving for unknowns, working with fractions and percentages). If terms like "supply curve" or "equilibrium" feel completely unfamiliar, start here. If you already know those, this set of notes will sharpen your exam technique and fill gaps.
Demand curves slope down, supply curves slope up, and equilibrium is where they cross. Price elasticity measures how sensitive quantity is to price changes (use the midpoint formula). Consumer choice theory explains how people allocate a fixed budget across goods by comparing marginal utility per pound spent, using budget lines and indifference curves.
Demand
The relationship between a good's price and the quantity consumers are willing and able to buy, holding all else constant. In simple terms, it answers "how much will people buy at each price?"
Supply
The relationship between a good's price and the quantity producers are willing and able to sell, holding all else constant. Think of it as the seller's side of the same question.
Equilibrium price and quantity
The price at which quantity demanded equals quantity supplied, so there is no tendency for the price to change. In simple terms, it is the price the market settles on when left alone.
Price elasticity of demand (PED)
A measure of how responsive the quantity demanded of a good is to a change in its price. Think of it as "how much do buyers flinch when the price moves?"
Midpoint method
A formula for calculating elasticity that uses the average of the old and new values as the base, avoiding the problem of getting different answers depending on which direction you calculate. Also called the arc elasticity method.
Income elasticity of demand
Measures how quantity demanded responds to a change in consumer income. Positive for normal goods, negative for inferior goods.
Cross-price elasticity of demand
Measures how quantity demanded of one good responds to a change in the price of another good. Positive for substitutes, negative for complements.
Normal good
A good for which demand increases when income rises (positive income elasticity). In simple terms, you buy more of it when you get richer, such as organic produce.
Inferior good
A good for which demand falls when income rises (negative income elasticity). Think instant noodles: as income grows, people switch to better alternatives.
Substitutes
Goods that can replace each other in consumption. A rise in the price of one increases demand for the other. Cross-price elasticity is positive.
Complements
Goods that are consumed together. A rise in the price of one reduces demand for the other. Cross-price elasticity is negative.
Income effect
The change in quantity demanded that results from a price change altering the consumer's real purchasing power. When a good's price falls, your budget effectively stretches further, so you can buy more.
Substitution effect
The change in quantity demanded that results from a price change making the good relatively cheaper or more expensive compared to alternatives.
Budget line (budget constraint)
A line showing all the combinations of two goods a consumer can afford given their income and the prices of the goods. Its slope equals the negative ratio of the two prices.
Indifference curve
A curve showing all combinations of two goods that give a consumer the same level of total utility. The consumer is equally happy at every point on the curve.
Marginal rate of substitution (MRS)
The rate at which a consumer is willing to trade one good for another while keeping total utility constant. It equals the absolute value of the slope of the indifference curve at any given point.
Diminishing marginal utility
The principle that each additional unit of a good consumed adds less to total utility than the previous unit. Total utility still rises, just more slowly.
Reservation price (willingness to pay)
The maximum price a buyer is willing to pay for a good or service. Also known as WTP.
The demand curve slopes downward: as price rises, quantity demanded falls (law of demand).
The supply curve slopes upward: as price rises, quantity supplied increases (law of supply).
Equilibrium occurs where the two curves intersect. At that price, the market clears.
A change in the good's own price causes a movement along the curve.
A shift of the entire curve is caused by something other than the good's own price:
Demand shifters: income, tastes/preferences, prices of related goods, expectations, number of buyers.
Supply shifters: input prices, technology, expectations, number of sellers, prices of related goods in production.
A technological breakthrough that increases crop yields shifts the supply curve to the right.
A change in consumer preferences toward healthy eating shifts the demand curve, not the supply curve.
A decrease in the price of chemical fertilisers for non-organic farming could shift supply of organic produce to the left (producers switch away), but this is a supply-of-substitutes-in-production question, so read carefully.
Price elasticity of demand (PED) measures percentage change in quantity demanded divided by percentage change in price.
The midpoint method uses the average of old and new values as the base:
%ΔQ = (Q2 - Q1) / ((Q1 + Q2)/2)
%ΔP = (P2 - P1) / ((P1 + P2)/2)
PED = |%ΔQ / %ΔP|
Example: price goes from $10 to $12, quantity falls from 100 to 80. %ΔQ = -20/90 = -0.222. %ΔP = 2/11 = 0.1818. PED = 0.222/0.1818 = 1.22 (elastic).
Perfectly inelastic demand: PED = 0, the demand curve is vertical, quantity does not change regardless of price. If a tax is imposed, buyers bear the entire burden because they will not reduce their purchases.
Cross-price elasticity: positive for substitutes (price of one rises, demand for the other rises), negative for complements (price of coffee rises, demand for creamer falls).
Income elasticity: positive for normal goods, negative for inferior goods.
Normal good: demand increases when income rises. The demand curve shifts right.
Inferior good: demand decreases when income rises. The demand curve shifts left.
The classification depends on income elasticity: positive means normal, negative means inferior.
When the price of a good falls, two things happen simultaneously:
Income effect: the consumer's real purchasing power increases, allowing them to buy more of all goods.
Substitution effect: the good is now relatively cheaper compared to substitutes, so the consumer shifts spending toward it.
The income effect is about purchasing power. The substitution effect is about relative prices.
The budget line shows every combination of two goods the consumer can afford. Its equation: Px * Qx + Py * Qy = Income.
The slope of the budget line = -Px/Py. This is the opportunity cost of one good in terms of the other, determined by relative prices.
A price decrease for one good pivots the budget line outward along that good's axis. The intercept for the other good stays the same, and the slope becomes flatter (in absolute value).
Example: Lee has $100, Daggers cost $20 each, Dolls cost $10 each. Budget line: 20Qx + 10Qy = 100. X-intercept = 5, Y-intercept = 10, slope = -2. If Daggers fall to $10, X-intercept becomes 10, slope becomes -1.
Indifference curves show combinations of goods giving equal utility. They slope downward, are convex to the origin, and do not cross.
The MRS is the absolute value of the slope of the indifference curve. It diminishes as you move along the curve (reflecting the diminishing willingness to give up one good for another).
Utility is maximised where the budget line is tangent to the highest attainable indifference curve, which is the point where MRS = Px/Py.
Each additional unit consumed adds less satisfaction than the one before.
Total utility still increases, but at a decreasing rate, as long as marginal utility is positive.
Total utility only falls once marginal utility turns negative. This is a common exam trap: diminishing marginal utility does not mean total utility is falling.
Midpoint elasticity formula
PED = |(Q2 - Q1) / ((Q1 + Q2)/2)| / |(P2 - P1) / ((P1 + P2)/2)|
Budget constraint
Px * Qx + Py * Qy = Income
Slope of the budget line
Slope = -Px / Py
MRS at the optimal bundle
MRS = Px / Py (at the tangency point between the indifference curve and the budget line)
Income elasticity of demand
Ei = %ΔQd / %ΔIncome
Cross-price elasticity of demand
Exy = %ΔQd of good X / %ΔP of good Y
The midpoint elasticity formula is exactly how economists and pricing analysts estimate whether a price increase will raise or lower total revenue. If PED > 1 (elastic), raising the price actually reduces revenue because customers leave faster than the price rises.
Budget lines and indifference curves are the theoretical backbone of how consumer research firms model trade-offs: if a phone costs $200 more, how many other purchases does the consumer forgo, and is the upgrade still worth it?
Students often confuse a shift of the demand or supply curve with a movement along it. A change in the good's own price is always a movement along; everything else shifts the curve.
Diminishing marginal utility does not mean total utility is decreasing. Total utility keeps rising as long as marginal utility is positive. It only falls once marginal utility turns negative.
The slope of the budget line is not the MRS. The slope of the budget line is the price ratio (-Px/Py). The MRS is the slope of the indifference curve. They are equal only at the optimal consumption point.
Cross-price elasticity is negative for complements, not positive. Students frequently mix this up. If coffee gets more expensive and you buy less creamer, that is a negative relationship.
⚠️ The midpoint method is almost guaranteed to appear. Practise the arithmetic until you can do it without hesitation.
⚠️ Know the difference between a shift and a movement. The exam will offer a price change as one of the options for "what shifts the curve" to catch you out.
⚠️ Budget line slope questions test whether you know that slope = -Px/Py (the price ratio), not the MRS.
⚠️ Perfectly inelastic demand and tax incidence: if demand is perfectly inelastic, buyers bear the full tax. This is a favourite exam question.
⚠️ Income effect vs substitution effect: the income effect is about purchasing power changing, the substitution effect is about relative prices changing. The exam will try to make you confuse them.
True or false: diminishing marginal utility means total utility is falling. (False)
Fill in the blank: the slope of the budget line equals ____. (-Px/Py)
True or false: cross-price elasticity is positive for complements. (False, it is negative)
If PED = 1.22, is demand elastic or inelastic? (Elastic, because PED > 1)
True or false: a change in consumer preferences shifts the supply curve. (False, it shifts the demand curve)
Q: If the price of a good increases from $10 to $12 and the quantity demanded falls from 100 to 80 units, what is the price elasticity of demand using the midpoint method?
A: %ΔQ = (80 - 100)/90 = -0.222. %ΔP = (12 - 10)/11 = 0.1818. PED = |-0.222/0.1818| = 1.22.
Q: Which of the following would cause a shift in the supply curve for organic produce: (a) an increase in market price, (b) a decrease in fertiliser costs for non-organic farming, (c) a technological breakthrough increasing yields, (d) a change in consumer preferences?
A: (c). Technology is a supply shifter. Price changes cause movements, not shifts. Preferences shift demand, not supply.
Q: If a good is an inferior good, what happens to demand when income rises?
A: Demand falls (the demand curve shifts left). By definition, inferior goods have negative income elasticity.
Q: The income effect explains that when the price of a good falls, what happens?
A: The consumer's purchasing power increases, allowing them to buy more. This is distinct from the substitution effect, which is about the good becoming relatively cheaper.
Q: What does the slope of the budget line represent?
A: The relative price of the two goods, expressed as -Px/Py. It represents the opportunity cost of consuming one more unit of the x-axis good in terms of the y-axis good.
Q: Lee has a $100 budget, Daggers cost $20 and Dolls cost $10. If Daggers drop to $10, how do the budget line intercepts and slope change?
A: The Dagger intercept (x-axis) shifts from 5 to 10. The Doll intercept (y-axis) remains 10. The slope changes from -2 to -1. The budget line pivots outward and becomes flatter.
Q: If a 10% tax is imposed on a good with perfectly inelastic demand, who bears the burden?
A: The buyers bear the full burden. Perfectly inelastic demand means consumers will not change the quantity they buy regardless of price, so the entire tax is passed on to them.
This connects to market efficiency and surplus because consumer and producer surplus are calculated from the demand and supply curves covered here. Understanding elasticity is essential for analysing tax incidence and deadweight loss in the next set of notes.
Budget lines and consumer choice theory feed directly into demand curve derivation: the demand curve is built from the consumer's optimal choices at different prices.
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