question
Economics
answer
Study of how to allocate scare resources to satisfy unlimited human wants.
question
Questions Microeconomics seeks to answer by studying the behavior of individual economic units (3)
answer
What goods and services will be produced and by how much?
Who will produce them and how?
Who will get them?
Who will produce them and how?
Who will get them?
question
Model
answer
Simplified version of reality that economists study the relationship between them and variables.
question
Exogenous Variable
answer
A variable whose value is taken as given in a model. Determined outside of the system.
question
Endogenous Variable
answer
A variable whose value is determined within the model. We solve for the endogenous variable.
question
Constrained Optimization
answer
Tool to analyze markets. Tool for making the best (optimal) choice, taking into account any possible limitations or restrictions on the choice. Contains two parts.
question
Objective Function
answer
Part of the Constrained Optimization, the relationship the decision maker seeks to maximize or minimize. Maximize profit, minimize costs.
question
Constraints
answer
Part of the Constrained Optimization, the restrictions or limitations imposed on a decision maker in a constraint optimization problem (C.O.P), reflection of scarce resources- income, etc.
question
Constrained Optimization Problem Format
answer
(max) or (Min): Objective Function (in terms of X,Y)
Subject to: (Constraints)
- The solution to any C.O.P. depends on the marginal impact of the decision variables on the value of the objective function (The satisfaction begins to decrease with additional units purchased)
Subject to: (Constraints)
- The solution to any C.O.P. depends on the marginal impact of the decision variables on the value of the objective function (The satisfaction begins to decrease with additional units purchased)
question
Marginal
answer
Tells how a dependent variable changes as a result of adding one more unit of an independent variable.
question
Marginal Cost
answer
Measures incremental impact of the last unit of the independent variable on the dependent variable, thought of as the "Rate of Change"
question
Equilibrium
answer
A state or condition that will continue indefinitely as long as the factors exogenous to the system remain unchanged.
question
Market Equilibrium
answer
Markets move toward equilibrium to sell/buy goods for the correct amount. Market Equilibrium is achieved at a price where the market "Clears", where Qs=Qd. When out of equilibrium, either the price is too high or too low and there is either a surplus or a shortage.
question
Comparative Statics
answer
Analysis used to examine how a change in an exogenous variable will affect the level of an endogenous variable in an economic model. -Shows before and after of a change in Exogenous Variable. - Helps determine Elasticity.
question
Positive Analysis
answer
Explains how an economic system works to predict how it will change over time. Asks "what has happened"
question
Normative Analysis
answer
Analysis that typically focuses on issues of social welfare, examining what will enhance or detract from the common good. Asks "What should be done?"
question
Perfect Competitive Markets
answer
Large number of buyers and sellers, individual transactions are so small that both buyers and sellers are price takers. No barriers to entry, selling identical goods.
question
Market Demand Curve
answer
A curve that shows us the quantity of goods that consumers are willing to buy at different prices. Consists of Derived Demand and Direct Demand. Shows the highest price that the "market will bear" for a given quantity or supply of output.
question
Derived Demand
answer
Demand for a good that is derived from the production and sale of other goods.
question
Direct Demand
answer
Demand for a good that comes from the desire of buyers to directly consume the good itself.
question
Movement along demand curve
answer
A change in price causes movement along the demand curve.
question
Demand Shifters
answer
PINTE:
P:rices of related goods
I:ncome of consumers
N:umber of buyers
T:astes
E:xpectations
P:rices of related goods
I:ncome of consumers
N:umber of buyers
T:astes
E:xpectations
question
Law of Demand
answer
The inverse relationship between the price of a good and the quantity demanded, holding all other factors that influence demand constant (Ceteris Paribus)
question
Market Supply Curve
answer
A curve that shows us the total quantity of good that their suppliers are willing to sell at different prices. Slopes upward because as prices rises, more suppliers are willing to offer more of the good.
question
Movement along supply curve
answer
Movement along supply curve is caused by a change in price.
question
Supply Shifters
answer
PINTE
P:rice of substitutes in production- shitting to other goods b/c of a change in market price.
I:nput prices- factors of production
N:umber of Sellers
T:echnological enhancements
E:xpectations
P:rice of substitutes in production- shitting to other goods b/c of a change in market price.
I:nput prices- factors of production
N:umber of Sellers
T:echnological enhancements
E:xpectations
question
Law of Supply
answer
The positive relationship between price and quantity supplied when all other factors that influence supply are held fixed.
question
Market Equilibrium
answer
a point at which there is no tendency for the market price to change as long as the exogenous variables remain unchanged. At any other point other than the equilibrium, there is pressure to move towards equilibrium.
question
Basics Laws of Supply and Demand (4)
answer
1) Increase in demand+Unchanged Supply= higher equilibrium price, larger equilibrium quantity.
2) Decrease in Supply+ Unchanged Demand= Higher equilibrium price and smaller equilibrium quantity.
3) Decrease in Demand + Unchanged Supply= lower equilibrium price and smaller equilibrium quantity.
4) Increase in supply+ unchanged demand= lower equilibrium price and larger equilibrium quantity.
2) Decrease in Supply+ Unchanged Demand= Higher equilibrium price and smaller equilibrium quantity.
3) Decrease in Demand + Unchanged Supply= lower equilibrium price and smaller equilibrium quantity.
4) Increase in supply+ unchanged demand= lower equilibrium price and larger equilibrium quantity.
question
Shifts in both supply and demand
answer
Increase in demand + decrease in Supply= increase in equilibrium price and ambiguous change in quantity.
question
Price Elasticity of Demand
answer
A measure of the rate of percentage change of quantity demanded with respect to price, ceteris paribus. Measures sensitivity of the quantity demanded to price.
question
Formula for Price Elasticity of Demand
answer
E(q,p)=% change in quantity/ % change in price equivalent:
E(q,p)= (dQ/dP) * (P/Q)
-d denotes the derivative (rate of change)
E(q,p)= (dQ/dP) * (P/Q)
-d denotes the derivative (rate of change)
question
Equation for Linear Demand Curve
answer
Q=a-bP
a= all factors that will shift the demand curve
b= how price affects Qd
a= all factors that will shift the demand curve
b= how price affects Qd
question
Inverse Demand Curve
answer
1-(Q/P)
question
Total Revenue
answer
TR=P*Q. Elasticity of the good determines the price effect and quantity effect. Have to find out which is stronger to determine the change in TR. If the good is inelastic, an increase in price raises the TR. Elastic with an increase in price decreases TR.
question
Perfectly Inelastic Demand
answer
E(q,p)= 0. TR changes with price. completely vertical demand curve. QD is totally insensitive to P. * the flatter of the two curves that cross at a particular point is the more ELASTIC good.
question
Inelastic Demand
answer
-1<E(q,p)<0. TR changes with price. Price effect. Qd is relatively insensitive to price.
question
Unit Elastic Demand
answer
E(q,p)=-1. Neither effect changes TR, a % increase in Qd= a % decrease in P. Completely horizontal demand curve.
question
Elastic Demand
answer
-infinity<E(q,p)<-1. TR changes with quantity effect. Qd is sensitive to P.
question
Perfectly Elastic Demand
answer
Any increase in price results in Qd decreasing to zero and any decrease in price results in quantity demanded increasing to infinity. P Increase= TR= 0. P decrease= TR= Infinity.
question
Determinants of Price Elasticity of Demand (4)
answer
1) Number of available substitutes: more substitutes available means the demand is more elastic. (more narrowly defined markets have more substitutes- market for minute maid vs juice in general)
2) Percentage of income spent: demand for highly priced items which take up larger shares of income is more elastic. Usually durable goods: Cars, furniture, kitchen appliances.
3) The good is a Necessity or a Luxury: Necessities tend to have inelastic demand- food. Luxuries tend to have more elastic demand- diamonds.
4) Time horizon: for some good, the demand is more elastic in the long run. For gas, it is a necessity in the short run but you can substitute away from driving in the long run.
* Remember, consider the different elasticities for general goods (cigarettes) vs brands (parliaments)
2) Percentage of income spent: demand for highly priced items which take up larger shares of income is more elastic. Usually durable goods: Cars, furniture, kitchen appliances.
3) The good is a Necessity or a Luxury: Necessities tend to have inelastic demand- food. Luxuries tend to have more elastic demand- diamonds.
4) Time horizon: for some good, the demand is more elastic in the long run. For gas, it is a necessity in the short run but you can substitute away from driving in the long run.
* Remember, consider the different elasticities for general goods (cigarettes) vs brands (parliaments)
question
Income Elasticity of Demand
answer
The ratio of the percent change in QD to the percent change in income, determinants held constant.
Normal goods have Positive income Elasticity.
Inferior goods have Negative income elasticity.
Necessities has small income elasticities.
Luxuries have large income elasticities.
Normal goods have Positive income Elasticity.
Inferior goods have Negative income elasticity.
Necessities has small income elasticities.
Luxuries have large income elasticities.
question
Income Elasticity of Demand Equation
answer
E(q,i)= dQ/dI * (I/Q)
question
Cross-Price Elasticity of Demand
answer
The ratio of the percent change of the Quantity of one good demanded with respect to the percent change in the price of another good.
Substitutes have positive cross-price elasticity.
Complements have negative cross-price elasticity.
Substitutes have positive cross-price elasticity.
Complements have negative cross-price elasticity.
question
Cross-Price Elasticity of Demand Equation
answer
E(Qi,Pj)= dQi/QPj * (Pj/Qi)
j= good 2
i= good 1.
j= good 2
i= good 1.
question
Price Elasticity of Supply
answer
The percent change in quantity supplied for each percent change in price. Determinants held constant.
question
Price Elasticity of Supply Equation
answer
E(qs,p)= dQs/dp * (p/qs)
question
Basket
answer
A combination of goods and services that an individual might consume. Also known as a "Consumption Bundle"
question
Consumer Preferences
answer
Indications of how a consumer would rank any two possible baskets, assuming the baskets were available to the consumer at NO COST.
question
Assumptions about Consumer Preferences (3)
answer
1) Preferences are complete: the consumer is able to rank any two baskets; A & B.
- Completeness:
If a consumer prefers A: A>B (not a greater sign)
Etc. Indifference looks like a = sign but with two of these: ~
2) Preferences are transitive: The consumer makes consistent choices.
-If a consumer likes basket A more than B and B more than C, the consumer should like basket A more than basket B.
3) More is Better- More is ALWAYS better.
- Completeness:
If a consumer prefers A: A>B (not a greater sign)
Etc. Indifference looks like a = sign but with two of these: ~
2) Preferences are transitive: The consumer makes consistent choices.
-If a consumer likes basket A more than B and B more than C, the consumer should like basket A more than basket B.
3) More is Better- More is ALWAYS better.
question
Ordinal Ranking
answer
Rankings that indicate whether a consumer prefers one basket to another but does not contain quantitative information about the intensity of that preference. does NOT TELL DEGREE.
question
Cardinal Ranking
answer
A quantitative measure of the intensity of a preference for one basket over another. Shows INTENSITY OF PREFERENCE. gives more information than an Ordinal Ranking.
question
Utility Function
answer
A function that measures the level of satisfaction a consumer receives from any basket of goods and services. Must satisfy the 3 assumptions of preference: Completeness, transitive, and more is better.
question
Marginal Utility
answer
Denoted MU. The rate at which total utility changes as the level of consumption rises. It is the derivative of the Utility function.
1)MU is always positive, so U is increasing in T.
2) MU is decreasing, so U is increasing at a decreasing rate.
1)MU is always positive, so U is increasing in T.
2) MU is decreasing, so U is increasing at a decreasing rate.
question
Marginal Utility Equation
answer
MUt= Du/Dt (derivative of T in the Utility function)- slope of U at different levels of T.
question
Principle of Diminishing Marginal Utility
answer
The principle that after some point, as consumption of a good increases, the MU of that good will begin to fall.
-UT and MU cannot be plotted on the same graph, vertical axis represent U for the respective functions.
-MU is slope of UT.
1) The slope of MU is Negative.
2) 1st order derivatives decides if U is increasing or not.
3) 2nd order derivative decides the rate at which U is changing.
4) TR increases when MU is positive.
5) TR decreases when MU is negative.
- on a graph, the portion of the graph above the X axis shows where U is increasing, below is where U is decreasing.
-UT and MU cannot be plotted on the same graph, vertical axis represent U for the respective functions.
-MU is slope of UT.
1) The slope of MU is Negative.
2) 1st order derivatives decides if U is increasing or not.
3) 2nd order derivative decides the rate at which U is changing.
4) TR increases when MU is positive.
5) TR decreases when MU is negative.
- on a graph, the portion of the graph above the X axis shows where U is increasing, below is where U is decreasing.
question
Preferences with Multiple goods
answer
When measuring the MU of the utility of two goods, we hold constant the levels of consumption of all other goods. You take partial derivatives of both goods.
question
Indifference Curves
answer
A curve connecting a set of consumption baskets that yield the same level of satisfaction to the consumer.
question
Properties of Indifference curves (4)
answer
1) When the consumer likes both goods (MUx & MUy > 0) all the indifferences curves have negative slope.
2) Indifference curves cannot intersect, the baskets need to be transitive to satisfy them being a consumer preference so if the curves intersect, that means it depends on what side of the curve you're looking at, they will change which one is more NE.
3) Every consumption basket likes on one and only one indifference curve. (They can't cross)
4) Indifference curves aren't thick. For two baskets that are right next to each other, you would assume the more NE one is the preferred basket, but since they lie on the same curve, that can't be true and that isn't true.
2) Indifference curves cannot intersect, the baskets need to be transitive to satisfy them being a consumer preference so if the curves intersect, that means it depends on what side of the curve you're looking at, they will change which one is more NE.
3) Every consumption basket likes on one and only one indifference curve. (They can't cross)
4) Indifference curves aren't thick. For two baskets that are right next to each other, you would assume the more NE one is the preferred basket, but since they lie on the same curve, that can't be true and that isn't true.
question
Marginal Rate of Substitution
answer
A feature of consumer preferences for which the MRS of one good for another good diminishes as the consumption of the first good increases along an indifference curve. MRS is the negative of the slope of the indifference curve. Y=vert X=Horiz. Holding Utility constant. If MUx & MUy are positive. IC curves are negatively sloped. MRSxy diminishes as increase X along an indifference curve. Diminishing MRSxy MUST have indifference curves bowed towards the origin.
question
Marginal Rate of Substitution Equation
answer
MRSxy= MUx/MUy= Change Y/ Change X
*as you increase consumption of one good, you are willing to give up less of the other good.
*as you increase consumption of one good, you are willing to give up less of the other good.
question
Perfect Substitutes
answer
Two goods such that the MRS of 1 good for the other is CONSTANT. Therefore, the indifference curves are straight lines. MRS=1. Slope of IC=1.
COKE AND PEPSI. MRS is constant along ICs. Same shape as the DEMAND CURVE.
COKE AND PEPSI. MRS is constant along ICs. Same shape as the DEMAND CURVE.
question
Perfect Complements
answer
Two good that the consumer ALWAYS wants to consume in fixed proportion to one and other. Left and Right Shoes. IC are RIGHT ANGLES. The indifference curves are parallel to the ORIGIN, same exact shape.
question
Cobb-Douglas Utility Function
answer
U(x,y)=Ax^&y^%
&= Alpha- (fish shape)
%= Beta-(Chinese Character shape)
A, &, % are positive constants. (usually &+%=1)
1) MU>0 for each good- more is better.
2) MU>0 means downward sloping IC
3) Diminishing MU (when % and & <1)
&= Alpha- (fish shape)
%= Beta-(Chinese Character shape)
A, &, % are positive constants. (usually &+%=1)
1) MU>0 for each good- more is better.
2) MU>0 means downward sloping IC
3) Diminishing MU (when % and & <1)
question
Cobb-Douglas Utility Function Proof
answer
U(x,y)=Ax^&y^%
MUx=&A^(&-1)y^%
MUy=%Ax^&y^(%-1)
MRS(x,y)=&A^(&-1)y^%/%Ax^&y^(%-1)
= &/% * Y/x
MUx=&A^(&-1)y^%
MUy=%Ax^&y^(%-1)
MRS(x,y)=&A^(&-1)y^%/%Ax^&y^(%-1)
= &/% * Y/x
question
Quasi-Linear Function
answer
When a consume buys the same amount of a commodity regardless of her income. Indifference Curves are Parallel to one and other, utility jumps when increase consumption of the good. At any value X, the slope of all the indifference curves will be the same (MRSxy remans the same) MRS depends SOLELY on X.
question
Quasi-Linear Function Equation
answer
U(x,y)=X^2+y (quadratic in X, NOT Y)
question
Budget Constraint
answer
The set of baskets that a consumer can purchase with a limited amount of Income. Measure of purchasing power of your nominal money: REAL income. So a change in nominal income is equivalent to a change of the same ratio of the price of both goods.
question
Budget Line
answer
The set of baskets that a consumer can purchase when spending all of his/ her income. The slope of the budget line tells us how many units of the good on the vertical axis a consumer must give up to obtain an additional unit of the good on the horizontal axis. Location depends on Level of Income.
1)Income Shifts B.L.
2) Price changes change intercepts.
1)Income Shifts B.L.
2) Price changes change intercepts.
question
Budget Line Equation
answer
I=PxX+PyY
I= Income
Px, Py= Price of good.
I= Income
Px, Py= Price of good.
question
Budget Constraint Equation
answer
I<(OR EQUAL TO) PxX+PyY
question
Optimal Choice
answer
Consumer choice of a basket of goods that
1) Maximizes satisfaction while,
2) allowing him to live within his budget constraint.
-Optimal amount of each good to purchase.
-Located on the Budget Line.
C.O.P: Maximize U(x,y)
{x,y} subject to:
PxX+PyY<(equal to) I
X>(or equal to) 0
Y>(or equal to) 0
Optimal consumption bundle is the tangent point of her budget line and on one of her indifference curves. (Slope of BC=Slope of IC)
1) Maximizes satisfaction while,
2) allowing him to live within his budget constraint.
-Optimal amount of each good to purchase.
-Located on the Budget Line.
C.O.P: Maximize U(x,y)
{x,y} subject to:
PxX+PyY<(equal to) I
X>(or equal to) 0
Y>(or equal to) 0
Optimal consumption bundle is the tangent point of her budget line and on one of her indifference curves. (Slope of BC=Slope of IC)
question
Tangency Condition
answer
MUx/MUy=Px/Py
Shows optimal Basket
"bang for your buck"
Shows optimal Basket
"bang for your buck"
question
Interior Optimum
answer
An optimal basket at which a consumer will be purchasing positive amount of all commodities. Where BL is tangent to IC. MUx/Px=MUy/Py. consumer chooses commodities so that the MU per dollar spent on each commodity is the same.
question
Cookbook for finding Interior Solution
answer
1) Take Partial Derivatives of U(x,y) to get MUx and MUy.
2) Set MRSxy= MUx/MUy=Px/Py
3) Get relationship between X and Y from (2). Solve for Y in terms of X.
4) Plug (3) back into BL, solve for remaining variable X to get X*.
5)Plug solution X from (4) into solved equation from (3), solve for Y to get Y.
6) Check to make sure I is exhausted (In BL)
7) Optimum is X,Y.
2) Set MRSxy= MUx/MUy=Px/Py
3) Get relationship between X and Y from (2). Solve for Y in terms of X.
4) Plug (3) back into BL, solve for remaining variable X to get X*.
5)Plug solution X from (4) into solved equation from (3), solve for Y to get Y.
6) Check to make sure I is exhausted (In BL)
7) Optimum is X,Y.
question
Corner Point
answer
A solution to the consumer's optimal choice problem at which some good is not being consumed at all, in which case the optimal basket lies on an axis. Optimal when a consumer is quite willing to substitute one commodity for another.
question
Perfect Complements
answer
AKA Leontief Preferences, Form: U(x,y)= MIN (ax, by)
1) set ax=by and solve for y in terms of x.
2) plug (1) into BL to solve for x*.
3) plug x into (1) to get y.
The IC curves are right angles to the axis, exact same as the axis.
1) set ax=by and solve for y in terms of x.
2) plug (1) into BL to solve for x*.
3) plug x into (1) to get y.
The IC curves are right angles to the axis, exact same as the axis.
question
Composite Goods
answer
A good that represents the collective expenditures on every other good except the commodity being considered.
question
Application of Composite Good
answer
Coupons and Cash Subsidies: Gov't/ deals given to give consumers the option of a better basket. (flat BL line until the coupon runs out)
question
Application of Composite Good
answer
Joining a Club: Consumers can join clubs that let them purchase goods and services at a discount, consumers can be no worse off after joining the club because they can still purchase the basket they choose when he was not in the club.
question
Application of Composite Good
answer
Borrowing or Lending: We assuming lending entails money in the bank. The slope of the B.L= -(1+R) R being interest rate. Horizontal intercept= I1+I2/(1+R). This shows how consumer preferences and interest rates determine why some people are borrowers and some are lenders.
question
Application of Composite Good
answer
Quantity Discounts: Firms offer a better price for the more bought. Quantity discounts expand the set of baskets a consumer can purchase.
question
Revealed Preference
answer
Analysis that enables us to learn about a consumer's ordinal ranking of baskets by observing how his or her choices of basket change as price and income vary. Preferences don't change
question
Price Consumption Curve
answer
The set of optimal baskets as the price of one good varies. Ceteris Paribus. When plotted, shows the demand curve for that good, CHANGE IN PRICE.
question
Income consumption curve
answer
Set of optimal baskets as income varies and prices held constant. CHANGE IN INCOME. It's a connection of all the optimal baskets when income is changing. when the points are plotted on a demand curve, they are separate lines because income is a demand shifter.
question
Engel Curve
answer
A curve that relates the amount of a commodity purchased to the level of income, holding prices of all other goods constant.
question
Normal Goods
answer
A good that consumers purchase more of as income rises. For a normal good, the Engel curve will have POSITIVE SLOPE. *Income elasticity of Demand is POSITIVE.
question
Inferior Goods
answer
A good that consumers purchase less of as income rises. The engel curve for inferior goods will have negative slope. *Income elasticity of demand is NEGATIVE.
question
Substitution effect
answer
The Change in the amount of a good that a consumer would buy as purchasing power changes, holding all prices and level of utility constant.
question
Finding Substitution effect
answer
1) Find initial basket (P is at initial price)
2) Find Final Basket (with price decrease)
3) Find Decomp. Basket, it's on the original BL, reflects the price decrease. SE=Decomp-Intial. Decomp basket is where the budget line is tangent to the initial indifference curve. Remember, the decrease in the price makes the b.l flatter, the point on B.L2 that is tangent to UC1 is the decomp. basket.
2) Find Final Basket (with price decrease)
3) Find Decomp. Basket, it's on the original BL, reflects the price decrease. SE=Decomp-Intial. Decomp basket is where the budget line is tangent to the initial indifference curve. Remember, the decrease in the price makes the b.l flatter, the point on B.L2 that is tangent to UC1 is the decomp. basket.
question
Income Effect
answer
The change in the amount of a good that a consumer would buy as purchasing power changes, holding prices constant. IE=Final-initial.
We cannot have two inferior goods in our basket, EVER. When one is normal and one is inferior, we consume more of the normal good.
We cannot have two inferior goods in our basket, EVER. When one is normal and one is inferior, we consume more of the normal good.
question
Giffin Goods
answer
A good so strongly inferior that the income effect outweighs the substitution effect, resulting in an upward sloping demand curve over some regions of prices. No good examples because it is so unlikely to happen. Income elasticity would have to be negative and the expenditures on the good would need to represent a large portion of the consumers budget. Closest Example: Irish Potato Famine.
question
Consumer Surplus
answer
The difference between max amount a consumer is willing to pay fora good and the amount actually paid. (CS=WTP-P). Area below the demand curve and above the price.
question
Compensating Variation
answer
A measure of how much money a consumer would be willing to give up AFTER a reduction in the price of a good to be just as well of as before the price decrease. Consumer is making decision AFTER the price change and wants to get back to original utility. CV is positive when P is decreasing- giving up money. CV is negative when P is increasing getting paid.
question
Equivalent Variation
answer
A measure of how much additional money a consumer would need BEFORE a price reduction to be as well off as after to price decrease. Consumer is making decision BEFORE the price change and wants to reach the new utility curve. EV is positive when P decreases, getting paid. EV is negative when P is increasing, giving up money.
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
