Economics (Micro) Sem 1

What are 4 main assumptions of microeconomics?

• Individuals aim at maximising personal satisfaction / utility

• Decisions involve trade-offs

• Opportunity cost exists

• People respond to incentives

• 
  

What is the total surplus?

The monetary measure of the value created by the exchange

Name some factors demand depends on:

• Income

• Trends/preferences

• Price of substitutes

• Availability of the good

• Quality

• Macroeconomic context e.g. recession

• Credit availability

• Taxes

How do we represent demand mathematically as a function

Q^D_i = D(P_i, other factors)

for good i

What is an eNDOgenous variable?

iNternal to the function. e.g. price and quantity demanded

Changes in reaction the model

What is an eXOgenous variable?

eXternal to the function e.g. consumer incomes / weather

Imposed on the model as fixed

Name some factors that quantity supplied depends on

• The demand

• The price of inputs e.g. raw materials + labour

• Competitors

• Taxes/subsidies

• Credit available

• Natural events

How to write the inverse demand and supply functions

When instead of having Q as the subject of the demand and supply functions, you make P the subject

Define a consumption bundle

A list of goods/services that an individual consumes over a period of time

What is the ranking principle of bundles?

Given two bundles, the consumer always knows the ranking (A>B, A~B, A<B)

What is it called when if A<B and B<C then A<C?

preferences are negatively transitive

What is the more-is-better principle (non-satiation)?

A>B if the quantity of good x is larger in A than B and good y is larger or equal in A than B

What is the preference for variety or convexity?

If B>A and C is obtained as an average of B and A, C>A → consumers like variety

Goods can be of 2 kinds: (divisible)

• Indivisible (a movie)

• Divisible (you can buy fractions of kg, litres)

Define an indifference curve

A curve that contains all bundles that are indifferent with respect to A

What are three properties of indifference curves?

• They are thin - if they were thick then a point above point A could be seen as the same utility as A, however, x_A < x_B and y_A<y_B so the indifference principle tells us the curve must be thin

• They do not slope upwards - again, if they went upwards, a bundle with greater X and Y quantities would be seen as A~B which is impossible

• They are convex - due to preference for variety

What are two properties of families of indifference curves?

• They do not intersect

• Indifference curves closer to the origin correspond to lower satisfaction

What is the utility function U used for

To express consumer preferences

U is an ___ ____ that tells us if a bundle …

U is an ordinal concept that tells us if a bundle gives more or less welfare than another

What do the variables in the Stone-Geary U function mean? u(x,y) = (x + σ)^α (y + σ)^β

x,y = quantity of each good

α,β = importance given by the consumer to goods x and y

σ = substitutability between x and y

What does a high σ mean and what does it look like on a graph?

The consumer has little preference for variety → he is willing to substitute and the two goods are substitutes _{^{(not complements)}}

On the graph, indifference curves have less convexity _{^{(at σ=∞, goods are perfect substitutes and indifference curves become straight lines.)}}

How do we demonstrate the relative importance of the two goods?

α

_^—-

b

When does a Cobb-Douglas Utility Function occur?

When σ=0 and the utility function just looks like u(x,y) = x^α y^β

What happens when σ=0?

The consumer wants to consume a positive quantity of both goods and the indifference curve never touches the axis

What does the slope of the indifference curve signify?

The rate at which the consumption of y must change as x changes to keep utility equal

_{^{(△y / △x)}}

What is the Marginal Rate of Substitution (MRS_xy)

The rate at which a consumer must adjust y when x changes by a small amount to keep utility unchanged

How can you calculate MRS_xy mathematically based on the indifference curve?

The magnitude of the slope of the indifference curve

| △y / △x |

What is the economic meaning of the MRS?

It indicates the maximum number of units of y that you’re willing to give up to have one more unit of x, keeping utility equal

e.g. MRS=2, to get 1 more x, you give up 2 y

How does a low MRS_xy look on an indifference curve?

Flatter curve - willing to give up less y for 1 more x

How else can you calculate MRS_xy mathematically?

MU_x

—

MU_y

Define MU_x

The change in utility as the consumption of good x changes by little, holding the other good fixed

How can we mathematically calculate marginal utility? (in words)

MU is the partial derivative of the U function wrt the consumption of the good

How can we calculate marginal utility (formal formula)

How can we calculate marginal utility by derivation?

What’s the mathematical way to tell if a bundle is affordable?

P_x • X + P_y • Y ≤ M

Why is it ≤?

If goods are indivisible, you might not be able to spend all of your M

What is the formula for the budget line?

P_x • X + P_y • Y = M

What are two definitions of the slope of the budget line (- P_x / P_y)

• The rate at which the market allows you to trade good X with good Y

• The opportunity cost of good X in terms of good Y

Define the optimal choice

The preferred bundle among the affordable bundles

Where is the optimal choice on a graph (in words)?

At the point where indifference curve and budget line are tangent, they have the same slope

What is the mathematical formula for the optimal choice?

When MRS = P_x / P_y

How else can MRS = P_x / P_y be written

MU_x P_x

_{—-— = -—-}

MUy P_y

What does it mean if MRS > P_x / P_y

For you, one unit of X is worth more than what it’s worth for the market, so you’ll increase X and decrease Y

What to do if when solving for the optimal choice you get a negative quantity for the good

You set the quantity to zero

What’s the formula to calculate optimum quantity of x with cobb-douglas (not to do in exam, but just to check answer)

What does the individual demand curve do?

Indicates the quantity demanded of a good for each possible price level, holding everything else constant.

How do we calculate the individual demand curve for good X from M and P_y

How to tell based on the utility function if x and y and homogenous goods?

when alpha = beta (aka goods have the same importance) and sigma → infinity

What happens if goods x and y are homogenous

If P_x = P_y , You consume any combination of x,y given your budget constraint

If P_x ≠ P_y , you consume only the cheaper of the two → a corner solution

Define a corner solution

When an optimal choice occurs at the boundary limit of a constraint, and a consumer spends all income on one good and zero on the other

Define Equivalent Variation

The amount of money that would need to be taken away (or given) BEFORE the change to leave the consumer with the same level utility as after the change.

Aka, we consider prices/income before the change and utility after the change

Define Compensating Variation

The amount of money needed, AFTER the change, to bring the consumer back to the original level of utility (compensation happens after the event)

aka we consider prices/income after the change, and utility before the change

What does k̄ (k with a line) mean

means k is not variable and cannot be changed

e.g. k̄ = 1 means k is fixed at 1

What does a firm’s production function look like?

Q = F(L)

Gives the max Q you can obtain given the L you use

What is the general production function?

Q = A • L^α

where A = productivity, technology

α can be any number, but ebook usually considers it to be <1, usually 1/2

What does α measure in the general production function

The output elasticity of labour - measures how responsive total output (Q) is to a percentage change in the labour input (L)

What is the mathematical formula for the average productivity of L

AP_L = Q / L

→ = AL^α / L

→ = AL^{α - 1}

What is a reason that α may be 1 in the general production function?

Q = A • L

AP_L = Q / L = AL / L = A

AP_L is constant - the job is so basic no matter who you hire the work is always the same

What is the marginal product of labour (MP_L)

It measures the extra output produced by the last minimal quantity △L employed

this number is always positive

How do we mathematically calculate the MP_L

Through partial derivatives

MP_L = dQ / dL

MP_L = A • αL^{α - 1}

How do AP_L and MP_L look on a graph?

What is the inverse production function

When L is the subject of the formula

L = (Q/A) ^1/α

Define a fixed cost

A cost that doesn’t depend on the quantity of output produced

Define a variable cost

Depends on the quantity produced - for us its the cost of L as we are only looking at labour

What is the calculation for VC (given that we only have labour)?

VC(Q) = W • L = average wage • number of workers

How do we then make VC(Q) an actual function in terms of the variable Q?

W • Q^1/α / A^1/α

How do C(Q), VC(Q) and FC look together on a graph?

How do we compute AVC(Q)

VC(Q) / Q - then substitute so everything is in terms of w, q, and a

also

W / APL

How do we compute AP_L connecting it with AVC(Q)

AVC(Q) = W / AP_L

AC =

AVC + AFC

Define marginal cost

Cost paid on average to produce one of the last △Q units of output

What are the two ways of computing MC

• Partial derivative of the cost function wrt Q

• W / MP

• △WL / △Q

Define MP_L

The quantity of output obtained, on average, by one of the last △L units of L

MP_L and MC are ___

MP_L and MC are inversely related

AC_min occurs at the lowest point of AC where..

MC=AC

What is the function for revenue in terms of Q

R = P(Q) • Q

What does the demand curve look like for a price-taking firm

In the SR, FC is a…

is a sunk cost. It has no opportunity cost and no impact on the optimal choice → we ignore it

What is the profit maximisation condition

MR = MC

How to find MR by differentiation

dR

—

dQ

What is the LR profit maximisation rule

R(Q) = C(Q)

2 choices: shut down or produce, either way profit = 0

In the LR you produce if:

P > ACmin

How is PS calculated in the short and long run

Short run: PS = R - VC

Long run: PS = R - Avoidable costs (vc and fc) = R - C = profit

vc are the only avoidable costs in the sr

How else can we calculate PS in the short run?

PS = π + FC

Where are avoidable costs on a SR price-taking firm diagram

What are some characteristics of competitive markets?

• A large number of sellers and consumers

• Good is homogenous

• Each buyer is a tiny fraction of the market

capital N is the number of ___

capital N is the number of consumers

What is market demand

The horizontal summation of all the individual consumers’ demand functions

What is the individual demand function for a competitive market

q^D = f^D(p^equ)

A LR equilibrium is ___ a SR equilibrium. The opposite is ___ true.

A LR equilibrium is also a SR equilibrium. The opposite is not true (when sr profits > or < 0.)

Define total surplus

The overall benefit for society due to the consumption / production of a certain quantity of a good at a certain price

How do we calculate total subsidies

TS = CS + PS + Taxes - Subsidies

last two are market interventions — government revenue and government expenses, for the moment we ignore them so TS = CS + PS

Under perfectly competitive markets, TS is ___

Under perfectly competitive markets, TS is maximised

The competitive market outcome is ___-___, which means __

The competitive market outcome is pareto-efficient, which means it is not possible to increase the welfare of one agent without making the other worse off

What are three things the price elasticity of demand depends on?

• Whether the good has no, perfect, or close substitutes. If the good has no substitutes, its demand curve will be steeper and inelastic

• How much the purchase of the good affects income: the less it affects income, the more inelastic the demand (conn’s toothpaste)

• The time frame: in the short run, demand is more inelastic than in the medium and long run

How does E^D change along the demand line?

What are the categories for elastic, inelastic, unit elastic?

Elastic: 1 < |E^D| _{(p rises by 1% your Q decreases by more than 1%)}

Inelastic: 0 < |E^D| < 1

Unit elastic: E^D = -1

What is TE and how is it calculated

Total expenditure

TE = p • Q = R (total revenue collected by the firm)

How does TE change when there is an increase in price for a good with elastic demand

TE decreases bc although p increases, q decreases by more, so p x q is lower

What are three reasons why a monopoly may arise?

• A firm may acquire exclusive control over essential resources

• Barriers to entry such as high initial costs or patents may exist

• May be created by state policies that grant a single firm the exclusive right to produce and distribute