Microeconomic Principles and Theories

These flashcards cover key economic principles related to microeconomics, preferences, and equilibrium, providing a comprehensive review tool for the upcoming exam.

What represents the maximum willingness to pay?

Reservation price (Reservation P).

How is the budget constraint represented mathematically?

P1x1 + P2x2 ≤ m.

What is the equation for the budget line?

x2 = (m/P2) - (P1/P2)x1.

What is the effect of a tax on price (Q_t)?

Price increases from P to P + t.

What does a subsidy do to the price (Q_s)?

Price decreases from P to P - s.

What is a lump-sum tax on the budget?

m decreases to m - t.

What are the four ways to rank preferences?

Strict preference (≻), indifference (~), weak preference (≽), or incomparability.

What is the axiom of completeness in preferences?

Any two bundles can be compared with preference relations.

What does reflexivity imply in preference axioms?

Any bundle is at least as good as itself.

What is transitivity in preference orderings?

If x ≽ y and y ≽ z, then x ≽ z.

Why can't indifference curves cross?

Crossing would violate the transitive property of preferences.

What characterizes perfect substitutes in preferences?

Indifference curves are straight lines with a constant slope of -1.

What characterizes perfect complements in preferences?

One good is useless without the other (L-shaped indifference curves).

Define a bad in economic terms.

A good that the consumer does not like.

What is satiation in consumer preferences?

A point where the consumer prefers a specific bundle to all others.

What does monotonicity imply for preferences?

More of a good is preferred to less, which leads to a negative slope of indifference curves.

What does convexity of preferences indicate?

Average bundles are preferred to extreme bundles in consumption.

What does strict convexity imply?

The preferences show a real strict preference between average and extreme bundles.

What does the marginal rate of substitution (MRS) measure?

The rate at which a consumer is willing to give up good x2 for an additional unit of x1 while keeping utility constant.

What is a utility function?

A function that assigns a number to every bundle such that more preferred bundles yield higher numbers.

What does the form of a Cobb-Douglas utility function look like?

u(x1, x2) = (x1^c)(x2^d).

What is the relationship between marginal utility (MU) and quantity consumed?

MU indicates the change in utility from a small increase in consumption.

What does the Inada condition state in terms of demand optimization?

MRS should not cut axes, which ensures no extreme consumption.

What is the definition of demand function (D)?

xi = D(P1, P2, m), representing the quantity demanded based on prices and income.

What is the Engel Curve?

It tracks how quantity demanded changes for a good as income changes while keeping price constant.

Define a Giffen Good.

A good for which an increase in price leads to an increase in quantity demanded.

What are the defining characteristics of market demand?

The sum of all individual demands holding prices and other goods constant.

What does the elasticity of demand measure?

The responsiveness of the quantity demanded to changes in price.

What does it mean when elasticity of demand (εD) is greater than 1?

Demand is elastic, and an increase in price leads to a proportionally larger decrease in quantity demanded.

What do we understand as the principle of equilibrium optimization?

Individual demand and supply are derived from consumer and firm optimization, leading to market demand and supply intersections.

What does it mean if P1Z1 + P2Z2 = 0 involves equilibrium?

It suggests that the total value of excess demand is zero for all goods being analyzed.

What does Walras' Law state?

The sum of the prices of goods multiplied by their excess quantities equals zero in an equilibrium state.

What are the two types of general equilibrium analyses?

Partial equilibrium (specific goods) and general equilibrium (all goods in an economy).

What is a competitive equilibrium?

An allocation of resources where supply equals demand for every good at a given price level.

Define the term ‘Contract Curve.’

A curve in an Edgeworth Box showing all efficient allocations of resources.

What does the term ‘Pareto Efficiency’ imply?

No reallocation can make one individual better off without making someone else worse off.

What does the theorem of welfare economics state?

All competitive equilibria are Pareto efficient.

What role does technology play in production?

It transforms inputs into outputs, determining feasible production points.

What does an isoquant represent?

All combinations of inputs that yield the same level of output.

What is the significance of free disposal in production?

Unused inputs can be discarded without cost.

What are the three types of returns to scale?

Constant returns to scale (CRS), decreasing returns to scale (DRS), and increasing returns to scale (IRS).

What is the goal of profit maximization for firms?

To choose a level of output where marginal cost equals marginal revenue.

What is the shutdown condition for a firm?

A firm should shut down if price is less than average variable costs.

Define economic rents in the context of production factors.

Payments made to factors of production in excess of their minimum supply costs.

What is the relationship between perfectly competitive and monopolistic markets?

In monopolistic markets, firms have market power and don't take prices as given.

How does monopoly pricing differ from perfect competition?

Monopolies can set higher prices due to lack of substitutes and exert control over supply.

What does the principle of revealed preferences entail?

Consumers’ choices reveal their preferences based on available options and their budgets.

What is the significance of the Slutsky equation in economics?

It separates the substitution effect from the income effect when analyzing price changes.

What happens to demand for normal goods when prices decrease?

Demand increases as both income and substitution effects reinforce each other.

What is the impact of a price increase for inferior goods?

Demand may also increase because the income effect works counter to the substitution effect.

What is the calculation method to isolate the substitution effect?

Adjust the budget line to keep the original bundle affordable after a price change.

What is the definition of total cost (TC) in production?

TC = Variable costs (VC) + Fixed costs (F).

What is meant by marginal product (MP)?

The additional output produced from an additional unit of input.

What effects the firm’s decision making based on market conditions?

Factors such as input prices, output prices, and competitive pressures.

What does the term ‘free entry and exit’ refer to in competitive markets?

New firms can enter the market freely, while existing firms can exit without barriers.

What does it mean for a market to be perfectly elastic?

Demand changes dramatically with price changes, leading to a horizontal demand curve.

Define economic profit in the context of market competition.

The profit remaining after all opportunity costs have been accounted for.

What does the term ‘markup’ indicate in monopoly pricing?

The difference between the price charged and the marginal cost of production.

What is the purpose of effective lobbying in economics?

To influence policy or regulations to benefit specific firms or industries.

What information can be inferred from observed demand outcomes?

It provides insights into consumer preferences under different conditions.

What does the weak axiom of revealed preferences indicate about consumer choices?

If a bundle is preferred over another, it cannot be that the other is later preferred.

What is the Sarp condition in consumer choices?

Transitive preferences must hold across observations as revealed preferences.

How do changes in relative prices affect consumer choice?

They pivot the budget line, facilitating a shift in consumption patterns.

What are the main determinants of demand fluctuations?

Changes in consumer income, preferences, and relative prices.

What does the indirect revealed preferences principle entail?

It allows for observed choices to infer preferences indirectly based on budget constraints.

How is utility affected by consumption changes in the small-scale approach?

It is measured as the marginal utility per unit of consumption.

What signifies normal goods in utility functions?

Utilities increase with consumption increase, reflecting positive income elasticity.

What is the concept of adjustment in consumer income related to demand?

Changes in perceived utility affect purchasing power, thus influencing demand.