BADM 7200 Final Exam Notes

Budget line

set of bundles that cost exactly *m.*

slope of budget line is

\-p1/p2

to find, x1-int:

x1 = m/p1

to find, x2-int:

x2 = m/p2

the slope of the budget line is the ________________ of consuming good 1.

opportunity cost

to consume more of good 1, you must _________ p1/p2 of good 2.

* (depending on relative prices between the two goods)

give up

composite good

represents all but one of the goods in the relevant budget

quantity tax definition & example

* fixed amount of tax for each unit of a good/service sold.
* ex: gas has 18.4c/gallon tax

value tax definition & example

* tax on the value (i.e., price) rather than the quantity
* ex: sales tax

subsidy definition & example

* opposite of a tax
* sum of money granted by govt or a public body to an entity

quantity subsidy example

ex: renewable energy, food stamps, EV

ad valorem subsidy example

ex: a share or % of quantity subsidy)

consumption bundle

the complete list of all goods & services the consumer considers.

\~ means _________.

indifferent to

≿ means ____________.

weakly prefers

≻ means _____________.

strictly prefers

complete assumption

* any two bundles can be compared.
* (x1, x2) ≿ (y1, y2) OR (y1, y2) ≿ (x1, x2) OR (x1, x2) \~ (y1, y2)
* consumer weakly prefers bundle x over bundle y OR consumer weakly prefers bundle y over bundle x OR consumer is indifferent between bundle x and y.

reflexive assumption

* any bundle is at least as good as itself.
* (x1, x2) ≿ (x1, x2)

transitive assumption

* If (x1, x2) ≿ (y1, y2) AND (y1, y2) ≿ (z1, z2), THEN (x1, x2) ≿ (z1, z2)
* If A is preferred to B and B is preferred to C, then A is preferred to C.

An indifference curve represents….

the tradeoff between bundles you’re indifferent between

indifference curves representing distinct level of preferences cannot ____________.

cannot intersect

perfect substitutes

consumer is always willing to sub good 1 for the other at a constant rate

* moving further out increases utility (therefore, better off)

perfect complements

goods that are always consumed together in __fixed proportions__

(e.g., left shoes & right shoes)

* have to give more of both to get more utility

bads (bad goods)

a commodity that a consumer doesn’t like

* ex: people don’t like anchovies on pizza

neutral good

consumer doesn’t care about it one way or another.

* always on vertical axis (ex: some ppl don’t care about anchovies on pizza)

monotonic preferences

* unless stated otherwise, we consider goods, not bads.
* a little more of any good increases utility.

what does it mean to be monotonic?

* a little bit more of any good increases utility.
* indifference curve has a negative slope

examples of monotonic preferences

pick 13 donuts & coffee

over

12 donuts & coffee

What does convex mean?

we prefer averages over extremes

What does convex give us?

the curvature of the indifference curve

strict convexity

the weighted average of 2 bundles is __strictly preferred__ to the extreme bundles.

marginal rate of substitution (MRS) is

the slope of an indifference curve at a particular point

* the amount you would trade to make it indifferent
* the amount of one good the consumer is indifferent to trade for the other good.

marginal rate of substitution (MRS)

_________________ is also referred to as willingness to pay when good 2 is a composite good (willingness to pay = 1). It represents how much a consumer is willing to pay for 1 additional unit of x1.

the marginal rate of substitution (MRS)

diminishing marginal rate of substitution

for convex monotonic preferences, the MRS decreases (in absolute value) as x1 increases.

diminishing marginal rate of substitution example:

bundle 1: 30oz coffee & 6 donut holes

bundle 2: 12 oz coffee & a dozen donut holes

* willing to give up a lot more coffee for more donuts in bundle 1 than bundle 2.

For the diminishing marginal rate of substitution,

with more of something, you’re willing to give up more of it for something else.

utility

neoclassical economic thought starts w/ the idea of “maximizing utility” (i.e., maximizing happiness)

A utility function is

a way of assigning a # to every possible consumption bundle such that more preferred bundles are assigned higher values.

* thus, “consumer preferences” are synonymous with “utility”

concerned with a consumers rank order of different bundles. the number value itself is meaningless.e

ordinal utility

Consider a consumer with bundle (x1, x2). Marginal utility (MU) of good 1 is

the change in utility when the consumer receives a little more of x1.

recall: MRS is…

the rate at which a consumer is just willing to substitute a small amount of good 2 for good 1.

The rate at which the consumer is willing to trade x1 for x2 (MRS) is the ratio of the _____________ from the goods at that level of consumption.

marginal utility

choice

consumers will choose the most preferred bundle (i.e., the bundle that provides the most utility) given their budget set.

the optimal choice for the consumer is…

point at which the curve touches the budget line at 1 point.

utility functions should be ________ and _________.

monotonic

convex

the utility curve is ______ to the budget line.

tangent

the slope of the budget line is…

the ratio of the prices

\-p1/p2

The MRS is the _________ of the indifference curve

slope

the MRS =

ratio of marginal utility

if the indifference curve is tangent to the budget line at the optimal choice set, then what is MRS equal to?

\-p1/p2

consumer’s demand bundle

the optimal choice of goods 1 & 2 at the same set of prices and income

the consumer’s demand bundle is…

the bundle they choose

as prices and income change, the _________ ___________ will __________.

demand bundle will change

what does the demand function show?

shows the demand bundles chosen as income and prices change

comparative statics

the study of how a choice responds to changes in the economic environment

Consider a change in income, *m.* What happens if *m* increases from *m0* to *m1*?

the consumer will consume __more__ of x1, at the same P1 because she has more income, *m.*

a movement along a demand curve means…

consumer changes the amount they consume in response to price change.

a shift in a demand curve means…

consumers choose to consume a different amount holding the price constant.

the demand for a normal good _______ as income _______.

increases, increases

△x/△m > 0

for an inferior good, as income _______, demand _______.

increases, decreases

△x/△m < 0

what is an example of a normal good?

house stuff (fridge, sofa)

what is an example of an inferior good?

mac n cheese

goods are substitutes if…

the price of good 2 increases and the demand for good 1 increases.

△x1 /△P2 > 0

examples of substitutes

tea & coffee

goods are complements if…

the price of good 2 increases and the demand for good 1 decreases.

△x1 /△P2 < 0

examples of complements

hot dogs & hot dog buns

coffee & bagels

market demand is also called

aggregate demand

market demand involves how many consumers?

more than 1 consumer

a representative consumer is

the consumer whose budget shares are identical to the shares of commodities in market demand

how do you recognize an inverse demand curve?

for an inverse demand curve, you map P’s to Q’s.

the sum of individual linear demand curves are __________________.

not unnecessarily linear.

what’s intensive margin?

the consumer decides to __consume more or less__ when price changes (or other factors).

example of intensive margin

deciding to buy almond butter over peanut butter

what’s extensive margin?

the consumer decides to __enter or exit the market__ in response to changes in price (or other factors).

example of extensive margin

Apple products

whether you use or don’t use their new phone model

economists commonly refer to the price elasticity of demand as…

the % change in **Q**uantity divided by the % change in **P**rice.

E = △Q / Q E = P △Q

------- more commonly ---- x -----

△P / P Q △P

price __elasticity of demand__ equation

t/f: “E of 3 is less elastic than 2.”

false

even though a linear demand curve has a constant slope, E ranges from __________.

0 → ∞

If E > 1, (or 1 < E < ∞), then it’s

elastic demand

If E < 1, (or 0 < E < 1), then it’s

inelastic demand

If E = 1, then it’s

unit elastic demand

the slope of a demand curve is

\-b

R = P x Q

elasticity of revenue equation

P △Q

\---- x ----- means elasticity of revenue is…

Q △P

positive

For elasticity of revenue, if demand is elastic,

increase in price is associated with decrease in revenue

For elasticity of revenue, if demand is inelastic,

increase in price is associated with increase in revenue

For elasticity of revenue, if demand is unit elastic,

increase in price is associated with no change in revenue.

Constant elasticity demand is

a demand curve where E is constant across all P & Q combinations

Q = AP*^*E

where…

A = constant

E (epsilon) = elasticity of demand

constant elasticity demand equation

%△Q/%△m

where…

Q = quantity demanded

m = income of consumer

income elasticity of demand equation

normal good where ↑m, ↑Q

means income elasticity > 0

inferior good where ↑m, ↓Q

means income elasticity < 0

luxury good where

income elasticity > 1

technology:

how much outputs can I produce w/ inputs?

factors of production:

inputs needed to produce outputs

factors of production examples?

land, labor, capital, raw materials

capital goods are

inputs themselves that are produced

(goods that are needed to produce another product or service)

examples of capital goods?

classroom → producing MBAs

tractor on a farm → producing crops