Introduction to Economics Unit 3&4

Rational individual

Has to make a tradeoff between free time and consumption. Makes decisions under scarcity and to maximalise their utility.

individuals make choices to maximize their utility given constraints such as income, time, and prices. This is a simplifying assumption that allows us to build models and analyze behavior under scarcity

Budget constraint

all combinations of goods and services that can be acquired using the entire budget

Indifference curves

all combinations of goods and services that provide a given utility to the individual

Optimal choice

combination of free time and consumption which gives the highest utility within the feasible set (all combinations of goods and services that can be acquired using the all or part of the budget)

Income effect

MORE FREE TIME CHOSEN change in income → expansion of feasible set you are richer, you can consume more

Substitution effect

LESS FREE TIME CHOSEN change in price → change in opportunity cost you consume more, you have less free time as OC is higher

Decrease in working hours in 20th cenury

• share of income by the rich → increase

• lavish consumption of the rich → higher bar of standard for anyone else

• people higher value on the goods their wages can buy to fit in

• conspicuous consumption

• working more to afford more expensive goods

Empirical test: avg. annual working hours vs. % share of money of the top 1%

Conspicious consumption

Social status, Velben effect, working more as you the rich is getting richer and you want to be like rich so you are more likely to pay more for services and goods

Gender pay gap

• unpaid work

• constraints from unpaid work

• allocation of better paid man work to men

• culture expectations

Social dilemmas

actions taken by individuals in the pursuit of their own benefis leave everyone worse off comparing to if everybody would cooperate

Private solutions to social dilemmas

• Altruism → social preference in which individual’s utility is increased by benefits to others. Inequality aversion meaning preference for fairness.

• Repeated interactions → individuals cooperating now to incentivise other’s behaviour tomorrow. Repeated prisoners dilemma = 50% more cooperation probability from players

• Social norms → shared understanding of a community about how people should behave. Trust and reciprocity > social exclusion, disapproval. Eleanor Ostern → rules and social norms impacting sustainable use and maintenance of common property resources

Governmental solutions to social dilemmas

• Government policies

  • regulation → eg. fishing quotas, pollution limits

  • legal constraints and standards → prohibiting harmful actions

  • punishment and enforcement → fines and penalties, discouraging free-riding

• International agreements

  • eg. climate change

  • individual governmental actions are not enough

  • reaching outcomes better than the non-cooperative nash equilibriums

  • difficulty in realisation

Pareto criterion

test or rule for judging changes: a change is a Pareto improvement if it makes someone better off and no one worse off, thus increasing social welfare.

Pareto efficiency

• no one can be made better off without making someone else worse off; it's the outcome or condition achieved when all Pareto improvements are exhausted.

• an allocation that is not pareto dominated by any other allocation

• there is no allocation in which at least one party is better off without making nobody worse off