Microeconomics Final Exam Review

Budget Line

Set of bundles (x₁,x₂) that satisfies the following property: for any bundles within this set, given the set of prices and income, the total amount of money equals the total amount of disposable income (p₁x₁ + p₂x₂ = m)

Indifference Curve

Describes consumer preferences. Graphically, the set of all bundles between which the consumer is indifferent

Marginal Rate of Substitution

Measures the rate at which a consumer is willing to substitute one good for another good and remain indifferent. Graphically, MRS = slope of indifference curve

Types of Monotonic Transformation

1. multiply by a positive number

2. add a number

3. take the natural log

4. raise to some positive number

Utility Function

A way of describing preferences by assigning a number to each bundle such that the more preferred bundles receive a larger number than less preferred bundles

Marginal Utility

Change in utility from a little bit more of good i, holding the quantity of the other good fixed. MRS = -MU₁/MU₂

Demand Function

A function that assigns values x₁^* and x₂^* to any set of (p₁,p₂) and m

Normal Goods

When income increases, demand increases and vice versa

Inferior Goods

When income increases, consumption decreases

Ordinary Goods

Demand increases and prices decreases

Giffen Good

Drop in price causes a drop in demand

Price Elasticity of Demand

Measures responsiveness of consumers to changes in demand

Production Function

f = relationship between quantity of inputs and quantity of outputs [y=f(x₁,x₂)]

Isoquant

Set of all possible combinations of x₁ and x₂ needed to produce a given fixed level of output

Marginal Product

How much output de we produce by increasing the quantity of one output by a little

Law of Diminishing Marginal Product

Productivity of a factor will dimmish as we use more of that factor (other factor remains constant)

Technical Rate of Substitution

TRS = -MP₁/MP₂

Returns to Scale

What happens to output if we scale the quantity of both input factors by some amount t>1

Isoprofit Line

All possible combinations of x₁ and y that give the same profit

Profit (π)

Revenue - costs (π = py - w₁x₁ - w₂x₂)

Isocost Line

All combinations of x₁ and x₂ that yield the same total cost

Partial Equilibrium

Focus on one market and disregard interactions with other markets

General Equilibrium

How demand and supply interact across markets, assuming; 1. Markets are competitive, 2. looking at two goods and two consumers, and 3. ignore production

Edgeworth Box

Used to depict an exchange economy

Pareto Efficiency

An allocation where you can’t make one person better off with out making the other person worse off (The two consumer’s indifference curves are tangent). At x^* there is no further room for mutually beneficial trades

Contract Curve

Set of all pareto efficient allocation of goods

Competitive/Walrasion Equilibrium

Set of prices (p₁^*, p₂^*) such that, given the initial endowment: 1. each person is choosing their most preferred bundle, and 2. the markets clear [x_a¹(p₁^*, p₂^*) + x_b¹(p₁^*, p₂^*) = w_a¹ + w_b¹ or x_a²(p₁^*, p₂^*) + x_b²(p₁^*, p₂^*) = w_a² + w_b²]

Walrus’ Law

If one of the two markets clear, the other also automatically clear

First Theorem of Welfare Economics

A Walrasian equilibrium allocation is also Pareto efficient

Consumption Externality

One person’s consumption directly impacts another person’s

Production Externality

Production of one firm is impacted by choices of another firm

Public Goods

Once provided, it is available in the same amount to all effected consumers (infrastructure, public services)

Free Riding

Everyone waits for someone else to provide publice goods