Principles of Microeconomics

ceteris paribus

all other things being equal

positive

explains what happens

normative

explains what should be done

optimization assumption

each agent chooses in self-interest

equilibrium assumption

each market adjusts until quantity demanded equals quantity supplied

reservation price

a person’s maximum willingness to pay for something

pareto outcome

no wasted welfare—increasing one lowers another

pareto inefficient outcome

leaves mutual gains to trade

consumption choice sets

collection of all consumption choices available to consumers

consumption bundle

(x1,...,xN), where xi represents number of commodity i

budget constraint

set of bundles only just affordable

budget set

set of all affordable bundles

numeraire

unit of account (benchmark)

behavioral postulate

a decision maker always chooses their preferred alternative from the set of alternatives

completeness axiom

for any two bundles x and y, it is always possible to say x>=y or x<=y

reflexivity axiom

any bundle is at least as preferred as itself x>=x

transitivity axiom

x>=y and y>=z implies x>=z

rational preference relation

possesses completeness and transitivity

well-behaved (preference)

a preference is well-behaved if it is monotonous, convex, and continuous

monotonicity

more of one commodity is always preferred

convexity

mixtures of bundles are at least weakly preferred to the bundles themselves

continuity

for any given bundle y, the set {x: x>=y} is closed

SP(x)

set of bundles strongly preferred to x

WP(x)

set of bundles weakly preferred to x

marginal rate of substitution

slope of indifference curve at x’—rate at which customer is willing to trade commodity 2 for commodity 1

utility function u: X —> R

represents preference relation, x>=y <=> u(x)>=u(y)

marginal utility

rate of change of total utility as quantity of commodity consumed changes

invariance

if u is a utility function representing a preference relation and f is strictly increasing, V = f(u) also represents that preference relation

consumer’s optimal choice

consumer’s most preferred bundle

Engel curve

graph of demand for one of the goods as a function of income

homotheticity

(x1,x2) < (y1,y2) <=> (kx1,kx2) < (ky1,ky2)

p1-price offer curve

curve containing all utility-maximizing bundles as p1 changes

ordinary demand curve

plot of x1-coordinate of p1-price offer curve as p1 changes

ordinary good

good where quantity demanded increases as price decreases

Giffen good

for some values of its price, quantity demanded increases as price increases

gross substitute

price of one good increasing causes demand of other to go up

gross complement

price of one good decreasing causes demand of other to go up

income elasticity

how responsive demand is to change in income

price elasticity

how responsive demand is to change in price