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1
Q

what is the cost-benefit approach

A

if B(x) is more than C(x) then do the task

B(x) can be defined as the maximum monetary amount you would be willing to pay to do X
C(x) can be defined as the value of all the resources you would need to give up to do X

tells us to continue increasing the level of an activity as long as it’s marginal benefit exceeds marginal cost

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2
Q

what is the reservation price

A

the price at which a person would be indifferent between doing X and not doing X

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3
Q

what is the opportunity cost

A

the value of all that must be sacrificed in order to do the activity

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4
Q

what are sunk costs

A

costs that are beyond recovery at the time a decision is being made and so should be ignored

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5
Q

what is marginal cost

A

the increase in total cost that results from carrying out one additional unit of the activity

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6
Q

what is marginal benefit

A

the increase in total benefit that results from one additional unit of the activity

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7
Q

what is a positive question

A

a question that has a definitive right or wrong answer

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8
Q

what is a normative question

A

a question that elicits value judgement on what ought or should be

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9
Q

what does the demand curve tell us

A

how much buyers want to purchase for each possible price

only key property is that it is downward sloping
quantity demanded usually rises as the price of the product falls - LAW OF DEMAND

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10
Q

what does the supply curve tell us

A

the quantity that sellers are willing to supply at any possible price

usually upward sloping - quantity supplied rises as the price of the product rises

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11
Q

what is equilibrium

A

the price-quantity pair at which both buyers and sellers are satisfied

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12
Q

what is surplus

A

a situation where price exceeds its equilibrium value

also called excess supply

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13
Q

what is a shortage

A

a situation where price lies below its equilibrium value

also called excess demand

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14
Q

what is a pareto efficient outcome

A

an outcome where it is not possible to make some person better off without harming another person

no reallocation in the market can improve some peoples position without harming the position of at least some other people

an outcome is pareto efficient if it maximises total surplus in the market

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15
Q

what is consumer surplus

A

a monetary measure of the extent to which a consumer benefits from participating in a transaction

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16
Q

what is producer surplus

A

the monetary amount by which a firm benefits by selling output

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17
Q

what is a price ceiling

A

the level above which the price of a good is not permitted by law to rise

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18
Q

what is a price floor

A

a minimum price for a good, established by law and supported by governments offer to buy the good at that price

requires the government to become an active buyer in the market

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19
Q

what is the rationing function of price

A

the process whereby price directs existing supplies of a product to the users who value it most highly

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20
Q

what is the short run function of price

A

its focus is the distribution of output that already exists

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21
Q

what is the long run function of price

A

its focus is to induce resources to migrate from indistries with excess supply to those with excess demand

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22
Q

what is the allocative function of price

A

the process whereby price acts as a signal that guides resources away from the production of goods whose prices lie below cost towards the production of goods whose prices exceed cost

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23
Q

what are the determinants of demand

A

incomes, tastes, prices of substitutes/complements, expectations, population

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24
Q

what is a normal good

A

the quantity demanded at any price rises with income

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25
Q

what is an inferior good

A

for these goods the quantity demanded at any price falls with income

consumers abandon these goods in favour of higher quality substitutes as soon as they can afford to

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26
Q

what is the effect of complements (price rise)

A

a sharp increase in the price of one leads not only to a reduction in the quantity of itself but also a reduction in the quantity of its complement

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27
Q

what is the effect of complements (price rise)

A

an increase in the price of one will tend to increase demand for the other

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28
Q

effects on a demand graph (complements, substitutes, income, population, tastes)

A

demand shifts to the right - price of complement falls, income rises (normal goods), population grows, if a price increase is expected, if tastes shift in favour

demand shifts to the left - price of substitutes falls, income rises (inferior goods), if an income decline was expected

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29
Q

what are the determinants of supply

A

technology, factor prices, the number of suppliers, expectations, weather

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30
Q

effects on a supply graph (technology, wages, interest, price of raw materials, weather, expectations etc)

A

supply shifts to the left - improved technology, lower interest rates, increase in number of firms, good weather

supply shifts to the right - higher wages, higher prices for raw materials, expectations of higher prices soon, bad weather

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31
Q

what does a ‘change in demand’ mean

A

refers to a shift in the entire demand curve
e.g. when the average income level of buyers changes

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32
Q

what does a ‘change in quantity demanded’ mean

A

refers to a movement along the demand curve
e.g. when the price of a good falls the result is an increase in the quantity demanded not an increase in demand

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33
Q

how does an increase in demand effect price and quantity

A

increase in both equilibrium price and quantity

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34
Q

how does a decrease in demand effect price and quantity

A

decrease in both equilibrium price and quantity

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35
Q

how does an increase in supply effect price and quantity

A

decrease in the EQ price and increase in the EQ quantity

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36
Q

how does a decrease in supply effect price and quantity

A

increase in the EQ price and decrease in the EQ quantity

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37
Q

if the supply curve is vertical….

A

sellers have fixed amounts of the good they are willing to sell at any price

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38
Q

if the supply curve is horizontal …

A

increase in demand leads to an increase in EQ quantity but not price
perfect competition

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39
Q

algebra for EQ

A

set supply and demand formulas equal to each other and sub back in

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40
Q

what is a social dilemma

A

a type of game where individual incentives conflict with group efficiency
worth doing if the benefit exceeds the cost

people would do better if they could collectively commit themselves to behave in a way that is inconsistent with their own material interests

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41
Q

what is a coordination game

A

games where individuals need to coordinate their actions in some way - such as two drivers who meet on a narrow road

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42
Q

what is a sequential game

A

where individuals choose actions over time, usually in turn - such as a game of chess

one player moves first and the other is then able to choose his strategy with full knowledge of the first players choice

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43
Q

what is a game of incomplete information

A

one or more individuals don’t know some salient point about the game
e.g. buyer of an antique may not know some value of the item

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44
Q

what are external benefits and costs

A

benefits and costs that do not fall on the person doing the activity

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45
Q

what is a prisoner dilemma

A

no matter what the other person does, each prisoner gets a shorter sentence by confessing
however if they had both remained silent they would have received an even shorter sentence

if both prisoners could commit themselves to remain silent, they would do better than if left free to pursue their narrow material interests

not pareto efficient

46
Q

what is a commitment device

A

a device that commits ta person to behave in a certain way in the future, even though he may wish to behave otherwise when the time comes

47
Q

what are repeated games

A

when the players interact more than once

48
Q

what is the tit-for-tat strategy

A

cooperate at first and then do whatever the other player did in the previous interaction

49
Q

what is the grim-trigger strategy

A

strategy to cooperate unless the other player defects but defect for ever more if the other player defects

50
Q

what is a nash equilibrium

A

the combination of strategies in a game such that neither player has any incentive to change strategies given the strategy of his opponent

best option for both players

does not have to result in pareto efficiency - is a prediction of what players will or should do if they follow their own interest

51
Q

what is the best-response function

A

says what strategy a player should choose conditional on the strategy of other players

52
Q

what is the maximin strategy

A

choosing the option that makes the lowest payoff one can receive as large as possible

one way of dealing with strategic uncertainty - the player knows with certainty the worst that can happen

53
Q

what is strategic uncertainty

A

when a player does not have a dominant strategy of its own it needs to second guess what others will do

54
Q

what is backward induction

A

the technique to find a nash EQ in a sequential game by working backwards from the last decision to the first (finding the optimal choice in each case)

55
Q

what is a sub-game perfect nash EQ

A

sub-game perfect if players behave rationally at every decision point in the game

56
Q

what is a budget constraint

A

a line formed by spending all income on option 1 and then all income on option 2

consumer is able to purchase any other bundle that lies along the straight line joining these points
also able to purchase any bundle that lies within the budget triangle bounded by it and the two axes

formula: -p(y)/p(x)

budget constraint must satisfy: p(Y)Y + p(X)X

57
Q

effect of price changes with a budget constraint

A

this effects the slope of the line (slope fully determined by consumers income and the prices of the respective goods)

the original budget constraint rotates around one point

58
Q

effect of income changes with a budget constraint

A

new budget constraint has the same slope as the old but moves in one direction (e.g. closer to the origin)

59
Q

what is a composite good

A

in a choice between a good X and numerous goods, the amount of money the consumer spends on those other goods

60
Q

what is preference ordering

A

a ranking of all possible consumption bundles in order of preference

enables the consumer to rank any two bundles of goods in terms of their desirability or order of preference

61
Q

features of preference ordering

A

completeness, transitivity, more-is-better, continuity, convexity

62
Q

completeness feature of preference ordering

A

is complete if it enables the consumer to rank all possible combinations of goods and services

can make 3 possible statements
A is preferred to B
B is preferred to A
A and B are equally attractive

never satisfied if taken literally - many goods we know too little about

implies that there is an indifference curve that passes through every possible bundle

63
Q

transitivity feature of preference ordering

A

for any three bundles A B and C, if he prefers A to B and prefers B to C then he always prefers A to C

64
Q

more-is-better feature of preference ordering

A

other things being equal, more of a good is preferred to less

violations of this property can only occur when the free-disposal principle does not apply

65
Q

what is the free disposal principle

A

if a consumer can freely store or dispose of goods they don’t want then more of something cant make them worse off

66
Q

continuity feature of preference ordering

A

small changes in the quantity of goods should not lead to sudden ‘jumps’ in preferences

a consumers preference ordering is continuous if for any two bundles A and B where the consumer prefers A to C then any bundle sufficiently close to A is also preferred to C

67
Q

what is an indifference curve

A

a set of bundles among which the consumer is indifferent

allows us to compare the satisfaction implicit in bundles that lie along it with those that lie either above or below it

they are ubiquitous - any bundle has an indifference curve passing through it (completeness)
they are downward sloping - upward sloping would violate the more-is-better property
two indifference curves from the same map cannot cross - violates transitivity assumption

68
Q

what is marginal rate of substitution

A

at any point on an indifference curve is the rate at which the consumer is willing to exchange the good measured on the vertical axis for the good measured along the horizontal axis

equal to the absolute value of the slope of the indifference curve at that point

the rate at which we can substitute X for Y without changing total satisfaction

MRS = Px/Py
right hand side is opportunity cost
left hand side is the absolute value of the slope of an indifference curve at the point of tangency

69
Q

convexity feature of preference ordering

A

mixture of goods are preferable to extremes

eg if you are indifferent between 9units of A and 1unit of B or 1unit of A and 9units of B; your preferences are convex if you would prefer a bundle of 5units of A and 5units of B

70
Q

diminishing MRS

A

MRS declines as we move downwards to the right along an indifference curve

any indifference curve with diminishing MRS are thus convex when viewed from the origin

diminishing MRS means consumers like variety

71
Q

best affordable bundle

A

most preferred bundle of those that are affordable

more-is-better assumption implies that best affordable bundle must lie on the budget constraint not inside

won’t be on an indifference curve that lies partly inside the budget constraint - will intersect only once

72
Q

what are corner solutions

A

in a choice between two goods a case in which the consumer does not consume one of the goods

MRS < Px/Py when amount of x = 0

more likely to occur for substitutes - almost certain for perfect substitutes

73
Q

what are perfect substitutes

A

straight line indifference curves

if steeper than budget constraint we get a corner solution on horizontal axis
if less steep we get corner solution on vertical axis

74
Q

what is a price consumption curve (PCC)

A

shows the quantity of goods a consumer is able to purchase when the price of the good changes

indicates the elasticity as well

75
Q

how to change from PCC to individual demand

A

first record the relevant price-quantity combinations from the PCC
second plot the price quantity pairs with the price of Y on the vertical axis and the price of X on the horizontal

moving from a graph in which both axes measure quantities to one in which price is plotted against quantity

76
Q

what is the individual demand curve

A

a relationship that tells us how much the consumer wants to purchase at different prices

77
Q

what is the income consumption curve

A

holding the prices of X and Y constant, the ICC for a good X is the set of optimal bundles traced on an indifference map as income varies

on the vertical axis we measure the amount the consumer spends each week on all goods other than X

78
Q

how to generate an ICC

A

we hold preferences and relative prices constant and trace out the effects of changes in income

set of best affordable bundles

79
Q

what is an engel curve

A

a curve that plots the relationship between the quantity of X consumed and income

vertical axis measures total weekly income of the consumer

if the engel curve is upward sloping it implies the more income a consumer has, the more product he will buy each week

80
Q

what is a normal good

A

one whose quantity demanded rises as income rises

81
Q

what is an inferior good

A

one whose quantity demanded falls as income rises

for any consumer who spends all their income, not all goods can be inferior
when income rises it is impossible to spend less on all goods at once

usually those with close substitutes

82
Q

what is the substitution effect of a price increase

A

when the price of a good rises, close substitutes become more attractive than before

83
Q

what is the substitution effect

A

that component of the total effect of a price change that results from the associated change in the relative attractiveness of other goods

always causes the quantity purchased to move in the opposite direction from the change in price

84
Q

what is the income effect

A

that component of the total effect of a price change that results from the associated change in real purchasing power

direction depends on whether the good is normal or inferior
for normal goods the income effect works in the same direction as the substitution effect
for inferior goods the income and substitution effects work against each other

85
Q

what is the total effect

A

the sum of the substitution and income effects

86
Q

substitution effect and convex indifference curve

A

for consumers whose indifference curves have the conventional convex shape, the substitution effect of a price increase will always reduce consumption of the good whose price increased

87
Q

what is a giffen good

A

one for which the quantity demanded rises as its price rises

must be an inferior good so that the income effect is larger than the substitution effect
also has to occupy a large share of the consumers budget
has to have a relatively small substitution effect

total effect is to increase, not reduce, the quantity purchased

88
Q

can the price consumption curve for a normal good ever be downward-sloping

A

yes
a downward sloping PCC simply implies that as the price of a good falls, the consumer purchases so much more of the good that the proportion of income spent on the good actually increases

89
Q

what is a sin tax

A

its purpose is to increase prices for consumers so that they will substitute to other goods

90
Q

effect of a sin tax if the good is price inelastic

A

raise revenue but do less to reduce consumption

91
Q

effect of a sin tax if a good is demand inelastic

A

tax will raise revenue but lead to a reduction in consumption

92
Q

what is the purpose of a sin tax

A

to increase prices for consumers so that they will substitute to other goods

93
Q

what happens when a tax is levied on sellers

A

the market price would have to be P0 + tax (T) for them to get the same net payment that they used to receive when the price was P0

shifts the supply schedule upwards by T units

(may be specific) note that the even though the seller pays a tax of T on each product purchased, the total amount the seller receives per unit lies less than T below the old equilibrium price

even though the tax is collected from the seller, its effect is to increase the price paid by buyers
burden of the tax is thus divided between the buyer and the seller

94
Q

how to work out sellers share of the tax burden (ts)

A

given by the reduction in the price the seller receives, divided by the tax
ts = (P-(P1-T))/T

95
Q

how to work out buyers share of the tax burden (tb)

A

the increase in price (including tax) divided by the tax
tb = (P1-P)/T

96
Q

effect of tax on price if demand is highly price inelastic

A

prices will rise by nearly as much as the tax
share of tb will be close to 1 and ts close to 0
means buyers will pay most of the tax burden

97
Q

effect of tax on price if demand is highly price elastic

A

prices will hardly rise at all
share of tb will be close to 0 and ts close to 1
means sellers will pay most of the tax burden

98
Q

what happens when a tax is collected directly from buyers

A

the effect of a tax of T = 10 would shift the demand curve downwards by 10 units

tax causes a reduction in equilibrium quantity
new price paid by the buyers rises
new price received by the sellers falls

99
Q

what is the legal incidence of the tax

A

whether the buyer or seller is responsible for paying the tax to the government

100
Q

what is the economic incidence of the tax

A

the respective share of the tax borne by buyers and sellers through the tax’s effect on the price of the good

does not depend on the party from whom the tax is directly collected but this does not mean that buyers and sellers always share the burden of taxes equally

101
Q

what is a consumer price index

A

measures changes in the ‘cost of living’, the amount a consumer must spend to maintain a given standard of living

102
Q

what is an income-compensated demand curve

A

a demand curve that tells how much consumers would buy at each price if they were fully compensated for the income effects of price changes

to generate this curve eliminate the income effect from the total effect of price changes

103
Q

what will the income-compensated demand curve look like for a normal good in comparison to the ordinary one

A

always steeper than the ordinary demand curve

104
Q

what will the income-compensated demand curve look like for an inferior good in comparison to the ordinary one

A

always less steep than the ordinary demand curve

105
Q

what is consumer surplus

A

a monetary measure of the extent to which a consumer benefits from participating in a transaction

measured using ordinary demand curve

106
Q

what does the height of the demand curve at any quantity tell you

A

the most the consumer would be willing to pay for an extra unit of shelter

107
Q

how to find the consumer surplus

A

height of the demand curve at any quantity minus the market price

total consumer surplus is the shaded area between the demand curve and market price

at price P
CS = 1/2 (max price on Y axis - P)(where P hits X axis)

108
Q

what is compensating variation

A

the amount of money a consumer would need to compensate for a price change

monetary measure of the welfare effect of the increase in price

for a price rise: area under an income compensated demand curve

109
Q

loss in consumer surplus will be larger than the compensating variation when the good is

A

inferior

110
Q

loss in consumer surplus is smaller than the compensating variation when

A

the price of a normal good rises

111
Q

what is two-part pricing

A

a pricing scheme that consists of a fixed fee and a marginal charge for each unit purchased

transfers a portion of the consumer surplus from the buyer to the seller

112
Q

what is equivalent variation

A

the amount of money a consumer would pay to avoid a price change

econ1 (1 decks)

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