Flashcards in Term-1 Deck (61):
What are the Axioms of Preference?
If A>B and B>C, A>C
Can rank all bundles in order of preference
More is always preferred to less
Weak: B>C, B~C
An average is preferred to extremities
Strong: Any point on line is preferred to points on curve
Weak: Can be indifferent also
Describe MRS for Normal IC and Perfect Compliments
Normal: Constantly declining
Perfect Comp: Vertical = Infinity, Horizontal=0
How would you prove MRS is decreasing?
Calculate MRS and differentiate
What happens if increasing income yields parallel budget lines?
If parallel, bundles have the same MRS
If not, due to X2 being inferior
What should XPED, PED and YED sum to?
What is the optimum point of consumption for perfect substitutes?
The degree to which doubling inputs raises outputs:
If Degree 0, doubling incomes and prices will not change utility
How do you find homogeneity?
Add the powers, sum the elasticises
How do you calculate indirect utility?
Sum optimum values back into utility function
What is the income effect, substitution effect, and price effect
A-C is the Substitution Effect
A-B is the Price Effect
B-C is the income effect
What are the properties of Hicksian demand Functions?
Law of demand applies
The Goods are Net Substitutes
Homogeneous degree 0
What is the formula for income effect?
What is the formula for substitution effect?
What is it the slope of?
Slope of hicksian demand function
What is the formula for the price effect?
Sub Effect + Income Effect
What is the Slutsky equation?
dx1*/dP1= dx1h/dP1 -
When calculating income effect, how is X1 obtained?
An average of the values of X1 at A and C
Discuss the slutsky equation for normal goods
Negative price effect
Income effect positive ( but negative sign)
Negative Sub effect
Discuss the slutsky equation for inferiord goods
Price effect is Negative
Income is negative
Sub is negative
Sub > Income
Discuss the slutsky equitation for giffen goods
Price effect is positive
Income is Negative
Sub is Negative
Sub < Income
How will rising income be distributed?
BSX1*YED1 + BSX2*YED2 = 1
Discuss a subsidy
(P1−S)x1+P2x2=M If x1≤K
P1x+P2x2=M+sK If X1>K
If XK Slope = P1/P2
Discuss Free Provision
P2 x2=M If X1≤K
P1x1+P2x2=M+P1 K If X>K
Discuss Bulk Discounts
(P1+c)X1+P2x2=M IF X1≤K
P1 x1+P2x2=M−cK if X>K
Graph looks like staircase as every other good is free
Discuss labour leisure Choice?
Work = 24-L
Income = (24-L)W
What does a labour supply curve look like for a normal good
If wage increases
Income Effect: More Leisure less work
Sub Effect: Less leisure, more work
If Income > Sub: Backwards Bending
If Sub>Income: Tends to Vertical
What does a labour supply curve look like for a inferior good
If Wages Increase:
Both Income and Sub say have less leisure and more work
Therefore always backwards bending
Discuss Consumption Savings
What you save today is tomorrows consumption:
M=C1 + C2/1+R
Discuss Weak Axiom of Revealed Preference
If Cons Chooses A in P1, we know A>B
Therefore, must always choose A if A and B affordable
What is the difference between exogenous and endogenous uncertainty
Exogenous: Not sensitive to your behaviour
Endogenous: You can influence the probabilities
What is a fair bet?
Where the expected return EY=0
How can you make an unfair bet fair?
Pay the loosing party money to play
Discuss the ST Petersburg Paradox?
Flipping a Coin,
EY=100, therefore opponent needs 100 to play
Need to reach round 7 to Profit
What are the measures of risk aversion?
What can you do when facing risk?
Nothing : U=EU
Avoid: EY = CE
Provide an Overview of Insurance
Good Outcome =W
Bad Outcome = L
Insurance Cover = D
Premium Amount = γD
How do you work out the optimal insurance cover (D)?
MAXE=PB * U(YB) +PG * U(YG)
Diff and Set = 0
What is the value of γ
As PC Eπ=γD−PBD=0
Discuss constant utility across all states?
Same amount of utiltiy regardless of good or bad
Create the Job Search Model
Salary distributed over a line
Old Wage W*
What is the probability of finding a w>W*
What is the net expected W from a job search?
NETEW=(b−w*)/(b−a) X (b−w*)/2) + (1−(b−w*)/(b−a)w*−c
What should W* be to stop searching?
Set NETEW = W*, Solve for W*:
Discuss the lemon problem
As buyers cannot tell quality of car, will only pay low price, therefore only lemons come to market
Discuss the optional insurance problem
You only buy insurance if:
Therefore: π=(U(W)−U(W−P))/((U(W)−U(W−L)) )
Only people with a risk higher than the critical probability will buy insurance, therefore average increases and market breaks down
What is screening?
Getting the informed party to reveal there information through varipus means
Why is first degree price discrimination not possible if markets are not separated?
High price will purchase at low price, thus gaining a discount
How would you price discriminate if markets are not separate?
Design different bundles, allow consumers to self select
Discuss the high bundle
Discuss the Low Bundle
What is total profit?
To optimise, diff for X and solve
What other methods are available for discovering hidden information
Signalling: Adopting costly means to communicate information
Discuss moral hazard in the loan market
Initially high as banks will not reposes for small loans
Then falls as they repossess
Then rises, as even if banks do repossess, cannot find buyer for large assets
What are the two types of valuation?
Private Valuation - Each WTP is independent
Common Valuation - Also known as correlated, is linked in some way
What are the four types of private auctions?
Open Bid English - Open and accending
Open Bid Dutch - Open and decending
First price sealed - Pay highest
Second Price Sealed - Pay second highest
What are the similarities between auction types?
English and Second price are identical
Dutch and First are identical
Dutch is better for seller and efficency