WEEK 5

Question 1

perfect knowledge

Answer 1

assumption that

• Households possess a knowledge of the qualities and prices available in the market
• Firms have all available information concerning:
  
  • Wage rates
  • Capital costs
  • Technology
  • Output prices

Question 2

perfect competition

Answer 2

industry structure in which there are:

• Many firms, each small relative to the industry
• Produce virtually identical productions
• No firm is large enough to have any control over prices

Question 3

homogenous products

Answer 3

products that are identical/indistinguishable from one another

Question 4

What are the 3 basic decisions households make in the output market?

Answer 4

1. how much of each product to demand
2. how much labor to supply
3. how much to spend today and how much to save for the future

Question 5

budget constraint

Answer 5

limits imposed on household choices by

1. income
2. wealth
3. prices

Question 6

choice/opportunity set

Answer 6

set of options that is limited by a budget constraint

Question 7

real income

Answer 7

set of opportunities to purchase real goods/services available to a household as determined by price and money income

Question 8

budget constraint equation

Answer 8

where I = household income

Question 9

What is the effect of a change in price on budget constraint?

Answer 9

n.b. the opportunity set after the price decrease is both triangles

Question 10

utility

Answer 10

satisfaction a product yields

Question 11

marginal utility

Answer 11

additional satisfaction gained by the consumption of one more unit of a g/s

Question 12

total utility

Answer 12

total amount of satisfaction obtained from consumption of a g/s

Question 13

law of diminishing marginal utility

Answer 13

the more of any one good consumed in a given period, the less utility generated by consuming each additional unit of the same good

Question 14

total utility and marginal utility graphs

Answer 14

Question 15

financial capital market

Answer 15

complex set of institutions in which suppliers of capital (households that save) and demand for capital (firms wanting to invest) interact

Question 16

What are the assumptions of the indifference curve?

Answer 16

1. analysis is restricted to goods with positive marginal utility
2. diminishing marginal rate of substitution defined as (see pic) - ratio at which a household is willing to substitute X for Y
3. consumers have ability to choose among combinations of g/s available
4. consumer choices are consistent (rational)

Question 17

indifference curve

Answer 17

set of points, each a comination of good X and good Y, that all yield the same total utility

Question 18

indifference curve graph

Answer 18

• consumer is indifferent between points A,B,C
• however, if at point to the left of the curve then the consumer is unequivocally worse off

Question 19

indifference curves + budget constraint

Answer 19

highest possible utility curve is at the point where the indifference curve is tangent to the budget constraint

Question 20

diamond/water paradox

Answer 20

states:

• things with the greatest value in use frequently have little or no value in exchange
• things with the greatest value in exchange frequently have little or no value in use

Question 21

income effect

Answer 21

• if a household continues to buy the same amount of every g/s after a decrease in the price of one good, it will have income left over
• extra income can be spent on the product whose price declined or on other products

Question 22

substitution effect

Answer 22

• when the price of a product decreases, the product becomes relatively cheaper and therefore more attractive than substitutes
• household will shift away from substitutes and towards this product

Question 23

income and substitution effects as demand mechanisms

Answer 23

Question 24

What are the 3 decisions made by households in input markets?

Answer 24

1. whether to work
2. how much to work
3. what kind of job to work

Question 25

What are the determinants of labor supply?

Answer 25

* availability of jobs * market wage rates * skills possessed * limited hours in a week

Question 26

What are some labor supply-related trade-offs households face?

Answer 26

* wages and non-market production (e.g. child-rearing) * wages and leisure

Question 27

labor supply curve

Answer 27

curve that shows the quantity of labor supplied at different wage rates

Question 28

What is the effect of the substitution and income effects on the labor supply curve?

Answer 28