question

demand

answer

A weakly negative function of the price

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Supply

answer

A weakly positive function of the price

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Equilibrium Price

answer

The price point when Qs = Qd

question

Demand Curve

answer

a curve showing how much of a product a consumer is willing to buy at each price point, holding all else equal

question

Demand Shifts for a Normal Good

answer

For this kind of good, given an Income M

↑M ⇒ ↑D

so demand curve shifts right

↑M ⇒ ↑D

so demand curve shifts right

question

Demand Shifts for an Inferior Good

answer

For this kind of good, given an Income M

↑M⇒ ↓D

so demand curve shifts left

↑M⇒ ↓D

so demand curve shifts left

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Demand Shifts for Substitutes

answer

Given a substitute with price P,

↑Psubstitute⇒ ↑D

so demand curve shifts right

↑Psubstitute⇒ ↑D

so demand curve shifts right

question

Demand Shifts for Complements

answer

Given a complement with price P,

↑Pcomplement⇒ ↓D

so demand curve shifts left

↑Pcomplement⇒ ↓D

so demand curve shifts left

question

Movements along the curve

answer

Quantity change due to a change in the price is shown as a movement along the curve.

question

Demand Function

answer

Quantity Demanded = D(Price, Other factors)

Mathematical relationahip where Quantity Demanded is a function of price and other factors.

Mathematical relationahip where Quantity Demanded is a function of price and other factors.

question

Supply Curve

answer

a curve showing how much of a product a seller is willing to sell at each price point, holding all else equal.

question

Supply Shifts

answer

• Prices of inputs

• Technology

• Taxes/regulations

• Other factors

• Technology

• Taxes/regulations

• Other factors

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Supply Function

answer

Quantity Supplied= S(Price, Other factors)

Mathematical relationship where quantity supplied is a function of price and other factors.

Mathematical relationship where quantity supplied is a function of price and other factors.

question

Excess Supply

answer

⇒ sellers lower their prices

⇒ Qs decreases and Qd increases

⇒ lowering excess supply until it disappears.

⇒ Qs decreases and Qd increases

⇒ lowering excess supply until it disappears.

question

Excess Demand

answer

⇒ buyers increase their bids

⇒ Qs increases and Qd decreases

⇒ lowering excess demand until it disappears.

⇒ Qs increases and Qd decreases

⇒ lowering excess demand until it disappears.

question

Market Equilibrium

answer

a situation in which quantity demanded equals quantity supplied

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Horizontal Demand Curve

answer

perfectly elastic demand

example: two teenagers offering to shovel driveways after it snows. One charges $15 per driveway while the other charges $20. All things being equal between the two teens, no one hires the boy charging $20. If that teen then changes his price to $10 per driveway, the boy charging $15 loses all of his customers.

example: two teenagers offering to shovel driveways after it snows. One charges $15 per driveway while the other charges $20. All things being equal between the two teens, no one hires the boy charging $20. If that teen then changes his price to $10 per driveway, the boy charging $15 loses all of his customers.

question

Vertical Demand Curve

answer

perfectly inelastic demand

example: If the quantity demanded shows only slight change in response to a price increase, for example, demand is inelastic. This is often the case with products that are considered necessities, such as food and housing.

example: If the quantity demanded shows only slight change in response to a price increase, for example, demand is inelastic. This is often the case with products that are considered necessities, such as food and housing.

question

Horizontal Supply Curve

answer

perfectly elastic supply

example: In practice, this means that any increase in quantity demanded can be met without an increase in the price of the good.

example: In practice, this means that any increase in quantity demanded can be met without an increase in the price of the good.

question

Vertical Supply Curve

answer

perfectly inelastic supply

example: No matter how much a person is willing to pay, extra amounts of that good cannot be created. Land is an example of a good with a vertical supply curve.

example: No matter how much a person is willing to pay, extra amounts of that good cannot be created. Land is an example of a good with a vertical supply curve.

question

Elasticity of Demand

answer

Measures how responsive the quantity demanded is to changes in prices.

• A horizontal demand curve -> perfectly elastic.

• A vertical demand curve -> perfectly inelastic (elasticity=0).

In general, we call demand:

• elastic -> E < -1

• unit elastic E = -1

• inelastic -1 < E < 0

• A horizontal demand curve -> perfectly elastic.

• A vertical demand curve -> perfectly inelastic (elasticity=0).

In general, we call demand:

• elastic -> E < -1

• unit elastic E = -1

• inelastic -1 < E < 0

question

Elasticity of Supply

answer

Measures how responsive the quantity supplied is to changes in prices.

Supply is called

• perfectly elastic if 𝐸 → ∞

• elastic if 𝐸 > 1

• unit elastic if 𝐸 = 1

• inelastic if 𝐸 < 1

• perfectly inelastic if 𝐸 = 0.

Supply is called

• perfectly elastic if 𝐸 → ∞

• elastic if 𝐸 > 1

• unit elastic if 𝐸 = 1

• inelastic if 𝐸 < 1

• perfectly inelastic if 𝐸 = 0.

question

Total Expenditure

answer

P x Q

(Price P, Quantity Q)

(Price P, Quantity Q)

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Change in Total Expenditure

answer

= P ⋅ ΔQ + ΔP ⋅ Q

(Price P, Quantity Q)

(Price P, Quantity Q)

question

Change in total expenditure over change in price

answer

𝛥TE/ 𝛥P = (Ed + 1)xQ

Note: it's the derivative

Note: it's the derivative

question

income elasticity of demand

answer

measures of the responsive the quantity demanded is to changes in income M.

𝐸dm = (ΔQd/Qd)/(ΔM/M)

• 𝐸dm > 0 ⇒ normal good

• 𝐸dm < 0 ⇒ inferior good

𝐸dm = (ΔQd/Qd)/(ΔM/M)

• 𝐸dm > 0 ⇒ normal good

• 𝐸dm < 0 ⇒ inferior good

question

cross-price elasticity of demand

answer

Measures how responsive the demand for one good is to changes in the price of another good.

𝐸dP0 = (ΔQd/Qd)/(ΔP0/P0)

• 𝐸dP0 > 0 ⇒ substitute good

• 𝐸dP0 < 0 ⇒ complement

• 𝐸dP0 = 0 ⇒ independent goods

𝐸dP0 = (ΔQd/Qd)/(ΔP0/P0)

• 𝐸dP0 > 0 ⇒ substitute good

• 𝐸dP0 < 0 ⇒ complement

• 𝐸dP0 = 0 ⇒ independent goods

question

Preference

answer

It tells us about a consumer's likes and dislikes.

It determines the choices individuals make, such as

• how much an individual is willing to pay for a good

• the rate at which an individual is willing to substitute one good against another.

It determines the choices individuals make, such as

• how much an individual is willing to pay for a good

• the rate at which an individual is willing to substitute one good against another.

question

Utility Functions

answer

Functions used to describe consumer preferences.

question

Indifference Curves

answer

curves showing all consumption bundles that a consumer likes equally well (bunldes that give the consumer the same utility)

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Properties of Indifference Curves

answer

1. Higher indifference curves are preferred to lower ones

2. Indifference curves are downward sloping

3. Indifference curves do not cross

4. Indifference Curves are THIN

2. Indifference curves are downward sloping

3. Indifference curves do not cross

4. Indifference Curves are THIN

question

Consumption Bundle

answer

the collection of goods that an individual consumes over a given period

question

More-is-better Assumption

answer

when a given consumption bundle A contains more of every good than a second bundle B, a consumer prefers bdl A over bdl B.

question

Ranking Assumption

answer

A consumer can rank in order of preference all potential available choices (ties are possible)

question

Rational Choice Assumption

answer

Among all available options, a consumer will select the one they rank highest

question

Properties of Preference: Completeness

answer

Between any pair of alternatives A and B a consumer either prefers A over B, B over A, or is indifferent between them.

question

Properties of Preference: Transitive

answer

If a consumer prefers a given alternative A over B, and B over C, then the consumer will also prefer alternative A over C.

question

Plotting Indifference Curves

answer

Suppose Utility U is given by U=CxF

1. Solve for good on vertical axis: C=U/F

2. Pick an arbitrary Utility level and plot.

1. Solve for good on vertical axis: C=U/F

2. Pick an arbitrary Utility level and plot.

question

Substitution Between Goods

answer

A consumer can substitute goods at a rate that leaves them indifferent between bundles. (Along the IC)

question

Marginal Rate of Substitution (MRS)

answer

The rate at which a consumer must adjust Y to maintain the same Utility level when X changes marginally:

MRSxy = -ΔY/ΔX

It is equal to the negative of the slope of the tangent to the indifference curve at point A (see example on notes for point A(3,3)

MRSxy = -ΔY/ΔX

It is equal to the negative of the slope of the tangent to the indifference curve at point A (see example on notes for point A(3,3)

question

Utility

answer

A numeric value representing a consumer's relative well being.

question

Utility Formula

answer

A formula that assigns a utility value to each consumption bundle

e.g. U(F,C) = 3F + 2C + 2CF

Special Cases:

-> Perfect Substitutes X,Y:

U(X,Y) = aX + bY

->Perfect Complement X,Y:

U(X,Y) = min(aX, bY)

e.g. U(F,C) = 3F + 2C + 2CF

Special Cases:

-> Perfect Substitutes X,Y:

U(X,Y) = aX + bY

->Perfect Complement X,Y:

U(X,Y) = min(aX, bY)

question

MRS in Utility Functions

answer

(MUx)/(MUy)

question

Cobb-Douglas Utility Function

answer

U(X,Y) = X^α * Y^β

question

Quasi-linear Utility Functions

answer

U(X,Y) = f(X) + Y

question

MRS in Cobb-Douglas Utility Function

answer

αY / βX

question

Utility Function for Perfect Substitutes

answer

U(X,Y) = 𝛼X + 𝛽Y

question

Utility Function for Perfect Complements

answer

U(X,Y) = min(𝛼X, 𝛽Y)

question

"Bad" Goods

answer

E.g. waiting time at the doctor: • Suppose utility depends on waiting time 𝑤 and quality 𝑞: 𝑈(𝑤,𝑞) = 20 − 𝑤 + 2𝑞.

• To draw an IC:

- Pick some 𝑈, say 𝑈 = 10

- Solve for variable on vertical axis, say 𝑤 = 10 + 2𝑞𝑞

⇒ upward sloping IC!

• To draw an IC:

- Pick some 𝑈, say 𝑈 = 10

- Solve for variable on vertical axis, say 𝑤 = 10 + 2𝑞𝑞

⇒ upward sloping IC!

question

Budget Constraint

answer

cost of consumption bundle ≤ income

question

Budget Line Equation

answer

PaA x PbB = M

Where Pa,Pb are the prices of goods A and B respectively, A, B are the number of units of A and B, and M is the income.

When this equation is satifyied, we are on the budget line.

Where Pa,Pb are the prices of goods A and B respectively, A, B are the number of units of A and B, and M is the income.

When this equation is satifyied, we are on the budget line.

question

Properties of Budget Lines

answer

1. Budget lines separate affordable and unaffordable consumption bundles

2. The slope of the budget line is given by −𝑃X/𝑃Y, where 𝑋 is the good on the horizontal axis.

3. The budget line cuts the horizontal axis at 𝑀/𝑃𝑋 and the vertical axis at 𝑀/𝑃Y.

4. An income change implies a parallel shift of the budget line

5. A price change rotates the budget line around the intersection with the axis of the good with the unchanged price (inward rotation for a price rise)

6. Multiplying all prices by the same number has the same effect as dividing income by that number.

2. The slope of the budget line is given by −𝑃X/𝑃Y, where 𝑋 is the good on the horizontal axis.

3. The budget line cuts the horizontal axis at 𝑀/𝑃𝑋 and the vertical axis at 𝑀/𝑃Y.

4. An income change implies a parallel shift of the budget line

5. A price change rotates the budget line around the intersection with the axis of the good with the unchanged price (inward rotation for a price rise)

6. Multiplying all prices by the same number has the same effect as dividing income by that number.

question

Interior Solution

answer

A consumption choice problem has an interior solution if there are other affordable bundles with a bit more of one and a bit less of the other good

question

Boundary Solution

answer

An optimal consumption bundle that does not contain at least a bit of every good is called a boundary solution

question

Properties of Best Choices

answer

1. The consumer's best choice lies on the budget line

2. At an interior solution, indifference curve and budget line are tangent, and hence MRSxy = 𝑃𝑋/PY

3. The intersection of an indifference curve and the budget line cannot be optimal at an interior solution

4. For indifference curves with declining MRS (convex preferences), an interior choice that satisfies the tangency condition always is the best affordable choice.

2. At an interior solution, indifference curve and budget line are tangent, and hence MRSxy = 𝑃𝑋/PY

3. The intersection of an indifference curve and the budget line cannot be optimal at an interior solution

4. For indifference curves with declining MRS (convex preferences), an interior choice that satisfies the tangency condition always is the best affordable choice.

question

Optimal Choice

answer

the choice which maximizes the consumer's utility function subject to the budget constraint.

question

How to Find Optimal Consumption Quantities

answer

Solution must lie on the budget line (i.e. 𝑃𝑋 + 𝑃𝑌 = 𝑀)

Taken together, we have two conditions that determine optimal consumption quantities 𝑋 and 𝑌:

• Being on the budget line: 𝑃x𝑋 + 𝑃y𝑌 = 𝑀

• Tangency: MRSxy = 𝑃𝑋/𝑃𝑌

⇒ Given a specific utility function, we can compute MUx and MUy (and hence MRSxy), and solve for optimal quantities 𝑋 and 𝑌.

Taken together, we have two conditions that determine optimal consumption quantities 𝑋 and 𝑌:

• Being on the budget line: 𝑃x𝑋 + 𝑃y𝑌 = 𝑀

• Tangency: MRSxy = 𝑃𝑋/𝑃𝑌

⇒ Given a specific utility function, we can compute MUx and MUy (and hence MRSxy), and solve for optimal quantities 𝑋 and 𝑌.

question

Optimal Consumption Quantities for Perfect Complements

answer

If X and Y are perfect complements (utility function 𝑈(𝑋,𝑌) = min{𝛼X, 𝛽Y}), they are purchased at a constant ratio 𝑋/𝑌 = 𝛽/𝛼, irrespective of prices

• Quantities of X and Y in the optimal bundle C are found by solving the following system

𝑃x𝑋 + 𝑃y𝑌 = 𝑀

𝑋/𝑌 = 𝛽/𝛼

• Quantities of X and Y in the optimal bundle C are found by solving the following system

𝑃x𝑋 + 𝑃y𝑌 = 𝑀

𝑋/𝑌 = 𝛽/𝛼

question

Optimal Consumption Quantities for Perfect Substitutes

answer

If X and Y are perfect substitutes (utility function 𝑈(𝑋,𝑌) = 𝛼X + 𝛽Y, consumers spend their income

- entirely on X if MRSxy = 𝛼/𝛽 > 𝑃𝑋/𝑃𝑌

- entirely on Y if MRSxy = 𝛼/𝛽 < 𝑃𝑋/𝑃𝑌

- entirely on X if MRSxy = 𝛼/𝛽 > 𝑃𝑋/𝑃𝑌

- entirely on Y if MRSxy = 𝛼/𝛽 < 𝑃𝑋/𝑃𝑌

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