. Flashcards
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
2
Q
what is the reservation price
A
the price at which a person would be indifferent between doing X and not doing X
3
Q
what is the opportunity cost
A
the value of all that must be sacrificed in order to do the activity
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
5
Q
what is marginal cost
A
the increase in total cost that results from carrying out one additional unit of the activity
6
Q
what is marginal benefit
A
the increase in total benefit that results from one additional unit of the activity
7
Q
what is a positive question
A
a question that has a definitive right or wrong answer
8
Q
what is a normative question
A
a question that elicits value judgement on what ought or should be
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
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
11
Q
what is equilibrium
A
the price-quantity pair at which both buyers and sellers are satisfied
12
Q
what is surplus
A
a situation where price exceeds its equilibrium value
also called excess supply
13
Q
what is a shortage
A
a situation where price lies below its equilibrium value
also called excess demand
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
15
Q
what is consumer surplus
A
a monetary measure of the extent to which a consumer benefits from participating in a transaction
16
Q
what is producer surplus
A
the monetary amount by which a firm benefits by selling output
17
Q
what is a price ceiling
A
the level above which the price of a good is not permitted by law to rise
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
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
20
Q
what is the short run function of price
A
its focus is the distribution of output that already exists
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
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
23
Q
what are the determinants of demand
A
incomes, tastes, prices of substitutes/complements, expectations, population
24
Q
what is a normal good
A
the quantity demanded at any price rises with income
25
what is an inferior good
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
26
what is the effect of complements (price rise)
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
27
what is the effect of complements (price rise)
an increase in the price of one will tend to increase demand for the other
28
effects on a demand graph (complements, substitutes, income, population, tastes)
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
29
what are the determinants of supply
technology, factor prices, the number of suppliers, expectations, weather
30
effects on a supply graph (technology, wages, interest, price of raw materials, weather, expectations etc)
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
31
what does a 'change in demand' mean
refers to a shift in the entire demand curve
e.g. when the average income level of buyers changes
32
what does a 'change in quantity demanded' mean
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
33
how does an increase in demand effect price and quantity
increase in both equilibrium price and quantity
34
how does a decrease in demand effect price and quantity
decrease in both equilibrium price and quantity
35
how does an increase in supply effect price and quantity
decrease in the EQ price and increase in the EQ quantity
36
how does a decrease in supply effect price and quantity
increase in the EQ price and decrease in the EQ quantity
37
if the supply curve is vertical....
sellers have fixed amounts of the good they are willing to sell at any price
38
if the supply curve is horizontal ...
increase in demand leads to an increase in EQ quantity but not price
perfect competition
39
algebra for EQ
set supply and demand formulas equal to each other and sub back in
40
what is a social dilemma
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
41
what is a coordination game
games where individuals need to coordinate their actions in some way - such as two drivers who meet on a narrow road
42
what is a sequential game
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
43
what is a game of incomplete information
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
44
what are external benefits and costs
benefits and costs that do not fall on the person doing the activity
45
what is a prisoner dilemma
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
what is a commitment device
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
what are repeated games
when the players interact more than once
48
what is the tit-for-tat strategy
cooperate at first and then do whatever the other player did in the previous interaction
49
what is the grim-trigger strategy
strategy to cooperate unless the other player defects but defect for ever more if the other player defects
50
what is a nash equilibrium
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
what is the best-response function
says what strategy a player should choose conditional on the strategy of other players
52
what is the maximin strategy
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
what is strategic uncertainty
when a player does not have a dominant strategy of its own it needs to second guess what others will do
54
what is backward induction
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
what is a sub-game perfect nash EQ
sub-game perfect if players behave rationally at every decision point in the game
56
what is a budget constraint
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
effect of price changes with a budget constraint
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
effect of income changes with a budget constraint
new budget constraint has the same slope as the old but moves in one direction (e.g. closer to the origin)
59
what is a composite good
in a choice between a good X and numerous goods, the amount of money the consumer spends on those other goods
60
what is preference ordering
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
features of preference ordering
completeness, transitivity, more-is-better, continuity, convexity
62
completeness feature of preference ordering
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
transitivity feature of preference ordering
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
more-is-better feature of preference ordering
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
what is the free disposal principle
if a consumer can freely store or dispose of goods they don't want then more of something cant make them worse off
66
continuity feature of preference ordering
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
what is an indifference curve
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
what is marginal rate of substitution
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
convexity feature of preference ordering
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
diminishing MRS
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
best affordable bundle
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
what are corner solutions
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
what are perfect substitutes
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
what is a price consumption curve (PCC)
shows the quantity of goods a consumer is able to purchase when the price of the good changes
indicates the elasticity as well
75
how to change from PCC to individual demand
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
what is the individual demand curve
a relationship that tells us how much the consumer wants to purchase at different prices
77
what is the income consumption curve
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
how to generate an ICC
we hold preferences and relative prices constant and trace out the effects of changes in income
set of best affordable bundles
79
what is an engel curve
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
what is a normal good
one whose quantity demanded rises as income rises
81
what is an inferior good
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
what is the substitution effect of a price increase
when the price of a good rises, close substitutes become more attractive than before
83
what is the substitution effect
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
what is the income effect
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
what is the total effect
the sum of the substitution and income effects
86
substitution effect and convex indifference curve
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
what is a giffen good
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
can the price consumption curve for a normal good ever be downward-sloping
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
what is a sin tax
its purpose is to increase prices for consumers so that they will substitute to other goods
90
effect of a sin tax if the good is price inelastic
raise revenue but do less to reduce consumption
91
effect of a sin tax if a good is demand inelastic
tax will raise revenue but lead to a reduction in consumption
92
what is the purpose of a sin tax
to increase prices for consumers so that they will substitute to other goods
93
what happens when a tax is levied on sellers
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
how to work out sellers share of the tax burden (ts)
given by the reduction in the price the seller receives, divided by the tax
ts = (P*-(P*1-T))/T
95
how to work out buyers share of the tax burden (tb)
the increase in price (including tax) divided by the tax
tb = (P*1-P*)/T
96
effect of tax on price if demand is highly price inelastic
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
effect of tax on price if demand is highly price elastic
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
what happens when a tax is collected directly from buyers
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
what is the legal incidence of the tax
whether the buyer or seller is responsible for paying the tax to the government
100
what is the economic incidence of the tax
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
what is a consumer price index
measures changes in the 'cost of living', the amount a consumer must spend to maintain a given standard of living
102
what is an income-compensated demand curve
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
what will the income-compensated demand curve look like for a normal good in comparison to the ordinary one
always steeper than the ordinary demand curve
104
what will the income-compensated demand curve look like for an inferior good in comparison to the ordinary one
always less steep than the ordinary demand curve
105
what is consumer surplus
a monetary measure of the extent to which a consumer benefits from participating in a transaction
measured using ordinary demand curve
106
what does the height of the demand curve at any quantity tell you
the most the consumer would be willing to pay for an extra unit of shelter
107
how to find the consumer surplus
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
what is compensating variation
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
loss in consumer surplus will be larger than the compensating variation when the good is
inferior
110
loss in consumer surplus is smaller than the compensating variation when
the price of a normal good rises
111
what is two-part pricing
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
what is equivalent variation
the amount of money a consumer would pay to avoid a price change
