Lecture 1 Flashcards
Optimization
Central assumption of optimizing behaviour
People want to make the best out of a set of choices
The idea of optimization is an excellent tool to improve decision making that is not optimal
Economic agents
Any group or individual that makes choices
They try to optimize; choose the best available option.
Concerns a comparison by the people of the benefits versus costs associated with the action
Constraints
A scarcity of goods or money or time
Models of the decision-making process
In the model, individuals are assumed to maximize utility.
Maximizing utility
Subject to a budget and time constraint Relative preferences (utility) for goods becomes relevant. The optimal decision confronts marginal gains in utility with marginal costs; this gives you the demand curve for a good.
Diminishing returns to scale
At high consumption, the additional benefit from more consumption is becoming smaller and smaller as the level of quantity increases.
Diminishing returns to scale Optimum
Marginal benefits = marginal costs
The result of optimization
The greatest level of utility is obtained
Demand Curve
Confronting marginal costs to marginal benefits provides the consumer a demand curve with a quantity of goods.
Demand is infulenced by preferences, consumer income, prices, other goods and own goods
The steepness of the slope reflects the willingness to pay
> The flatter the slope, the more preices sensitive individuals are
> The steeper the slope, the least price sensitive individuals are
Elasticity of demand
The responsiveness in the quantity to changes in the price
Inelastic demand
Regardless of the price, the same quantity of the good is demanded = no price sensitivity.
e.g. medical care in life threatening accident
Three concepts for consumer value
- Total consumer value
- Total expenditure
- Consumer surplus
Total consumer value
The sum of the maximum amount a consumer is willing to pay at different quantitites
= The consumer surplus + total expenditure
Total expenditure
The per-unit market price times the number of units consumed
Consumer surplus
Extra value that consumer derive from a good but do not pay extra for
(The expenditures that they had to pay for + the expenditures that they did not have to pay for)
Consumer surplus is defined as the difference between the consumers’ willingness to pay for a commodity and the actual price paid by them, or the equilibrium price.
Description: Total social surplus is composed of consumer surplus and producer surplus. It is a measure of consumer satisfaction in terms of utility.
Graphically, it can be determined as the area below the demand curve (which represents the consumer’s willingness to pay for a good at different prices) and above the price line. It reflects the benefit gained from the transaction based on the value the consumer places on the good. It is positive when what the consumer is willing to pay for the commodity is greater than the actual price.
Consumer surplus is infinite when the demand curve is inelastic and zero in case of a perfectly elastic demand curve.
Production problem
how many products to produce, given
- That consumer demand varies with prices
- The production costs
- The structure of the market
Producer surplus
Producer surplus is defined as the difference between the amount the producer is willing to supply goods for and the actual amount received by him when he makes the trade. Producer surplus is a measure of producer welfare. It is shown graphically as the area above the supply curve and below the equilibrium price.
Here the producer surplus is shown in gray. As the price increases, the incentive for producing more goods increases, thereby increasing the producer surplus.
A producer always tries to increase his producer surplus by trying to sell more and more at higher prices. However, it is simply not possible to increase the producer surplus indefinitely since at higher prices there might be very little or no demand for goods.
Equillibrium
When supply meets demand
Commodity taxes
Taxes on goods such as food, fuel, cigarettes
> Tax sellers for every unit sold
> Tax buyers for every unit bought
Both supplier and buyers pay the tax, it is determined by the forces of demand and supply
Standard assumptions related to the fundamental welfare theorems in economics
- Perfect competition
- Complete markets
- Absence of market failures
- Perfect information
Perfect competition
Standard assumption related to the fundamental welfare theorems in economics
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In theoretical models where conditions of perfect competition hold, it has been demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price.
Complete markets
Markets that provide all goods and services for which individuals are prepared to pay a price that covers the production costs
Absence of market failures
Example of merket failure is external effects: When agent A imposes costs/benefits on another agent B
Like with vaccination, when individals in society get vaccinated decreases the risk of other individuals to get the disease
Perfect information
Economic agents have perfect information, however, consumeres may have imperfect information about quality of good
Equity
Horizontal equity: equal rights for equal need (same income groups should be taxed the same)
Vertical equity: redistribution from rich to poor
Intervention on efficiency grounds is necessary when answering these 3 questions:
- can the market solve the problem itself?
- if not, what kind of intervention is needed?
- would the intervention be cost effective?
Types of intervention
- Regulation
- Finance
- Production
- Income transfers
The welfare state
State involvement in cash and in-kind benefits and provision of health care, education and other welfare services
Health care provision
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Pension provision
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