Lecture 1

Question 1

Optimization

Answer 1

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

Question 2

Economic agents

Answer 2

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

Question 3

Constraints

Answer 3

A scarcity of goods or money or time

Question 4

Models of the decision-making process

Answer 4

In the model, individuals are assumed to maximize utility.

Question 5

Maximizing utility

Answer 5

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.

Question 6

Diminishing returns to scale

Answer 6

At high consumption, the additional benefit from more consumption is becoming smaller and smaller as the level of quantity increases.

Question 7

Diminishing returns to scale Optimum

Answer 7

Marginal benefits = marginal costs
The result of optimization
The greatest level of utility is obtained

Question 8

Demand Curve

Answer 8

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

Question 9

Elasticity of demand

Answer 9

The responsiveness in the quantity to changes in the price

Question 10

Inelastic demand

Answer 10

Regardless of the price, the same quantity of the good is demanded = no price sensitivity.
e.g. medical care in life threatening accident

Question 11

Three concepts for consumer value

Answer 11

1. Total consumer value
2. Total expenditure
3. Consumer surplus

Question 12

Total consumer value

Answer 12

The sum of the maximum amount a consumer is willing to pay at different quantitites
= The consumer surplus + total expenditure

Question 13

Total expenditure

Answer 13

The per-unit market price times the number of units consumed

Question 14

Consumer surplus

Answer 14

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.

Question 15

Production problem

Answer 15

how many products to produce, given

• That consumer demand varies with prices
• The production costs
• The structure of the market

Question 16

Producer surplus

Answer 16

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.

Question 17

Equillibrium

Answer 17

When supply meets demand

Question 18

Commodity taxes

Answer 18

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

Question 19

Standard assumptions related to the fundamental welfare theorems in economics

Answer 19

1. Perfect competition
2. Complete markets
3. Absence of market failures
4. Perfect information

Question 20

Perfect competition

Answer 20

Standard assumption related to the fundamental welfare theorems in economics
>

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.

Question 21

Complete markets

Answer 21

Markets that provide all goods and services for which individuals are prepared to pay a price that covers the production costs

Question 22

Absence of market failures

Answer 22

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

Question 23

Perfect information

Answer 23

Economic agents have perfect information, however, consumeres may have imperfect information about quality of good

Question 24

Equity

Answer 24

Horizontal equity: equal rights for equal need (same income groups should be taxed the same)
Vertical equity: redistribution from rich to poor

Question 25

Intervention on efficiency grounds is necessary when answering these 3 questions:

Answer 25

1. can the market solve the problem itself?
2. if not, what kind of intervention is needed?
3. would the intervention be cost effective?

Question 26

Types of intervention

Answer 26

1. Regulation
2. Finance
3. Production
4. Income transfers

Question 27

The welfare state

Answer 27

State involvement in cash and in-kind benefits and provision of health care, education and other welfare services

Question 28

Health care provision

Answer 28

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Question 29

Pension provision

Answer 29

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