Public Finance - Chapter 2 Flashcards
What are Theoretical tools of Public Finance?
The set of tools designed to understand the mechanics behind economic decision making.
What are Empirical tools?
The set of tools designed to analyze data and answer questions raised by theoretical analysis.
What is a Utility function?
A mathematical function representing an individual’s set of preferences, which translates her well-being from different consumption bundles into units that can be compared in order to determine choice.
What is Constrained utility maximization?
The process of maximizing the well-being (utility) of an individual, subject to her resources (budget constraint).
What are Models?
Mathematical or graphical representations of reality.
What is Indifference curve?
A graphical representation of all bundles of goods that make an individual equally well off.
Because these bundles have equal utility, an individual is indifferent as to which bundle he consumes.
Consumers prefer _____ indifference curves.
higher
Indifference curves are always ______ sloping
downward
What is the utility function mathematical representation?
U = f(X_1,X_2,X_3,…)
What is X_1,X_2,X_3,… ?
They are the quantities of the goods consumed.
What does the f mathematical function describe?
How consumption of each good translates to utility.
What is marginal utility?
The additional increment to utility obtained by consuming an additional unit of a good.
What is Diminishing marginal utility?
The consumption of each additional unit of a good makes the individual less happy than the consumption of the previous one.
What is a Diminishing marginal utility example?
The first bite of pizza is often the tastiest.
What is Marginal rate of substitution (MRS)?
The rate at which a consumer is willing to trade one good for another.
What is the MRS equal to?
The MRS is equal to the slope of the indifference curve, the rate at which the consumer will trade the good on the vertical axis for the good on the horizontal axis.
What is a Budget constraint?
A mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income.
What is Opportunity cost?
The cost of any purchase is the next best alternative use of that money, or the forgone opportunity.
When a person’s budget is fixed, if he buys one thing he is, by definition, reducing the money he has to spend on other things. What does this purchase have the same effect as?
Indirectly, this purchase has the same effect as a direct good-for-good trade.
What is the Substitution effect?
Holding utility constant, a relative rise in the price of a good will always cause an individual to choose less of that good.
What is the Income effect?
A rise in the price of a good will typically cause an individual to choose less of all goods because her income can purchase less than before.
For Normal goods, how do changes in income affect demand?
Goods for which demand increases as income rises.
For Inferior goods, how do changes in income affect demand?
Goods for which demand falls as income rises.
What is a Market?
The arena in which demanders and suppliers interact.
What is Market equilibrium?
The combination of price and quantity that satisfies both demand and supply, determined by the interaction of the supply and demand curves.
The study of the determinants of well-being, or welfare, in society.
Welfare economics
What is a Demand Curve?
A curve showing the quantity of a good demanded by individuals at each price.
Obtained by finding the utility-maximizing bundle at each price.
What is the Elasticity of demand?
The percentage change in the quantity demanded of a good caused by 1% change in the price of that good.
Quantity demanded falls as price ____.
rises
Elasticities of demand are typically not constant along a ________.
demand curve.
What is cross-price elasticity?
The effect of one good’s prices on the demand for another good is the cross-price elasticity
When the elasticity of demand is zero, the demand curve is perfectly ______
inelastic
When the elasticity of demand is infinite, the demand curve is perfectly ______
elastic
When the demand curve is perfectly inelastic, the demand curve is _____, and quantity demand does not change when price rises
vertical
When the demand curve is perfectly elastic, the demand curve is _____.
horizontal
When the demand curve is perfectly elastic, quantity demanded
Changes infinitely for even a very small change in price
