Question Possibilities Flashcards
What is the budget line
graphical representation of
choice given preferences (indifference
curves) and consumption possibilities
(the budget line).
What happens when the price of a
commodity increases?
Subsititution/Income
• Substitution effect: the commodity is
relatively more expensive compared to
others, so consumers substitute it with
other commodities.
• Income effect: the consumer can now
purchase less than before and feels
poorer in real terms. The consumer
tends to consume less of all goods.
What is a normal good vs inferior
Normal Good: Demand increases as income rises (e.g., branded clothes).
• Inferior Good: Demand decreases as income rises (e.g., instant noodles).
Monetary vs non monetary
. Monetary Income:
• Income is expressed in terms of money (e.g., $500 salary, £100 savings).
• Common in most economic models, including utility and demand theory.
2. Non-Monetary Income:
• Value is expressed in terms of real goods or services instead of money.
• Examples:
• Barter system: Income could be “5 apples” or “2 cows.”
• Time-based income: Labor hours available for trade (common in labor economics).
• In-kind benefits: Free housing or food provided instead of cash.
What is a risk neutral
• A risk-neutral person evaluates decisions purely based on the expected value of outcomes.
• They do not care about uncertainty or variance in the outcomes.
What is risk averse
A risk-averse person values the certainty that insurance provides and would likely pay more than $100 to avoid the risk of losing $1,000.
What is the key exam tip for answering risk-neutral insurance questions?
Back:
• Calculate the expected loss.
• Compare it to the premium:
• If premium = expected loss, they buy.
• If premium > expected loss, they won’t buy.
Indifference
Indifference means they’re equally happy choosing either option—they’re not drawn to the gamble, but they’re also not avoiding it.
Expected loss
Probably of loss X amount
Why might a risk averse individual only gamble £40 instead of £50
• A risk-averse person values certainty more than the average value of a risky situation, so their certain equivalent is always less than the expected value.
Cobb douglas prefrences implys that
the demand for one good is not affected by a change in the price of the other good.
The engel curve
Shows the relationship between demand and income with an increase in income an increase in the demand for normal goods and a decrease for inferior
Formula for cobb douglas preference
X1 = a/a+b x m/p1
M is income
What effect goes in the opposite direction of a price change
Substitution effect.
Substitution Effect:
• Only considers relative prices; always works against the price change.
Income Effect:
Considers how the price change impacts purchasing power and demand, which depends on the type of good (normal or inferior).
Market value of endowments
p1 x x1 + p2 x x2
Prices of goods = P
Quantity of goods = x
This value represents the total amount Rahmi can spend if they sell their entire endowment.
Budget line equation
P1 x x1 +p2 x x2 = market value of endowment
P1= 5 P2=6
MoE=200
Will be written as
5x1 + 6x2 =200
Then plot on graph
Make them = 200
5x1=200
6x2=200
Calculate x
Slope of the budget line
- p1/p2
Labelling graph for endowment
And what is endowment
Endowment is is the total initial amount of goods and resources before making any trades or purchases in market
Good 2 on left Good 1 on bottom
Determine whether buy or sell at above market prices for specific good
E.g 1 or 2
Calculate market endowment
Use formula for good 1 or 2
X = a/a+b x m/p1
M= market endowmment
A= x power of
B= x2 power of
Is the answer greater or less than original
Buy nor sell any units at Price
P1/P2 = x1/x2
Rearrange to find whatever Price looking for and check if its the same. If not then no.
