Term 2 Week 1: Introduction to Economic Modelling and Demand Flashcards
What are different types of economic modelling (2,2)
-Descriptive models are how people make decisions
-Normative models are how people ought to make decisions to achieve a given objective
-Explanatory models examine the mechanisms underlying some phenomenon
-predictive models make predictions about the economy
What is the difference between partial and general equilibrium (2)
-General equilibrium is within the whole model
-Partial equilibrium models distinguish between feed background exogeneous variables, and the changing endogeneous variables we want to focus on
What are some criticisms of economic models, and how can we criticise those (4,4)
Some criticisms of economic models include:
-They always ignore things
-People aren’t rational
-Too mathematical
-Market isn’t always in equilibrium
Ignore things:
-Explanations with the fewest assumptions are the best (Occam’s Razor), allowing us to focus one the immediate and most relevant effects, omitting variables unrelated or small in impact
Assuming Rationality:
-rational in a sense of maximising utility relative to constraints, and using the as if argument (assuming people have all knowledge), as behavioural can show people making mistakes
Too mathematical:
-Use maths as a language to help figure things out, then translate back to english
Markets aren’t always in equilibrium
-Economists focus on this out of necessity, easier to work with and more predictive power
What assumptions are made about competitive markets (3)
-Large number of buyers and sellers
-The behaviour of any single buyer has no impact on overlal price
-Sellers make production decisions taking price as fixed and exogenous
Why do we assume a negative relationship between price and quantity for demand (3, 2, 1)
-Income and substitution effects
-Diminishing marginal utility
-Consumer heterogeneity (consumers have different tastes and incomes)
-First 2 are intensive margin (change in amount purchased by buyers)
-Last 1 is extensive margin (changes in number of buyers)
-Theroetical exceptions to downwards sloping demand include Giffen (income > substitution) and Veblen (price is attractive) goods
How do we work out market demand, and what does this depend on
-If we have an expression for a consumers i’s demand: qx, i (px, py, m), we simply sum across all consumers to get the market demand
-To find individual demand, partially differentate utility function, find the MRS (pdx/pdy), equal to price ratio, make Px(x) subject, put this into budget constraint and make x and y the subject
-Market demand depends on the price of the good (endog), prices of other goods (exo), incomes of buyers (exo)
How can we interpret shifts in demand (3)
-Shifts in demand can be interpreted as different level curves of the demand function
-Changes in income (Exogeneous) can cause shifts
-You can tell directly through looking at the equation Qx = (Nm/Px)(a) how demand shifts to changes
How do we work out Price Elasticity of Demand (4,2)
-The problem of using slopes to work out PED is difficulties in comparing between markets, as dQ/dP gives the change for a £1 change
-We therefore normalise the slope and use , εD = (dQ/dP) x (P/Q)
-As this number is negative, some use the absolute value
-We can also express it as d(ln(Q(p))/dln(p), differentiating with respect to ln p
-Elasticity changes along a demand curve
-just because demand is inelastic at a market level, doesn’t mean it is for each producer, as close substitutes can exist within markets but not always across
What are other elasticities (2)
-Income elasticity of demand is dQ/dm x m/q
-Cross price elasticity of demand is dQx/dpy x py/Qx
What does industry supply depend on, and how would you work it out (1,1)
-Industry supply only depends on factors common to all suppliers (price of good, costs of inputs)
-Similar to demand, you sum firm supply curves horizontally to get industry demand
