The Market

Question 1

Pareto Efficient

Answer 1

A situation whereby we can find no way to make anyone better off without making anyone else worse off in the process.

Question 2

Deadweight Loss

Answer 2

A measure of economic inefficiency - when resources left unexploited or excess production occcurs

Question 3

Budget Line Equation

Answer 3

p1x2+p2x2=M

Question 4

Budget Line

Answer 4

All affordable bundles lie on or under this line

Question 5

Slope of Budget Line

Answer 5

-p1/p2

Question 6

AXIOM of weak ordering- Completeness

Answer 6

A consumer must be able to say whether they prefer or are indifferent between any 2 goods

Question 7

AXIOM of weak ordering - reflexivity

Answer 7

Bundle A must be at least as good as itself

Question 8

AXIOM of weak ordering- transitivity of preference

Answer 8

If A is preferred to B and B is preferred to C then A is also preferred to C

Question 9

Rationality

Answer 9

Assumes consumer satisfies axioms of completeneness, reflexivity and transitivity -> is consistent

Question 10

AXIOM of weak ordering - continuity of preference

Answer 10

If A is weakly preferred to B, then bundles sufficiently close to A will also be weakly preferred to B

Question 11

AXIOM of weak ordering - monotonicity

Answer 11

‘more is preferred to less’

Question 12

AXIOM of weak ordering - convexity

Answer 12

Average is preferred to the extremes, mixed bundle is better.

Question 13

MRS

Answer 13

The absolute value of the slope of the indifference curve = MRS = MU1/MU2

Question 14

MRS DECREASING

Answer 14

Convex indifference curve

Question 15

MRS CONSTANT

Answer 15

Perfect substitutes

Question 16

MRS INFINITY OR ZERO

Answer 16

Complements

Question 17

Utility Maximisation Problem

Answer 17

When slope of budget line = slope of indifference curve: P1/P2=MRS=MU1/MU2

Question 18

Solutions to UMP are..

Answer 18

Marshallian demand functions for x1 and x2

Question 19

Marshallian demand function for x1 when utility function is Cobb-Douglas

Answer 19

x1=x1(p1,p2,M) = x1=α(M/P1)

Question 20

Marshallian demand function for x2 when utility function is Cobb-Douglas

Answer 20

x2=x2(p1,p2,M) = x2=(1-α)(M/P2)

Question 21

Marshallian demand function for x2 when utility function is Leontief (perfect complements)

Answer 21

x2*=aM/bp1+ap2

Question 22

Marshallian demand function for x1 when utility function is Leontief (perfect complements)

Answer 22

x1*=bM/bp1+ap2

Question 23

Optimal solution to UMP (exceptions)

Answer 23

Generally when p1/p1=MRS, exceptions when MRS does not exist or corner solution when MRS>P1/P2 or MRS

Question 24

Euler’s elasticity rule

Answer 24

If a function is homogenous to degree r, the sum of all elasticities will equal to r (for the Marshallian demand for any given good will have sum of price and income elasticities equal to zero)

Question 25

Own Price elasticity (e11)

Answer 25

dx1/dp1 x p1/x1

Question 26

Cobb-douglas own PED

Answer 26

dlnx1*/dlnp1

Question 27

Cobb-douglas income elasticity of demand

Answer 27

dlnx1*/dlnM

Question 28

Engel Curve

Answer 28

Tracing path of consumption as income changes, prices held constant.

Question 29

Homothetic preference

Answer 29

When MRS is a function of only the ratio of preferences, not the quantity of the goods individually

Question 30

Satiation point

Answer 30

The point of maximum satisfaction, the closer to this point the better off he is in terms of his preferences.

Question 31

Increasing slope Engel Curve (M, x1)

Answer 31

x1 necessary good

Question 32

Decreasing slope engel curve (M, X1)

Answer 32

x1 luxury good

Question 33

Constant slope engel curve

Answer 33

ratio of x2/x1 constant, homothetic preferences - income elasticity always 1

Question 34

Income elasticities of different goods are linked

Answer 34

s1 (budget share of x1) | S1E1m+(1-S1)E2m = 1

Question 35

Gross substitutes and law of demand

Answer 35

If x2 is a gross substitute of x1, the law of demand holds for x1 If dx2/dp1 > 0 then x2 is gross substitute and must be the case that dx1/dp1 < 0 (law of demand holds)

Question 36

Aggregate Demand

Answer 36

Derive market demand by summing individual marshallian demand curves

Question 37

Aggregate elasticity

Answer 37

e = weighted sum of individual elasticities= EaZa + EbZb where Za = xA/X and Za+Zb = 1

Question 38

Hicksian (Compensated) Demand Function

Answer 38

Refer to expenditure minimisation rather than utility maximisation

Question 39

Hicksian demand function for x1 when utility function is Cobb-Douglas

Answer 39

x1h=(α/1-α)^(1-α) (p2/p1)^(1-α) u0

Question 40

Marshallian demand function for x2 when utility function is Cobb-Douglas

Answer 40

x2h=(α/1-α)^(α) (p2/p1)^(α) u0

Question 41

Hicksian demand and price changes - both prices change

Answer 41

Hicksian demand homogenous to degree zero so demand will remain unchanged

Question 42

Hicksian demand and price changes - p1 increases

Answer 42

x1 must fall, x2 will rie (law of demand must hold for Hicksian demand functions)

Question 43

What effect happens with a price increase for Hicksian demand

Answer 43

Only substitution effect, no income effect.

Question 44

The slope of the Hicksian demand function

Answer 44

... is the substitution effect

Question 45

Expenditure function

Answer 45

the minimum cost of achieving a given level of utility --> E=p1x1h+p2x2h