Theoretical Tools

Question 1

Theoretical Tools

Answer 1

techniques that economists use to model the economy

Question 2

empirical tools

Answer 2

techniques that economists use to study data

Question 3

Constrained Utility Maximization

Answer 3

a mathematical model of how people make decisions, specifically how people make decisions by maxing their utility with their budget constraint

Question 4

steps for constrained utility maximization

Answer 4

1) preferences and utility functions
2) indifference curves
3) marginal utility & marginal rate of substitution
4) budget constraint
5) find where BC is tangent to IC (MRS (-qy/qx)= -px/py)

Question 5

preferences

Answer 5

what a person likes or doesn’t like

Question 6

utility function

Answer 6

a mathematical function that captures a person’s preferences, Reveals the amount of utility gained from consuming a given set of goods

Question 7

Indifference Curves

Answer 7

the set of bundles of goods that make a person equally well off

Question 8

Non-satiation

Answer 8

the assumption that “more is better

Question 9

Non-satiation Indifference Curves Properties

Answer 9

1) People prefer higher indifference curves (farther out from the origin
2) Indifference curves are downward sloping

Question 10

Marginal Utility

Answer 10

The addit. utility from consuming one more unit of a good

Question 11

Utility functions usually exhibit diminishing marginal utility

Answer 11

Consuming an additional unit gives less extra utility than was gained from the previous unit

Mathematically, ∂u/∂Xj decreases with Xj

Question 12

Marginal Rate of Substitution

Answer 12

the slope of the indifference curve
→ The rate at which a consumer is willing to trade the good on the vertical axis for the good on the horizontal axis

Question 13

Budget Constraint

Answer 13

mathematical representation of the bundles of goods
that a person can afford if she spends her entire income

Question 14

Substitution Effect

Answer 14

the impact on choices of a change in the price
ratio if we hold utility constant
- Y so that the person can stay on the same IC
- Choose less of the good that suffered the price

Question 15

Income Effect

Answer 15

The impact on choices that is due to the fact that a
price ↑ reduces a person’s purchasing power
- reflects that we don’t compensate people for price ↑s
- Choose less of all goods

Question 16

Individual demand curve

Answer 16

the demand curve for a single person
- Specifically: a function that relates the price of a good to the quantity that a person would choose to purchase

Question 17

Aggregate Demand Curve

Answer 17

the demand curve for the economy as a whole
- Specifically: a function that relates the price of a good to the total quantity that is demanded in the market

Question 18

The Elasticity of Demand

Answer 18

the % change in demand for a good caused by a 1% change in the price
(% change in quantity demanded) / (% change in price)

Question 19

Individual Supply Curve

Answer 19

function that relates the price of a good to the
quantity that a firm is willing to sell
- Outcome of the firm’s profit maximization problem
→ sell until marginal cost rises up to the market price of the good
⇒ Firm’s supply curve is its marginal cost curve

Question 20

Elasticity of Supply

Answer 20

% change in supply caused by a 1% change in the
price of a good:
(% change in quantity demanded) / (% change in price)

Question 21

Aggregate Supply Curve

Answer 21

function that relates the price of a good to the total quantity that is supplied in the market
- The horizontal sum of each firm’s individual supply curve
- For each price, add up each firm’s quantity supplied over all firms

Question 22

market eq

Answer 22

where aggregate supply and aggregate demand meet (are equal)

Question 23

Consumer Surplus

Answer 23

the benefit (in $) that consumers gain from the market
- I.e., the difference between:
1. The price that a consumer is willing to pay for a unit (demand)
2. The price that the consumer actually pays (the market price), summed over all units purchased

• Graphically, the area below the demand curve and above the market price

Question 24

Producer Surplus

Answer 24

The benefit (in $) that firms gain from the market
- I.e., the difference between:
1. The price that a firm is willing to receive for a unit (supply)
2. The price that the firm actually receives (the market price),
summed over all units sold
– the area above the supply curve and below the market price

Question 25

First Welfare Therom

Answer 25

When there are no market failures, the market maximizes the total surplus & is efficient
– it returns the largest benefits that consumers and firms can get, given their budget (and cost) constraints

Question 26

Limitations of the First Welfare Theorem

Answer 26

1) The FWT applies only if there are no market failures (No externalities, Perfect competition, Perfect information, Agents are rational)
2) Efficiency says nothing about distribution (equality)

Question 27

Social Welfare

Answer 27

the level of wellbeing in society
- Depends on: (i) whether resources are used efficiently and (ii) how resources are allocated across people

Question 28

Because of diminishing marginal utility of consumption

Answer 28

For any set amount of resources, social welfare will be higher if the resources are distributed more equally

Question 29

Social welfare function

Answer 29

A function that combines each person’s utility into a measure of the overall level of well-being in society

Question 30

social welfare maximization problem

Answer 30

Maximize social welfare subject to the society-wide budget constraint

Question 31

Utilitarianism

Answer 31

maximize the sum of individual utilities
- calls for redistribution, since MU higher for poor than rich

Question 32

Rawlsian

Answer 32

maximize the utility of society’s worst-off members
- Calls for strong redistribution

Question 33

Commodity egalitarianism

Answer 33

meet everyone’s basic needs
- Provide education, healthcare, retirement/disability benefits as “rights”
- Thereafter, don’t worry about distribution

Question 34

Equality of opportunity

Answer 34

give everyone the same chance to succeed
- Compensate people for inequalities that they’re not responsible for (e.g., family background, inheritance, ability)
- Don’t compensate for inequalities they are responsible for (being lazy)

Question 35

bigger focus on efficiency vs social welfare bc

Answer 35

1) seems more impartial
2) many types of social welfare theorems so it’s hard to decide which one to use