Theoretical Tools Flashcards

1
Q

Theoretical Tools

A

techniques that economists use to model the economy

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2
Q

empirical tools

A

techniques that economists use to study data

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3
Q

Constrained Utility Maximization

A

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

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4
Q

steps for constrained utility maximization

A

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)

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5
Q

preferences

A

what a person likes or doesn’t like

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6
Q

utility function

A

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

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7
Q

Indifference Curves

A

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

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8
Q

Non-satiation

A

the assumption that “more is better

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9
Q

Non-satiation Indifference Curves Properties

A

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

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10
Q

Marginal Utility

A

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

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11
Q

Utility functions usually exhibit diminishing marginal utility

A

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

Mathematically, ∂u/∂Xj decreases with Xj

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12
Q

Marginal Rate of Substitution

A

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

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13
Q

Budget Constraint

A

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

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14
Q

Substitution Effect

A

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

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15
Q

Income Effect

A

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

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16
Q

Individual demand curve

A

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

17
Q

Aggregate Demand Curve

A

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

18
Q

The Elasticity of Demand

A

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

19
Q

Individual Supply Curve

A

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

20
Q

Elasticity of Supply

A

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

21
Q

Aggregate Supply Curve

A

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

22
Q

market eq

A

where aggregate supply and aggregate demand meet (are equal)

23
Q

Consumer Surplus

A

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
24
Q

Producer Surplus

A

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

25
First Welfare Therom
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
26
Limitations of the First Welfare Theorem
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)
27
Social Welfare
the level of wellbeing in society - Depends on: (i) whether resources are used efficiently and (ii) how resources are allocated across people
28
Because of diminishing marginal utility of consumption
For any set amount of resources, social welfare will be higher if the resources are distributed more equally
29
Social welfare function
A function that combines each person’s utility into a measure of the overall level of well-being in society
30
social welfare maximization problem
Maximize social welfare subject to the society-wide budget constraint
31
Utilitarianism
maximize the sum of individual utilities - calls for redistribution, since MU higher for poor than rich
32
Rawlsian
maximize the utility of society’s worst-off members - Calls for strong redistribution
33
Commodity egalitarianism
meet everyone’s basic needs - Provide education, healthcare, retirement/disability benefits as “rights” - Thereafter, don’t worry about distribution
34
Equality of opportunity
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)
35
bigger focus on efficiency vs social welfare bc
1) seems more impartial 2) many types of social welfare theorems so it's hard to decide which one to use