week 2 Flashcards
utility
A numeric measure of a person’s happiness
utility function
a way of assigning a number to every possible consumption bundle in a way that more preferred bundles get larger numbers than less preferred ones
indifference map
the collection of all indifference curves for a given preference relation
utility function for perfect substitutes
u(x1, x2) = ax1 + bx2
utility function for perfect complements
u(x1, x2) = min{ax1, bx2}
Cobb-Douglas
u(x1, x2) = xc1*xd2
- where c and d are positive numbers that describe the preferences of the
consumer
marginal utility
the added satisfaction that a consumer gets from having one more unit of a good or service
marginal utility function
∆U = MU1*∆x1
using a utility function to measure MRS
M RS = ∆x2 / ∆x1 = − MU1 / MU2
optimal choice
best bundle that the consumer can afford
demand function
gives the optimal amounts of
each of the goods as a function of the prices and income faced by
the consumer
comparative statics
tudying how choice responds to changes in the
economic environment
normal good
he quantity demanded for it increases when income increases, and decreases when income decreases
inferior good
An increase of income results in a reduction in the consumption of the good
income offer curve
llustrates the bundles of goods that are demanded at the different levels of income
engel curve
ocuses on 1 good and graphs the demand for one of the goods as a function of income, with all prices being held constant
Giffen good
a non-luxury product for which demand increases as the price increases and vice versa, thus defying standard laws of demand
price offer curve
represents the bundles that would be demanded at different level of p1
demand curve
focuses on good 1, holding p2 and m fixed, plots the
optimal level of consumption of good 1 as p1 changes
inter-temporal choices
how current decisions affect what options become available in the future
consumption in two time periods
(c1, c2)
amount of money in two time periods
(m1, m2)
budget constraint with two periods
c2 = m2 + (m1 − c1)
borrowing
lend money at interest rate r
future value
c1 + (c2 / (1+r)) = m1 + (m2 /
(1+r))
endowment
total amount of income
horizontal intercept of budget constraint
the maximum amount of first-period consumption possible: c1 = m1 + (m2
/ (1+r))
vertical intercept of budget constraint
he maximum amount of second-period
consumption possible: c2 = (1 + r)m1 + m2
present value formula
pt = mt /
(1 + r)^t−1
present value formula explained
allows to calculate the value of a given
amount of money T years in the future
Net Present Value (NPV)
N P V = M1 − P1 +( (M2 − P2)
/(1 + r) )
