Summary Microeconomics: important concepts

Short summary ME

Lecture/knowledge clip:
Networkexternality  positive (bandwagon effect)  negative (snob effect)

Salience: people assign value by appearance (warings on garbage bins reduce littering)

Loss aversion: people fear losses more than they value gains

Endowment effect: people increase valuation of objects they own

Anchoring: suggested donations

Probability bias: betting on rare lottery numbers

Overconfidence: most people think they are above the average

Diminishing marginal utility: as more and more of a good is consumed, consuming additional
amounts will yield smaller and smaller contribution to utility

Fixed costs vs sunk costs: fixed costs are paid regardless of the output but can be recovered
if firm goes out of business.  sunk cost have been incurred and cannot be recovered



At which of the following utility functions are goods F and C perfect complements?
U(F,C)=min(F,2C)

Perfect substitutes:
U(F,C) = F + 2C

Convex indifference curves:
U(X,Y) = XY

Positive analysis: cause and effect (deal with explanation and prediction)
Normative analysis: what ought to be (what is best? Morally right to do)  makes value
judgement

Normal price: absolute price, unadjusted for inflation
Real price: constant dollar, adjusted for inflation

Price elasticity of demand  usually negative number
Cross-price elasticities subsitutes  positive number
Cross-price elasticities complements  negative

Linear demand curve form: Q=a-bP
Linear supply curve form: Q=c+dP

, The steeper (stijl) the slope of the curve  less elastic demand

For many goods demand/supply is more price elastic in long run, (takes time to change)
For some goods demand/supply more elastic in short run (they are durable)

For most goods income elasticity of demand is larger in long run
For a durable good, income elasticity of demand is larger in short run

Consumer behavior: consumer preferences, budget constraints & consumer choices

Basic assumptions about preference
1. completeness (prefer something else, but buy it because its cheaper)
2. transitivity (prefer A to C, etc)
3. more is better than less
4. diminishing marginal rate of subsitution

Indifference curve (downward sloping): curve representing all combinations of market
baskets that provide a consumer with the same level of satisfaction.
Basket ABOVE and to the RIGHT of indifference curve?  this one is preferred

Indifference curves CANNOT intersect, because more needs to be preferred to less

Marginal rate of substitution (MRS): maximum amount of a good that a consumer is willing
to give up in order to obtain one additional unit of another good (downsloping + convex)
IF MRS IS 3  CONSUMER WILL GIVE UP 3 UNITS OF CLOTHING TO OBTAIN 1 ADDITIONAL
UNIT OF FOOD - wrriten as -ΔC/ΔF

Perfect subsitutes: straight line linear shaped in corner (because one good is constant)
Perfect complements: L-shaped (because MRS is zero or infinite for two goods)

We do know that, for example, U3 is better than U2, but we DO NOT KNOW by how much
one is preferred to the other

Maximizing market basket must satisfy these conditions:
1. must be located on the budget line
2. must give the consumer the most preferred combination
(basket which maximizes satisfaction must lie on the highest indifference curve that touches
the budget line)
Satisfaction is maximized when MRS = Pf/Pc (ratio of prices)
Satisfaction is also maximized where MB = MC

MRS = -(ΔC/ΔF)