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1. The Market
By a model, we mean a simplified representation of allocation is such that no Pareto improvements are
reality. possible, it is called Pareto efficient.
Two different variables:
exogeneous variables (determined by factors
not in the model)
endogenous variables (determined by forces in
the model)
Two simple principles:
optimization principle (people try to choose
the best patterns of consumption that they can
afford)
equilibrium principle (people adjust until the
amount that people demand of something is
equal to the amount that is supplied)
The reservation price is a person’s maximum
willingness to pay for something. In other words: the
reservation price is the highest price that a given person
will accept and still purchase the good.
A demand curve relates the quantity demanded to
price. The supply curve relates the quantity of goods
available to price.
In a competitive market, the price is the same for all
goods and is the highest the market will bear.
By drawing both the demand curve and supply curve on
the same graph, we can find out what the equilibrium
behaviour of the market is (equilibrium price). This
price is determined by the intersection of the supply and
demand curves.
Comparative statics involves comparing two “static”
equilibria without worrying about how the market moves
from one equilibrium to another (“what happens if?”).
A situation where a market is dominated by a single
seller of a product is known as a monopoly.
Other ways to allocate goods:
discriminating monopolist (auction to the
highest bidder, reservation price known)
ordinary monopolist (same price to maximize
profit, reservation price unknown)
rent control (fixed price is decided by an
external party, e.g. the government)
If we can find a way to make some people better off
without making anybody else worse off, we have a
Pareto improvement. If an allocation allows for a
Pareto improvement, it is called Pareto inefficient; if an
Page 1 of 35
1. The Market
By a model, we mean a simplified representation of allocation is such that no Pareto improvements are
reality. possible, it is called Pareto efficient.
Two different variables:
exogeneous variables (determined by factors
not in the model)
endogenous variables (determined by forces in
the model)
Two simple principles:
optimization principle (people try to choose
the best patterns of consumption that they can
afford)
equilibrium principle (people adjust until the
amount that people demand of something is
equal to the amount that is supplied)
The reservation price is a person’s maximum
willingness to pay for something. In other words: the
reservation price is the highest price that a given person
will accept and still purchase the good.
A demand curve relates the quantity demanded to
price. The supply curve relates the quantity of goods
available to price.
In a competitive market, the price is the same for all
goods and is the highest the market will bear.
By drawing both the demand curve and supply curve on
the same graph, we can find out what the equilibrium
behaviour of the market is (equilibrium price). This
price is determined by the intersection of the supply and
demand curves.
Comparative statics involves comparing two “static”
equilibria without worrying about how the market moves
from one equilibrium to another (“what happens if?”).
A situation where a market is dominated by a single
seller of a product is known as a monopoly.
Other ways to allocate goods:
discriminating monopolist (auction to the
highest bidder, reservation price known)
ordinary monopolist (same price to maximize
profit, reservation price unknown)
rent control (fixed price is decided by an
external party, e.g. the government)
If we can find a way to make some people better off
without making anybody else worse off, we have a
Pareto improvement. If an allocation allows for a
Pareto improvement, it is called Pareto inefficient; if an
Page 1 of 35
