Chapter 1: Thinking like an Economist
Scarcity: not just material, but immaterial too. Think about time, space in your stomach etc.
Cost-Benefit approach to decisions: if Benefits > Cost → do x.
Benefits are mostly defined by the maximum you’d be willing to pay for x.
Cost: sum of total value you have to give up in order to do x.
Reservation price: the minimum price you’d have to pay someone to do x.
Will be higher if you’re rich, tired etc…
Opportunity cost: if doing x means you can’t do y, the value of y is an opportunity cost of x.
Sunk costs: costs that you made in the past and are not recollectible or changeable. Should
ignore them in decision making.
Marginal cost: the cost of an additional unit of activity.
Marginal Benefit: the benefit of an additional unit of activity
Common pitfalls in decision making:
1. Ignoring Implicit Costs: people tend to ignore opportunity cost. You might value
skiing at €60, which costs €40. However, you will not be able to do work which pays
€45 a day, work you like so much you’d do it for free. Total cost is now €85, > than
you value skiing so you won’t do it.
a. If you wouldn’t work for less than €x, this is considered an extra benefit. You
add that to the benefit of skiing (60+x). OR subtract the €x from the salary and
see €45-x as the new opportunity cost.
2. Failing to ignore Sunk Costs: when making a decision, you should ignore sunk
costs.
3. Measuring costs and benefits as proportions rather than absolute monetary amounts:
if you would spend 30 minutes to save €10 off of a €20 purchase, you should also
spend 30 min to save €10 off of a €1000 purchase.
4. Failure of average-marginal distinction: you should keep increasing the level of
activity as long as the marginal benefits > costs. People often compare AVERAGE
cost while they should compare MARGINAL costs.
General rule: you should keep consuming until MC=MB
Homo economicus:
- Selfish, does not care about morals, values or anything.
- Does what is best for his wallet
- No one would like to be him though
Normative question: Doesn’t have a definitive answer. A question about what policies lead
to the best outcomes. Our values are taken into account. It is a loaded, charged question
,Positive question: has a definitive answer. What are the consequences of a policy for
example.
Chapter 4
bundle: combination of two or more goods.
Budget constraint: the set of all bundles purchasable given their price and the income.
- Gives a budget line. The triangle under are all bundles purchasable given the
constraint.
Constructing a budget line:
1. Draw a plane and label the axis
2. On the Y-axis note how many of product A you can buy, given you buy 0 of product B
3. On the X-axis note how many of product B you can buy, given you buy 0 of product A
4. Draw a line between the points. Voilà, a budget line / triangle
Constructing a more complex budget line
- Sales/wholesale discount: draw the separate line
belonging to the prices and discounts.
LET OP: Soms kunnen het horizontale lijnen zijn, omdat het
niet deelbaar is. (Kan geen tussenliggende mogelijkheden
kopen)
Slope of budgetline = - Px/Py.
The rate at which Qx needs to be exchanged for Qy. (also called opportunity cost
of one extra Qs)
Price changes
As the price of one product changes, the budget line changes as well: it rotates around the
intercept of the product which does not change. (So the slope changes)
Slope doesn’t change: if BOTH prices change RELATIVELY the same. (same %)
Budgets with more than 2 goods:
We use a composite good: unit equals one, how much money is left over after buy x
amount of product A.
Slope is always -Px, because unit of Y (composite) is 1.
,Consumer preferences
We know how much the consumer CAN buy, not the preference of one product over the
other.
Preference ordering: ranking all possible consumption bundles in order of preference.
Properties of preference ordering:
1. Completeness: a consumer is able to rank all possibilities.
2. Transitivity: if A > B and B > C then A > C. Otherwise: vicious cycle.
3. More-Is-Better: more of a good is preferred to less of a good. As long as you can
freely store or dispose of products.
4. Continuity: small changes in the quantity of a good should not lead to sudden
‘jumps’ in preferences.
5. Convexity: Mixtures of goods are preferable to extremes.
Problems caused by non-transitive preferences:
- It would lead to cycles, which means we cannot rank the goods properly and cannot
construct an indifference curve.
Indifference curve: a set of bundles which are equally attractive (Have same Utility).
Bundles above IC: more attractive and vice versa
Indifference curves:
1. Any bundle has an indifference curve running through it
2. Downward sloping (convex)
3. They cannot cross (because of convexity and transitivity)
Indifference map: a graph with multiple indifference curves. (infinitely much curves)
Marginal Rate of Substitution (MRS): rate at which the consumer is willing to exchange a
good on the vertical axis for a good on the horizontal axis. (equal to slope of indifference
curve)
If we take X amount of Product A away, how much of product B do we have to give?
MRS = - Ux / Uy. (partial derivatives)
Using indifference curves to describe preferences:
1. If an indifference curve is very steep, it means that a person highly prefers one
product over the other: he/she is willing to give up a lot to get one unit of another
product
Exceptions
Sometimes:
, - more-is-worse counts: for example in a restaurant, more fish is not desirable because
you can’t store/dispose of it. → upward sloping indifference curve.
- less is better counts: for example in a restaurant, if the portion sizes are too big.
You’d rather have less than more → concave indifference curve.
Best affordable bundle:
best affordable bundle is the most
preferred bundle of those that are
affordable (within budget).
More-is-better assumption dictates:
the BAB must lie ON the budget, not
below. It intersects only ONCE.
The best affordable bundle is the one
at which the slope of the IC = slope of Budget
MRS = Px/Py
If there is no point of tangency (nowhere is the
above equation fulfilled) we can get a corner
solution. Only one good is purchased.
If MRS < Ps/Pf
interior solution: a choice between two goods
that results in a positive amount consumed of both
goods
Perfect substitutes: no preference over either, they are equal in the consumer's eyes. If A
is cheaper than the B, all of A will be consumed and none of B.
Perfect complements: they complement each other perfectly. (butter and toast).
Scarcity: not just material, but immaterial too. Think about time, space in your stomach etc.
Cost-Benefit approach to decisions: if Benefits > Cost → do x.
Benefits are mostly defined by the maximum you’d be willing to pay for x.
Cost: sum of total value you have to give up in order to do x.
Reservation price: the minimum price you’d have to pay someone to do x.
Will be higher if you’re rich, tired etc…
Opportunity cost: if doing x means you can’t do y, the value of y is an opportunity cost of x.
Sunk costs: costs that you made in the past and are not recollectible or changeable. Should
ignore them in decision making.
Marginal cost: the cost of an additional unit of activity.
Marginal Benefit: the benefit of an additional unit of activity
Common pitfalls in decision making:
1. Ignoring Implicit Costs: people tend to ignore opportunity cost. You might value
skiing at €60, which costs €40. However, you will not be able to do work which pays
€45 a day, work you like so much you’d do it for free. Total cost is now €85, > than
you value skiing so you won’t do it.
a. If you wouldn’t work for less than €x, this is considered an extra benefit. You
add that to the benefit of skiing (60+x). OR subtract the €x from the salary and
see €45-x as the new opportunity cost.
2. Failing to ignore Sunk Costs: when making a decision, you should ignore sunk
costs.
3. Measuring costs and benefits as proportions rather than absolute monetary amounts:
if you would spend 30 minutes to save €10 off of a €20 purchase, you should also
spend 30 min to save €10 off of a €1000 purchase.
4. Failure of average-marginal distinction: you should keep increasing the level of
activity as long as the marginal benefits > costs. People often compare AVERAGE
cost while they should compare MARGINAL costs.
General rule: you should keep consuming until MC=MB
Homo economicus:
- Selfish, does not care about morals, values or anything.
- Does what is best for his wallet
- No one would like to be him though
Normative question: Doesn’t have a definitive answer. A question about what policies lead
to the best outcomes. Our values are taken into account. It is a loaded, charged question
,Positive question: has a definitive answer. What are the consequences of a policy for
example.
Chapter 4
bundle: combination of two or more goods.
Budget constraint: the set of all bundles purchasable given their price and the income.
- Gives a budget line. The triangle under are all bundles purchasable given the
constraint.
Constructing a budget line:
1. Draw a plane and label the axis
2. On the Y-axis note how many of product A you can buy, given you buy 0 of product B
3. On the X-axis note how many of product B you can buy, given you buy 0 of product A
4. Draw a line between the points. Voilà, a budget line / triangle
Constructing a more complex budget line
- Sales/wholesale discount: draw the separate line
belonging to the prices and discounts.
LET OP: Soms kunnen het horizontale lijnen zijn, omdat het
niet deelbaar is. (Kan geen tussenliggende mogelijkheden
kopen)
Slope of budgetline = - Px/Py.
The rate at which Qx needs to be exchanged for Qy. (also called opportunity cost
of one extra Qs)
Price changes
As the price of one product changes, the budget line changes as well: it rotates around the
intercept of the product which does not change. (So the slope changes)
Slope doesn’t change: if BOTH prices change RELATIVELY the same. (same %)
Budgets with more than 2 goods:
We use a composite good: unit equals one, how much money is left over after buy x
amount of product A.
Slope is always -Px, because unit of Y (composite) is 1.
,Consumer preferences
We know how much the consumer CAN buy, not the preference of one product over the
other.
Preference ordering: ranking all possible consumption bundles in order of preference.
Properties of preference ordering:
1. Completeness: a consumer is able to rank all possibilities.
2. Transitivity: if A > B and B > C then A > C. Otherwise: vicious cycle.
3. More-Is-Better: more of a good is preferred to less of a good. As long as you can
freely store or dispose of products.
4. Continuity: small changes in the quantity of a good should not lead to sudden
‘jumps’ in preferences.
5. Convexity: Mixtures of goods are preferable to extremes.
Problems caused by non-transitive preferences:
- It would lead to cycles, which means we cannot rank the goods properly and cannot
construct an indifference curve.
Indifference curve: a set of bundles which are equally attractive (Have same Utility).
Bundles above IC: more attractive and vice versa
Indifference curves:
1. Any bundle has an indifference curve running through it
2. Downward sloping (convex)
3. They cannot cross (because of convexity and transitivity)
Indifference map: a graph with multiple indifference curves. (infinitely much curves)
Marginal Rate of Substitution (MRS): rate at which the consumer is willing to exchange a
good on the vertical axis for a good on the horizontal axis. (equal to slope of indifference
curve)
If we take X amount of Product A away, how much of product B do we have to give?
MRS = - Ux / Uy. (partial derivatives)
Using indifference curves to describe preferences:
1. If an indifference curve is very steep, it means that a person highly prefers one
product over the other: he/she is willing to give up a lot to get one unit of another
product
Exceptions
Sometimes:
, - more-is-worse counts: for example in a restaurant, more fish is not desirable because
you can’t store/dispose of it. → upward sloping indifference curve.
- less is better counts: for example in a restaurant, if the portion sizes are too big.
You’d rather have less than more → concave indifference curve.
Best affordable bundle:
best affordable bundle is the most
preferred bundle of those that are
affordable (within budget).
More-is-better assumption dictates:
the BAB must lie ON the budget, not
below. It intersects only ONCE.
The best affordable bundle is the one
at which the slope of the IC = slope of Budget
MRS = Px/Py
If there is no point of tangency (nowhere is the
above equation fulfilled) we can get a corner
solution. Only one good is purchased.
If MRS < Ps/Pf
interior solution: a choice between two goods
that results in a positive amount consumed of both
goods
Perfect substitutes: no preference over either, they are equal in the consumer's eyes. If A
is cheaper than the B, all of A will be consumed and none of B.
Perfect complements: they complement each other perfectly. (butter and toast).
