Microeconomics Notes
Topic 1 – Introduction and Review
Ø Optimization principle – economic agents are trying to do the best they can
Ø Equilibrium principle – prices adjust until supply is equal to demand
Ø The maximum willingness to pay is known as the reservation price – it is how the
demand curve is constructed
Ø Supply curve in the short run will be vertical – this is because it is hard to increase
supply with the current factors of production available
Ø A monopoly can use discriminating pricing where they charge the reservation price
to all consumers to consume all of the surplus
Ø If this is not possible the monopolist will charge price
maximizes revenue since MC is assumed to be 0
Ø Maximum and minimum prices can also be enforced –
when max prices are lower than equilibrium price
there will be excess demand which will cause renters
to not sell some of their apartments – vice versa
Ø Revenue is maximized when PED is equal to -1 as
there is no reason to move up or down along the demand curve
Ø PED = p/q x 1/slope of inverse demand
Ø Revenue = p x q
Ø Marginal Revenue = change in revenue/change in quantity
Ø MR has the same equation as the demand curve but twice the slope
Ø F(x) is used to define y – so y = output, f is the production function and x is the input
which is more than or equal to 0
,Topic 2 – Consumer Preferences and Utility
Ø Consumer’s choices are modelled as preferences with bundles which consist of 2
goods – we can compare the bundles to see which provides the greatest satisfaction
Ø Notations:
- > preferred to or more desirable
- < less desirable
- ~ indifferent between
Ø Axioms are just assumptions
Ø Completeness and reflexivity – given two bundles the consumer always has a
preference – there is no ambiguity the consumer can rank all the bundles
Ø Transivity – If consumer prefers A to B and prefers B to C then they will prefer A to C
– this is a consistency assumption – if there is no Transivity then you can:
- From bundles A, B, C which is the most preferred
- Money pump idea – A>B>C>A – then you can sell the individual A and he will buy
C for A + 1cent and continue on
Ø Nonsatiation – more is better – the consumer prefers some of the good as oppose
to none of the good – however, can be argued for non-smokers that if you give them
more cigarettes, they will be better off which is not true
Ø Continuity – if A is preferred to B then any bundle close to A will be preferred to B –
technical assumption so that preferences can be conveniently summarized by a
utility function
Ø Indifference curves – we can put each good on an axis – each point represents a
bundle – starting at a point we can start to graph a curve to show consumer is
indifferent between such bundles
Ø Axioms on preferences imply:
- Indifference curves have a negative slope – this is because you can’t
have quantity of both goods increase and consumer be indifferent
due to the Nonsatiation rule
- Indifference curves cannot intersect – this is because if we say the
consumer is indifferent between C ~ A and C ~ B then A ~ B but that is not true
under Transivity – also violates Nonsatiation since A is more than B
- Every consumption basket lies only on one indifference curve – otherwise
indifference curves cross – if A lies on two indifference curves you can’t argue
that they are indifferent – this violates reflexivity
- Indifference curves are not thick – that would mean two bundles are indifferent
from one another, but one would be more desirable
- Preference direction – bundles on in an indifference curve further from the origin
correspond to higher utility due to Nonsatiation
Ø Absolute value of the slope of an indifference curve is Marginal Rate of Substitution
– this shows how much of one good the individual is willing to give up for 1 more
unit of the other good
Ø Utility is a way of assigning numerical value to bundles – consumer has preferences
over bundles – you attach numbers to bundles in a way that it is consistent with
consumer preferences – consumer has preference ordering and utility helps to put a
numerical value on it
Ø Bundles on different indifference curves have different utility number – bundles on
same indifference curve have the same number
, Ø U(A) > U(B) means A>B and same with other preferences
Ø Completeness – allows us to assign a utility number to each curve
Ø Transivity – allows us to determine preference ordering by comparing the utilities
Ø Nonsatiation – utility must be increasing as more goods are consumed
Ø Continuity – allows for the continuity of utility
Ø Lexicographic bundles – a bundle with more of x is preferred to any
bundle with less x – if the x in two bundles is the same then the one
with more y is preferred – these cannot be represented by a utility
function
I. U = xy – these are don’t touch the axis and just sloping downwards
getting flatter as you move along x
II. U = x – doesn’t care about how much y they consume
so y may not be a good – only cares about x
III. U = x + y – downward sloping straight lines that are
parallel that touch the axis
Ø Perfect substitutes – u = x + y – to generalize it u (x, y)
= ax + by – slope of the indifference curve is -a/b
Ø Perfect complements – u = min {ax, by} – consumer wants to
consumer x and y only in that ratio so y/x = a/b – for example if
a=b – so if x increases by 3 and y increase by 1 the increase in
utility is only 1 as they both increased by 1 – the corner is
magnitudes of a and b – the slope is equal to 1 – really like to
consume goods in a fixed proportion
Ø If you increase one unit of a good without increasing the other in the same
proportion as individual’s preference, then they remain on the same indifference
curve
Ø The curves are right-angled so y/x=a/b which can equal y=ax/b
Ø Quasi-linear utility – utility depends on some function of x – u = v(x) + y – for
example v(x) = x0.5
Ø The indifference curves are vertical shifts – so if you fix x and change y the MRS stays
the same cause the curve has just shifted up
Ø If u (x, y) = x + v(y) – then curves are horizontal shifts from each other
Ø Cobb-Douglas utility – u = (xy)0.5 – u = xayb – in this case a = b = ½
Ø Indifference curves do not touch the axis – these are well-behaved curves
Ø Additively Separable Utility – u = v(x) + w(y) – where the utility functions are
separated into 2 chunks – where the utility depends on how much x is consumed
and how much y is consumed – and the plus is joining them
Ø Examples of this can just include – u = x + y or u = x2 + y2
Ø Marginal utility – increase in utility obtained from consumption of one more unit of
"#
a good – a nice utility can come from 𝑀𝑈! = "! – this is done
through integration – see tutorial 2
Topic 1 – Introduction and Review
Ø Optimization principle – economic agents are trying to do the best they can
Ø Equilibrium principle – prices adjust until supply is equal to demand
Ø The maximum willingness to pay is known as the reservation price – it is how the
demand curve is constructed
Ø Supply curve in the short run will be vertical – this is because it is hard to increase
supply with the current factors of production available
Ø A monopoly can use discriminating pricing where they charge the reservation price
to all consumers to consume all of the surplus
Ø If this is not possible the monopolist will charge price
maximizes revenue since MC is assumed to be 0
Ø Maximum and minimum prices can also be enforced –
when max prices are lower than equilibrium price
there will be excess demand which will cause renters
to not sell some of their apartments – vice versa
Ø Revenue is maximized when PED is equal to -1 as
there is no reason to move up or down along the demand curve
Ø PED = p/q x 1/slope of inverse demand
Ø Revenue = p x q
Ø Marginal Revenue = change in revenue/change in quantity
Ø MR has the same equation as the demand curve but twice the slope
Ø F(x) is used to define y – so y = output, f is the production function and x is the input
which is more than or equal to 0
,Topic 2 – Consumer Preferences and Utility
Ø Consumer’s choices are modelled as preferences with bundles which consist of 2
goods – we can compare the bundles to see which provides the greatest satisfaction
Ø Notations:
- > preferred to or more desirable
- < less desirable
- ~ indifferent between
Ø Axioms are just assumptions
Ø Completeness and reflexivity – given two bundles the consumer always has a
preference – there is no ambiguity the consumer can rank all the bundles
Ø Transivity – If consumer prefers A to B and prefers B to C then they will prefer A to C
– this is a consistency assumption – if there is no Transivity then you can:
- From bundles A, B, C which is the most preferred
- Money pump idea – A>B>C>A – then you can sell the individual A and he will buy
C for A + 1cent and continue on
Ø Nonsatiation – more is better – the consumer prefers some of the good as oppose
to none of the good – however, can be argued for non-smokers that if you give them
more cigarettes, they will be better off which is not true
Ø Continuity – if A is preferred to B then any bundle close to A will be preferred to B –
technical assumption so that preferences can be conveniently summarized by a
utility function
Ø Indifference curves – we can put each good on an axis – each point represents a
bundle – starting at a point we can start to graph a curve to show consumer is
indifferent between such bundles
Ø Axioms on preferences imply:
- Indifference curves have a negative slope – this is because you can’t
have quantity of both goods increase and consumer be indifferent
due to the Nonsatiation rule
- Indifference curves cannot intersect – this is because if we say the
consumer is indifferent between C ~ A and C ~ B then A ~ B but that is not true
under Transivity – also violates Nonsatiation since A is more than B
- Every consumption basket lies only on one indifference curve – otherwise
indifference curves cross – if A lies on two indifference curves you can’t argue
that they are indifferent – this violates reflexivity
- Indifference curves are not thick – that would mean two bundles are indifferent
from one another, but one would be more desirable
- Preference direction – bundles on in an indifference curve further from the origin
correspond to higher utility due to Nonsatiation
Ø Absolute value of the slope of an indifference curve is Marginal Rate of Substitution
– this shows how much of one good the individual is willing to give up for 1 more
unit of the other good
Ø Utility is a way of assigning numerical value to bundles – consumer has preferences
over bundles – you attach numbers to bundles in a way that it is consistent with
consumer preferences – consumer has preference ordering and utility helps to put a
numerical value on it
Ø Bundles on different indifference curves have different utility number – bundles on
same indifference curve have the same number
, Ø U(A) > U(B) means A>B and same with other preferences
Ø Completeness – allows us to assign a utility number to each curve
Ø Transivity – allows us to determine preference ordering by comparing the utilities
Ø Nonsatiation – utility must be increasing as more goods are consumed
Ø Continuity – allows for the continuity of utility
Ø Lexicographic bundles – a bundle with more of x is preferred to any
bundle with less x – if the x in two bundles is the same then the one
with more y is preferred – these cannot be represented by a utility
function
I. U = xy – these are don’t touch the axis and just sloping downwards
getting flatter as you move along x
II. U = x – doesn’t care about how much y they consume
so y may not be a good – only cares about x
III. U = x + y – downward sloping straight lines that are
parallel that touch the axis
Ø Perfect substitutes – u = x + y – to generalize it u (x, y)
= ax + by – slope of the indifference curve is -a/b
Ø Perfect complements – u = min {ax, by} – consumer wants to
consumer x and y only in that ratio so y/x = a/b – for example if
a=b – so if x increases by 3 and y increase by 1 the increase in
utility is only 1 as they both increased by 1 – the corner is
magnitudes of a and b – the slope is equal to 1 – really like to
consume goods in a fixed proportion
Ø If you increase one unit of a good without increasing the other in the same
proportion as individual’s preference, then they remain on the same indifference
curve
Ø The curves are right-angled so y/x=a/b which can equal y=ax/b
Ø Quasi-linear utility – utility depends on some function of x – u = v(x) + y – for
example v(x) = x0.5
Ø The indifference curves are vertical shifts – so if you fix x and change y the MRS stays
the same cause the curve has just shifted up
Ø If u (x, y) = x + v(y) – then curves are horizontal shifts from each other
Ø Cobb-Douglas utility – u = (xy)0.5 – u = xayb – in this case a = b = ½
Ø Indifference curves do not touch the axis – these are well-behaved curves
Ø Additively Separable Utility – u = v(x) + w(y) – where the utility functions are
separated into 2 chunks – where the utility depends on how much x is consumed
and how much y is consumed – and the plus is joining them
Ø Examples of this can just include – u = x + y or u = x2 + y2
Ø Marginal utility – increase in utility obtained from consumption of one more unit of
"#
a good – a nice utility can come from 𝑀𝑈! = "! – this is done
through integration – see tutorial 2
