Economics
Hoorcollege 1.
The economic problem
How to allocate scare resources?
- Infinite wants
- Finite resources (eindige middelen om aan het optimale te komen)
Consumers:
- Preferences: ‘’more is better’’
- Resources: income (restricted budget)
Producers
- Pursuit of profits: producing and selling
- Doing this optimally (firms also want to have it all)
- Given limited resources (factors of production)
In reality mostly mixed economies
- Some goods are privately produced
- For other goods the government regulates the market (labor market regulations:
minimum wages, lay-off production. Health care: licensing of doctors)
- And sometimes even takes over production (defense, police, roads, public health care,
education)
Government’s view on efficieny and equity important here
- Market outcome could be efficient, but not equitable
- Some products that we find important are not efficiently provided by the market or not
at all (some insurances).
Demand curve
- Demand influenced by preferences, consumer income, prices and other goods and own
good
- The slope indicates how sensitive demand is for price changes.
- Sensitively hangt af van de mate van substituten.
Modelling individual consumer behavior
Important are
a) The budget constraint (set of possibilities)
b) Behavioral assumptions
c) Utility and indifference curves
d) The utility maximum
e) Income changes
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, f) Price changes.
Budget constraint (income = expenditures): I= pmQm + pfQf
Bv.
I: weekly income
Qm: weekly quanity of meals
Qf: weekly quantity of films
pm: price of a meal
pf: price of a film
behavioral assumptions
people make decision on the basis of their preferences (taste), given their available budget
the consumer model requires 3 behavioral assumptions
1. completeness: consumers can rank alternative bundles of (quantities of) goods according
to satisfaction or utility
2. non satiation: more is better.
3. Diminishing marginal rate of substitution (MRS)
MRS: uitruilen van een goed tegen een ander goed
Utility and indifference curves
Because of behavioral assumption (i) we can express preferences by a utility function
Behavioral assumption (ii), more is better, implies positive marginal utility
If
- dQm: change in Qm change in utility associated with this is: MUmdQm
- dQf: change in Qf change in utility associated with this is: MUfdQf
- dU: change in utility dU = MumdQm + MUfdQf
then dU = 0 gives
MUmdQm + MUfdQf = 0
Or MRS = (dQf/dQm) = - (Mum/MUf)
*the MRS is equal to the ratio of the marginal utilities (how you value extra of the good)
*an indifference curve shows all the consumption bundles that yield the same utility
The utility maximum
objective of the consumer: reaching the highest possible utility level.
(!) In het optimum moet altijd gelden dat de prijsverhouding gelijk is aan de marginal rate of
substitution.
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, We know that the optimum is where the slope of the budget line is tangent to the slope of
the utility function
*Preferenties leiden tot indifference curves.
Change along and changes of the individual demand curve
Changes in price lead to changes along the individual demand curve
Changes in other factors that influence demand lead to changes of the location of the
demand curve
For instance: more preference for meals leads to steeper indifference curve (Why?) , which
lead to more meals demanded to any price.
Similarly for changes in income and prices of other goods.
Effect on consumption of Qm and Qf can be split in a substitution and income effect
Substitution effect: effect due to change in relative price (slope) keeping utility constant
Elasticities
- The theory says something about the direction of the impact of price and income
changes on consumption
- Price elasticity of demand = relative change in demand / relative change in price.
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Hoorcollege 1.
The economic problem
How to allocate scare resources?
- Infinite wants
- Finite resources (eindige middelen om aan het optimale te komen)
Consumers:
- Preferences: ‘’more is better’’
- Resources: income (restricted budget)
Producers
- Pursuit of profits: producing and selling
- Doing this optimally (firms also want to have it all)
- Given limited resources (factors of production)
In reality mostly mixed economies
- Some goods are privately produced
- For other goods the government regulates the market (labor market regulations:
minimum wages, lay-off production. Health care: licensing of doctors)
- And sometimes even takes over production (defense, police, roads, public health care,
education)
Government’s view on efficieny and equity important here
- Market outcome could be efficient, but not equitable
- Some products that we find important are not efficiently provided by the market or not
at all (some insurances).
Demand curve
- Demand influenced by preferences, consumer income, prices and other goods and own
good
- The slope indicates how sensitive demand is for price changes.
- Sensitively hangt af van de mate van substituten.
Modelling individual consumer behavior
Important are
a) The budget constraint (set of possibilities)
b) Behavioral assumptions
c) Utility and indifference curves
d) The utility maximum
e) Income changes
1|Page
, f) Price changes.
Budget constraint (income = expenditures): I= pmQm + pfQf
Bv.
I: weekly income
Qm: weekly quanity of meals
Qf: weekly quantity of films
pm: price of a meal
pf: price of a film
behavioral assumptions
people make decision on the basis of their preferences (taste), given their available budget
the consumer model requires 3 behavioral assumptions
1. completeness: consumers can rank alternative bundles of (quantities of) goods according
to satisfaction or utility
2. non satiation: more is better.
3. Diminishing marginal rate of substitution (MRS)
MRS: uitruilen van een goed tegen een ander goed
Utility and indifference curves
Because of behavioral assumption (i) we can express preferences by a utility function
Behavioral assumption (ii), more is better, implies positive marginal utility
If
- dQm: change in Qm change in utility associated with this is: MUmdQm
- dQf: change in Qf change in utility associated with this is: MUfdQf
- dU: change in utility dU = MumdQm + MUfdQf
then dU = 0 gives
MUmdQm + MUfdQf = 0
Or MRS = (dQf/dQm) = - (Mum/MUf)
*the MRS is equal to the ratio of the marginal utilities (how you value extra of the good)
*an indifference curve shows all the consumption bundles that yield the same utility
The utility maximum
objective of the consumer: reaching the highest possible utility level.
(!) In het optimum moet altijd gelden dat de prijsverhouding gelijk is aan de marginal rate of
substitution.
2|Page
, We know that the optimum is where the slope of the budget line is tangent to the slope of
the utility function
*Preferenties leiden tot indifference curves.
Change along and changes of the individual demand curve
Changes in price lead to changes along the individual demand curve
Changes in other factors that influence demand lead to changes of the location of the
demand curve
For instance: more preference for meals leads to steeper indifference curve (Why?) , which
lead to more meals demanded to any price.
Similarly for changes in income and prices of other goods.
Effect on consumption of Qm and Qf can be split in a substitution and income effect
Substitution effect: effect due to change in relative price (slope) keeping utility constant
Elasticities
- The theory says something about the direction of the impact of price and income
changes on consumption
- Price elasticity of demand = relative change in demand / relative change in price.
3|Page
