Class notes
POE notes
- Course
- Institution
Lecture notes of 94 pages for the course GEO1-2255 Principles Of Economics at UU (POE notes)
[Show more]
Seller
Follow
ehouwy
Content preview
Lecture 2; U3+4Economics > making assumptions about the world > simplify world because of complexity > predictions
Assumptions
Unit: individuals & firms
Homo economicus > view of human in which human is first and foremost an economic being:
- Humans are rational;
- Self-interested;
- Perfect information (> they know what the outcome will be > decision based on this);
- Individualistic.
Simplify enough that its clear but not to much that it doesn’t’ say anything > start with complex or
simple > economics start with simple unrealistic assumptions > improve upon idea > more complex
Production function > turning inputs into output > the relationship between the amount of outputs
(products & services) produced and the amount of inputs (labor & capital) used to produce it, holding
other factors constant (production environment)
>>> Describes what is technically feasible when the firm operates efficiently.
Firm internal structure and its production process as a black box
Basic assumptions about firm’s production processes:
• Technology is given
• The output is a result of only 2 input factors – capital and labour (can be extended for other
input factors in a similar way, like land or raw materials).
• The firms are always willing to produce as efficiently as possible.
Diminishing Marginal Returns: Situation in which the use of an additional unit of a factor of production
results in a smaller increase in output than the previous increase
Marginal product (MP): Change in output per one-unit change in input (at a given point, holding other
inputs constant) > slope of production function
Average product (AP): Average output per units of input (at a given point, holding other inputs
constant) > total output/total input (at certain point)
Preferences determine choices
Scarcity principle:
- Infinite desires vs. limited resources
- To get A > give up B
➢ For this tradeoff, economists look at economic costs
o Economic costs = explicit costs + opportunity costs
o Opportunity costs > the net benefit of the next best alternative action
➢ Indifference curve
,An indifference curve shows all combinations of two goods that give the same utility (satisfaction)
Marginal rate of substitution (MRS): the slope of the indifference curve. It represents the willingness to
trade one good for another (example: higher grades vs. more free time).
Indifference curves can’t cross.
Lower indifference curve is lower utility.
Choices are constraint > what is possible / feasible?
➢ Feasible frontier > all the possible outcomes that you can have
Feasible frontier: Maximum output that can be achieved of one good (grade) for every possible level of
the other good (free time)
Outside feasible frontier > not possible
Inside feasible frontier > feasible but inefficient > feasible set
Marginal rate of transformation (MRT): The tradeoff (opportunity costs) that an individual faces. The
slope of the feasible frontier.
Optimal choice (utility maximizing choice) > The amount of one good the individual is willing to trade off
for the other good (MRS) equals the actual tradeoff between the two goods (MRT)
➢ MRS = MRT
➢ Where MRS meets MRT > not cross, because then there will always be a line with a higher
utility
>>> Feasible frontier shows what you can, indifference curve shows what you want.
Game theory:
- Theory of goal-directed behavior in interdependent decision situations
- Mainly used to model to explain (solve) social dilemmas
- Social dilemma = a situation in which actions taken independently by self-interested
individuals result in a socially suboptimal outcome
Game involves:
- Players > (individuals, firms, countries, etc.) who make strategic decisions that take into
account each other’s actions and responses
- Strategies > a list of possible actions for each player
- Payoff > a value (e.g. in €) associated with a possible combination of strategies; typically the
expected net gain (benefits minus costs)
o Payoff matrix > Table showing payoff to each player given its decision and the
decision of its competitor.
,Outcome of the simultaneous-choice one-period game (Prisoners dilemma for example):
• Dominant strategy: optimal choice for each player no matter what the opponent does → for
both A and B to confess
• Nash equilibrium: if X is a best reply strategy of player A against Y and Y is a best reply strategy
of player B against X
• Pareto optimal: if there is no other strategy combination that yields higher payoffs for at least 1
player, and not lower for the other player(s).
Prisoners’ dilemma > individual decision making can create Nash equilibrium that is not pareto optimal
Examples: coordination game; rock, paper, scissors; volunteers’ dilemma
Repeated game → Game in which actions are taken and payoffs received over and over again.
• With a finite number of repetitions, the rational outcome is for both to Confess and not
cooperate with the other person.
• With infinite repetitions of the game, the expected gains from cooperation with the other
person (Lying) will outweigh those from competition
→ A repeated prisoners’ dilemma can have a long-lasting cooperative outcome.
Tit-for-Tat: Strategy for repeated PD, with the highest outcome
Tit-for-Tat is:
- Nice: Starts with defect (i.e., lying to the cops)
- Provocable: Reacts to defect other player
- Forgiving: stops punishment after show of remorse
Lecture 3; U6+7
What is a firm:
Firm is a business organization which:
- Employs people
- Owns capital goods and purchases inputs to produce market goods and services
- Sets prices greater than the cost of production to make profit
Concentration of economic power in the hands of owners/managers allows them to issue
commands to workers.
Different levels of hierarchy:
- Owners decide on long-term strategy
- Managers implement decisions by assigning tasks to workers and monitoring them
- Employees execute tasks; create networks of colleagues; acquire skills necessary for the job; etc.
> leads to problem of asymmetric information between different hierarchy levels
Principal-agent models capture interactions under incomplete contracts
, Incomplete contracts arise when:
- Information is not verifiable
- The relationship covers periods of time
- There is uncertainty
- There are difficulties with measurement
- Judiciary is absent
- Preferences for omitting some information
Agents take action that is hidden from principal. Principal cannot verify it.
Why large firm?
> Economies of scale
Cost advantages > decreasing averages costs for production in large quantities leads to
emergence of large firms
Due to:
- High fix costs for machinery
- High first unit costs (R&D etc.)
- Input purchases to better terms (bargaining power)
Demand advantages > value of output rises with number of users (network effects) support the
rise of dominant firms
Firm's problem: how much to produce and at what price?
Cost functions > to make pricing and production decisions, managers need to know costs of production.
A firm's costs depend on its scale of production and the type of production technology it has.
> show how total production costs vary with quantity produced
Fixed Cost > All costs independently arising from any level of production Q.
Examples: rental costs, interest payment on debt
Variable Cost > All costs varying with the level of production Q.
Examples: raw material, labor
Total cost > Total economic cost of production, consisting of fixed and variable costs
Average cost (AC) > average total cost per unit produced
> slope of the ray from origin to a given point on cost function
> determine (dis)economies of scale
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller ehouwy. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $5.89. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
67474 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now