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Samenvatting Microeconomics I (E_EBE1_MICEC)
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Samenvatting van alle 12 lectures Microeconomics 1 gegeven in studiejaar
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Lecture 1: introduction to microeconomics & consumer preferencesIn a market equilibrium demand equals supply. Supply depends on: (1) production
technology, (2) costs of inputs, (3) market price. Demand depends on: (1) preferences of
consumers, (2) income of consumers, (3) market price, (4) prices of other goods. When
supply > demand → price decreases and the price increases when supply < demand.
Consumers buy bundles (packages) of goods. Consumers make choices for bundles of
goods based on rationality. This choice is focused on maximizing utility (well being and
happiness). There are three kinds of assumptions for bundles:
1. Completeness: consider a bundle A and bundle B, then the consumer either has a
preference for bundle A, a preference for bundle B, or is indifferent.
2. Transitivity: If a consumer prefers bundle A over bundle B and bundle B over bundle
C, then the consumer prefers bundle A over bundle C.
3. More is better: if bundle A contains for all goods at least the same amount as bundle
B and for at least one good more, then a consumer prefers bundle A over bundle B.
Perfect substitutes are one extreme – the individual regards the goods as perfectly
interchangeable. The other extreme is Perfect Complements. In this type of preference the
individual considers that the goods should be consumed together.
If a consumer who has the same preference for two bundles, he is indifferent (onverschillig)
between these bundles. When there is a collection of bundles of goods for which the
consumer is indifferent we can make an indifference curve. All bundles on an indifference
curve have the same utility. Properties of an indifference curve are:
Non-increasing
Never crosses
Further away from the origin implies higher utility
Each bundle belongs to an indifference curve (bundles with the same utility have the
same indifference curve)
An indifference curve is downward sloping, so reducing the amount of good X can be
compensated by increasing the amount of good Y. This leads to the marginal rate of
substitution: the extent to which goods can be traded against each other without affecting
utility. MRS= -qyqx
MRS is the derivative of the indifference curve.
Lecture 2: budget & optimal consumer choice
Complements are goods that are consumed together (cereal & milk, movies & popcorn). The
extent to which the consumer likes a bundle is called utility by economists. The marginal rate
of substitution shows how two goods in a bundle can be traded without affecting the utility of
the bundle. A utility function gives a numerical value to a bundle of goods. The utility function
that describes qx & qy is U(qx,qy). This function describes how much utility the consumer
receives from having this bundle of goods. When a consumer prefers bundle (qx,qy) over
(qx’,qy’) it means U(qx,qy) > U(qx’,qy’). When a consumer is indifferent between the two
bundles it means: U(qx,qy) = U(qx’,qy’).
Utility function:
The marginal utility describes how much utility increases if the amount of a good in the
bundle increases with one. MUx=U(qx,qy)qx0
qy is in this case written with a line above the q to indicate that qy stays constant in this
case, so qx has a change and qy stays constant.
Marginal rate of substitution:
The marginal rate of substitution is the willingness of a consumer to replace one good for
another good, as long as the new good is equally satisfying.When can now look how the
,marginal utility has an influence on the marginal rate of substitution (MRS). When know that
U=qyMUy+qxMUx=0
This leads to the formula of the marginal rate of substitution:
MRS = -qyqx = MUxMUy
When MRS is small, only a few additional units of good Y are necessary to replace one unit
of good X.
Budget restriction:
We now want to find the best possible bundle. A constraint for this is of course that there is a
limited budget. B is the budget of the consumer for the goods. This means:
PxQx + PyQy B
Here Px is the price for good X and Qx is the quantity of good X. We can rewrite this to get
the formula of the budget line: Qy = 1PyB-PxPyQx
So there is for example a budget line 30,-. The price of good Y is 3,- and the price of good X
is 1,- → 1Qx + 3Qy < 30
The budget line is: Qy = 303-13Qx =10-13Qx
This final answer is just the function of the budget line Qy, so this function shows what
relation a substitution from good X to good Y has.
Marginal rate of transformation:
The marginal rate of transformation (MRT) is how much the consumer should sell of good Y
to be able to buy one additional unit of good X within the same budget. The formula for this
is: MRT=PxPy
MRT determines the slope of the budget line. MRT does not change if the budget increases,
because MRT does not depend on the budget. MRT does change when the price of goods
(Px&Py) changes.
Maximum utility under budget restriction:
The bundle of goods is optimal if:
1. The bundle lies on the budget line
2. The marginal rate of substitution equals the marginal rate of transformation
MRS = MRT
So this means that there is a point where the budget line (MRS) touches the indifference
curve (MRT). We know that when there is a point where two functions cross we should equal
the two functions → MRS =MRT.
When there is an additional euro in the budget it doesn’t matter if that euro is spent on good
X or good Y, because when you have the optimal bundle the goods are equaled out
perfectly.
When the consumer has a preference for a certain good he can only buy the good X, so in
that case Qy = 0, this leads to: Budget line=BPy
Lagrange:
The optimal bundle can also be determined using Lagrange multiplier method
L(Qx,Qy,) = U(Qx,Qy)-(PxQx+PyQy-B)
When you work this out you get from the two-first order conditions:
MuxMUy = PxPy
And from the third first order conditions you get:
PxQx+PyQy =B
Lecture 3: individual demand & market demand
In lecture 2 we discussed the maximization of the goods to get to the maximum utility. We
are now going to look at demand curves. Demand curves give the relation between the
price and the requested quantity (ceteris paribus). If the price changes, then the budget
restriction changes.
, The indifference curves show what quantities of the goods you can buy with different prices
for those goods. When multiple indifference curves are drawn, we can draw the
price/consumption curve. This curve shows the optimal bundles at every price point. From
this curve we can draw the demand curve.
A demand curve has a function called the demand function, for example Qx = 100 - 5Px.
When there are two identical consumers, then their joint demand equals Qx = 200 - 10Px.
If there are n identical consumer in the market, then the total market demand is
Qx = n(100 - 5Px). Because we know that price is always positive (Px>0), we know that the
quantity cannot be negative (Qx>0). Because we know these two things we can say
100 - 5Px = 0 → 0 < Px <= 20, so the price of good x is somewhere between 0 and 20.
When there are two consumers that are not identical, then the joint demand is simply:
Qx = Qx(A) + Qx(B). In this case you have to keep in mind that both consumers have a
maximal price for the good (in the previous example this was 20).
Elastic demand means there is a substantial change in quantity demanded when another
economic factor changes (typically the price of the good or service), whereas inelastic
demand means that there is only a slight (or no change) in quantity demanded of the good
or service when another economic factor is changed.
The price elasticity tells us when the price changes what happens with the market demand.
The formula for the price elasticity is: Px =% change in demand% change in
price=Qx/QxPx/Px=dQxdPxPxQxThis is just the derivative. The price elasticity is always
equal or lower than 0 (law of demand:Px<=0). When the demand is perfect elastic it means
that Px = - infinity. The demand is perfect inelastic when Px= 0. If Px < -1, then spending on
good x declines if the price increases. With the cross price elasticity we can measure how
the price elasticity is over two different products: Cross price elasticity yPx= %change in
quantity demanded for good Y%change in price of good X=dQyPxPxQy. If the cross price
elasticity is positive the goods are substitutes, and if the cross price elasticity is negative the
goods are complements.
Giffen goods:
The law of demand states that demand should decline if the price increases. The exceptions
are giffen goods. These are goods that are bought when the price increases. Consider a
consumer who has to choose between a necessary good and a luxurious good. If the price
of the necessary good increases, the demand for the luxurious good vanishes completely.
People then spend their complete budget on the necessary goods. A consumer has 12
euros each week. He uses this to buy 3 breads of 2 euro each and save 6 euros for an
iphone of 600 euros. The price of bread now increases from 2 to 3 euros. The consumer still
needs 3 breads to eat. Since saving 3 euros for an iphone is too little, he decides to buy 4
loaves of bread each week. These giffen goods occur for low-income people.
Engel curve:
The budget lines change at different budgets. These lines are always parallel, because the
prices of the goods stay the same, only the budget changes. We can now cross these
budget lines with the indifference curves. There are now multiple crosses, when we draw a
line through these points we get the Engel curve. Engel’s law states that the fraction of total
income spent on food declines if the household income increases. The Engel curve gives the
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