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Summary microeconomics weeks 1-8
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Samenvatting The Economy - Economics (ECONOM01)
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Week 1Ceteris paribus: all other things equal
Incentives matter: affect the benefits and costs of taking one action as opposed to another
Relative prices: helps with comparing alternatives. The price of one option relative to
another or the ratio of two prices
Economic rent: the benefit from the taken option minus the benefit of the next best option
Reservation option: a person's next best alternative among all options in a particular
transaction
Dominating technologies: win-win alternatives for which less input is needed for the same
output and therefore the most efficient option, these technologies are reviewed on their
isocost-line, showing what inputs are for a given output →
C = wage x labor + price x q
The slope of the isocost line is the relative price of labour. This can be calculated by
transforming c = wL + pq into q = c/p - w/p x L → slope = w/p, intercept = c/p
Creative destruction: a process of old technologies and old firms who do not use new
technologies.
Malthusian economics: population growth will always outrun food supply without strict
limits on reproduction or advancements in production technology
Production function: a function which describes the relationship between the amount of
output produced and the amounts of inputs used to produce it.
Diminishing average product of labour: a situation in which, as more labour is used in a
given production process, the average product of labour typically falls.
Average product = total output/total input
2 key ideas of the malthusian model:
1. the law of diminishing average product of labour
2. population expands if living standards increase
The malthusian model predicts that improvements in technology will not raise living
standards if:
- the average product of labour diminishes as more labour is applied to a fixed amount
of land
- population grows in response to increases in real wages
The Malthusian model did not consider the possibility of improvements in technology could
happen at a faster rate than population growth, offsetting the diminishing average product of
labour. This process shows that there were two important influences on wages: how much is
produced and the amount of which is going to the workers.
Average product: the average output per unit of input
,Marginal product: the slope of the production curve. The additional amount of output that is
produced if a particular input was increased by one unit, while holding all other inputs
constant. This can be calculated by dividing the vertical distance by the horizontal distance
Indifference curve: shows the preferences of each individual and shows all the
combinations of inputs giving the same level of utility (they never cross)
Utility: the number of values that one places on an outcome
Marginal rate of substitution (MRS): a trade-off that a person is willing to make between
two goods (slope of indifference curve)
Marginal rate of technical substitution (MRTS): amount by which the quantity of an input
can be reduced when one extra unit of another input is used, so that output remains
constant. The ease with which one input can be replaced by one or more units of the other
input while holding production constant, is reflected in the slope of the curve.
opportunity cost: the cost of letting go the next best alternative option.
economic cost: sum of out-of-pocket costs + the opportunity costs
Feasible frontier: the maximum feasible amount of one good for a given amount of the
other good
Feasible set: all feasible options, including the ones on the feasible frontier. The slope of the
feasible frontier is the Marginal rate of transformation (MRT).
MRT: the amount of some good that must be sacrificed to acquire an extra unit of the other
good. In the example, the rate at which he can transform free time into grade points.
In a constrained choice problem, there is a decision-maker that must find the right balance
between his preference (indifference curve) and his constraint (feasible frontier). The best
feasible choice is MRS = MRT.
Week 2
, Lagrange method → used to find the equal marginal principle, combination of goods that
achieve max total utility.
Conspicuous consumption = purchasing goods or services to publicly display wealth rather
than to cover basic needs, a raise will shift your budget constraint clockwise, resulting in two
effects:
1. Income effect: effect of additional income if there is no change in price or opportunity
cost
2. substitution effect: an effect due to increase in opportunity costs as not working has
become more ‘expensive’
Income effect of price: effect of a price change on your purchase power and through this
change in purchase power, the effect on demand
Substitution effect of price: the pure effect on demand of change in relative prices
(excluding change in purchasing power)
Inferior good: a good which can be replaced by a better version when people are able to
afford the better good → potatoes, rice, low-end used cars. Decreases income effect
Normal good: when income increases, so will quantities. Increases income effect
Week 3
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