Summary: Economic Foundations

Read the summary and the most important questions on Economic Foundations

• 1 Microeconomics

• 1.1 College 1

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• The above figure has been drawn from the ceteris-paribus assumption.What is the ceteris paribus assumption?What happens when consumer income rises?

  Ceteris paribus means keeping all other variables constant.
  
  a higher income will increase the demand of a good there will be a shift of the demand curve to the right where price stays unchanged

• How does a Utility function work?

  In the neoclassical theory of demand the utility function has to satisfy two conditions: the partial derivative of total utility with respect to the consumption of comodity  has to be strictly positive and two the consumer will always consume more if that is possible.
  more is always better. The second derivative of the utility function with repspect to consumption of the comodity has to be negative.

• Example of identifying the utility maximisation consumption bundle

  Write down the derivatives of the utility function for each commodity and equal it to the price conditions MRS Px/Pz

• In this example how does the optimal choice by the consumer change when the price of good 1 increases? Identify the total effect, the substitution effect and the income effect.

  Due to an increase in price 1 the area of affordable consumption becomes smaller and the slope of the budget line becomes steeper. The consumer can not maintain utility at its original level U1 and has to move down to a lower indifference curve. 
  total effect is the shift from point A to B. 
  
  substitution effect is negaitve for good 1 positive for good 2. The income effect is negative for both because the consumer suffers a loss in purchasing power.     

• What do microeconomist mean by the bandwagon effect in consumer demand theory?

  The bandwagon effect is the effect that is referred to in consumer demand theory where cosnumer demand is influenced or increased by the fact that others are consuming the same commodity.

• Critique to neoclassical theory of demand:

  - the main weakness is it assumption of the existence and convexity of the indifference curve,
  - questionable if a consumer is able to order his her preferences as consistently as the theory holds
  - the assumption that the preferences of the consumers are exogeneous is questionable.

• Key assumptions neoclassical model:

  It is assumed that market demand is the summations of the demand of the consumer
  - instrumental rationality: Consumer spends income to max utility
  - complete knowledge by consumer of market
  - utility is ordinal: consumer is thought to be able to rank his her preferences for commodiities
  - consiistency and trnasivisity of chaince 
  diminishing marginal utility
  consumer sovereignity

• Price and income of elesticity, what are they?

  The income of elasticity of demand Ey is defined as the proportionate change in the quantity q demanded of a particular good or service , resulting from a proportionate change of income Y 

• Different classes of income elasiticity based on demand

  Necessary good Ey 0-1
  Luxury good >1
  
  Inferior good<0

• Own price of consumer demand

  Is defined as the proportionate change in the quantity q demanded for a particular good or sercie resulting from a proportionate chnge in t eh price