Summary: Microeconomics

Read the summary and the most important questions on Microeconomics

• Reading 13 - Demand and Supply Analysis: Introduction

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• Calculating demand elasticities from demand functions

  If we choose values for each independent variable we can determine their elasticity in this base case. Quite straightforward as it is the slope of the independent variable of the demand curve multiplied by the ratio of the independent value over the dependent variable (demand).

• Reading 14 - Demand and Supply Analysis: Consumer Demand

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• What does the utility function look like?

  First we let consumers order their preferences based on the completeness axiom, then also insert quantities based on the bundles. The single task of the utility function is to translate each basket of goods an services into a number that rank orders the baskets according to our particular consumer's preferences. Measure it utils, which is the quantities of happiness or well-being.
  
  Note: these are ordinal rankings not cardinal, as they don't allow for the calculation and raking of differences between bundles.

• How do we map indifference curves?

  An entire family of indifference curves (i.e. different utility lines) is called an indifference utility map, and it represents our consumer's entire utility function. Moving upward or right implies an increase in utility. 
  
  IMPORTANT: because of our transitivity assumption, no two indifference curves for a given consumer can ever cross. So only restrictions: negative slope, strictly convex and they can never cross.

• How can we translate this into an investment opportunity set?

  Risk on horizontal axis and return on vertical axis, increasing slope from risk-free rate, by increasing the amount of stocks/riskier bonds. This line is also like a constraint/utility, if the want less tisk they should choose a point closer to the vertical axis (thereby less risk). So depending on the level of risk aversion an investor could be anywhere across the line.

• How do we get to a consumer equilibrium, i.e. maximing the utility to the budget constraint?

  We combine the budget constraint with the preference map to model the actual choice of our consumer. Maximization is optimizing utility within the given budget constraint. Thereby we look for a cross-section of an indifference curve and the budget constraint line, we aim for the farthest from the origin (more utility is better) at the tangency point. The functions will have the same slope, thereby the MRS is equal to the slope of the budget constraint, so the price ratio Py over Px

• What are consumer response to change in income?

  Consumer's behavior is contrained by income and the price of the goods. Consequently, if one changes the parameters change and the consumer is likely to change his consumption behavior. Remember that an increase in income shifts the budget constraint line outward.
  
  Note:
  - Normal goods: positive response to income increase
  - Inferior goods: negative response to income increase
  These characeristics are reflected in the curve of the indifference lines.

• How does the consumer response to a change in price?

  A decrease in price makes the budget constraint steeper or less steep depending on the axis (X = less steep and Y = steeper), for an increase viceversa. Look at whether responses are elastic/inelastic.

• Based on this, how can we revise the consumer's demand function?

  By the above theory we got a richer understanding of the demand curve as we start from more fundamental recognition of the consumer's preferences and her/his response to changes in the parameters that constrain their behavior.
  
  Note: the demand curve is derived from the indifference curve map and a set of budget constraints representing different prices of bread. Horizontal axis the same but on the other quantity vs price to get to the demand curve. So for each tangent point in the indifference/budget diagram there is a corresponding point in the demand curve diagram.

• How so substitution and income effects a normal good?

  When a price falls for the products, consumers will buy less, but there are still income and substitution effects. They are just in an opposite direction. Income adjustment is thereby very important. As the effects partly offset each other, i.e. substitution more quantity and income less quantity, the product is less elastic.
  
  It is possible that the income effect is larger than the substitution effect (interest rates rise, wait with consuming, but as your reward is higher you might need less income in the future), although that is not always the case with an inferior good.

• GIFFEN goods: negative income effect is larger than the subsitution effect

  This results in a positively sloped individual demand curve. Inversely this means that if the price rises a consumer would buy more. Thereby all Giffen goods must be inferior but not all inferior goods are given goods.
  
  There is some empirical evidence, but is it considered rare and only exist for a subset of consumers. It is unlikely that consumers as a whole will behave like this.
  
  Conclusion: a positive demand curve is extraordinary and seldom appears.