MICROECONOMICS AND BEHAVIOR LATEST UPLOAD EXAM 2025

MICROECONOMICS AND BEHAVIOR LATEST UPLOAD EXAM 2025 If the benefit of an activity exceeds the cost - -Do it If the cost of an activity exceeds the benefit - -Don't do it We must define and measure costs and benefits - -Monetary values are a common denominator Reservation Price - -The price at which a person would be indifferent between doing x and not doing x - if you are rich, it will tend to be higher than if you are poor, because a given amount of money will seem less important If costs and benefits happen to be equal - -You are indifferent The role of economic theory - -We judge economic theory not by how accurate its central assumption is but by how well its predicts behavior Useful insights into our behavior can be gained by assuming that we act as if governed by the rules of rational decision making Economic models provide useful guidance for decisions Common pitfalls in decision making - -1. Ignoring implicit costs 2. Failing to ignore sunk costs 3. Measuring costs and benefits as proportions rather than absolute dollar amounts 4. Failure to understand the average-marginal distinction Pitfall 1: Ignoring Implicit Costs - -One pitfalls is to overlook costs that are not explicit People tend to ignore the opportunity cost of activity The art in applying the concept correctly lies in being able to recognize the most valuable alternative that is scarified by the pursuit of a given activity Opportunity cost of activity - -The value of all that must be sacrificed to do the activity Costs and benefits are reciprocal - -Not incurring a cost is the same as getting a benefit Not getting a benefit is the same as incurring a cost Pitfall 2: Failing to ignore sunk costs - -Sometimes an expenditure make seem relevant when in reality it is not Sunk costs should be ignored MICROECONOMICS MICROECONOMICS Sunk costs have already happened and will be the same whether or not you make your decision Exp) eating additional food just to get your money's worth is not a sensible decision strategy Sunk costs - -costs that are beyond recovery at the moment a decision is made Pitfall 3: Measuring cost and benefits as proportions rather than absolute dollar amounts - -The tendency to think in percentage terms when comparing costs and benefits causes trouble When using the cost-benefit test, you should express costs and benefits in absolute dollar terms, mot proportions. Comparing percentages is not a smart way to make these decisions. Pitfall 4: Failure to understand the average-marginal distinction - -"Should I increase the level by which I am currently engage in activity x?" Must compare the cost and benefits on an additional unit of activity The cost-benefit rule tells us to keep increasing the level of an activity as long as its marginal benefit exceeds its marginal cost. Knowing average cost and average benefit does not enable us to make a logical decision. Marginal cost - -the increase in total cost that results from carrying out one additional unit of an activity Marginal benefit - -the increase in total benefit that results from carrying out one additional unit of an activity Average cost - -the average cost of undertaking n units of an activity is the total cost of the activity divided by n Average benefit - -the average benefit of undertaking n units of an activity is the total benefit of the activity divided by n Using marginal benefit and marginal cost graphically - -For activities that are continuously variable, it is often convenient to display the comparison of marginal benefit and marginal cost graphically The optimal amount of a continuously variable activity is the quantity for which its marginal benefit is just equal to its marginal cost. The Invisible Hand - -Self-interested consumers often act as if driven by what Adam smith called an invisible hand to produce the greatest social good. Although sellers were seeking only to promote their own advantage, the ultimate beneficiaries were the consumers. MICROECONOMICS MICROECONOMICS External cost of an activity - -a cost that falls on people who are not directly involved in the activity External costs and benefits often motivate laws that limit individual discretion Would parents want their daughter or son to marry homo economicus? - -Self-interest is one of the most important human motives. But it is not the only important motive. Self motives are important. The Economic Naturalist - -Someone who uses basic economic concepts to make sense of observations about all aspects of everyday life. Positive question - -a question about the consequences of specific policies or institutional arrangements Normative question - -a question about what policies or institutional arrangements lead to the best outcomes What ought to be/What should be Microeconomics - -The study of how households and firms make decisions and how they interact in markets Macroeconomics - -The study of the economy as a whole Supply and Demand Curves - -Basic tool for analyzing market outcomes Market - -consist of the buyers and sellers of a good or service - the best market definition will depend on the purpose at hand Demand curve - -a simple mathematical relationship that tells how much quantity is demanded at various possible prices (holding all else constant) downward sloping a summary of the various cost-benefit calculations that buyers make with respect to the good; the negative slope tells us that the cost-benefit criterion will be met for fewer and fewer potential buyers as the price of the product rises Real price of a product - -its price relative to the prices of other goods and services Horizontal interpretation of the demand curve - -describes the demand curve as a schedule telling how much of a product consumers wish to purchase at various prices Vertical interpretation of the demand curve - -start with the quantity on the horizontal axis and then read the marginal buyer's reservation price on the vertical axis Law of demand - -the empirical observation that when the price of a product falls, people demand larger quantities of it MICROECONOMICS MICROECONOMICS Two independent reasons for the quantity demand to fall when price rises - -1. many people switch to a close substitute 2. people are not able to buy as much as before Supply schedule - -a table that shows the relationship between the price of a good and the quantity supplied the set of price-quantity pairs for which suppliers are satisfied Law of supply - -the empirical observation that when the price of a product rises, firms offer more of it for sale Supply curve - -A curve that shows the relationship between the price of a product and the quantity of the product supplied. for a supplier to be willing to sell its product, its price must cover the marginal cost of producing or acquiring it Upward sloping because costs increase as quantity increases, substitution Horizontal interpretation of the supply curve - -we begin with a price, then go over to the supply curve to read the quantity that sellers wish to sell at that price on the horizontal axis Vertical interpretation of the supply curve - -we begin with a quantity, then go up to the supply curve to read the corresponding marginal cost on the vertical axis Equilibrium quantity and price - -the price-quantity pair at which both buyers and sellers are satisfied where supply and demand intersect at any other point, one party is dissatisfied Excess supply - -the amount by which quantity supplied exceeds quantity demanded when the price of a good exceeds the equilibrium price surplus Excess demand - -the amount by which quantity demanded exceeds quantity supplied when the price of a good lies below the equilibrium price shortage Adjustment to equilibrium - -at any price other than equilibrium price, one side of the market is dissatisfied dissatisfied sellers: downward pressure on price will persist as long as there remain any dissatisfied sellers (AKA until price falls to its equilibrium value) dissatisfied buyers: upward pressure on price will persist until price reaches its equilibrium value the adjustment toward equilibrium results more or less automatically from the natural reactions of self-interested individuals facing either surpluses or shortages MICROECONOMICS MICROECONOMICS Some welfare properties of equilibrium - -no reallocation can improve some people's position without harming the position of at least some other if price and quantity take anything other than their equilibrium values, it will always be possible to reallocate so as to make at lest some people better off without harming other no matter whether price starts out above or below its equilibrium value, a mutually beneficial transaction will always be possible Free markets and the poor - -all markets may be in equilibrium and yet many people may lack sufficient incomes to purchase even the bare necessities of life concern for the well-being of the poor motivates most societies to try to intervene but these intervention often produce unintended harmful consequences many critics of the market system complain that is unfair to ration goods and services by asking how much people are willing to pay for them Rent Controls - -Government imposed price ceiling for rent Leads to a huge shortage Because of price ceiling, prices can't rise - poorly maintained rental units - hidden fees - misallocations The main problem confronting the poor Is that they have too little money. Transferring additional money to the poor does more to help them than attempting to control the prices of things they buy Price ceiling - -the level above which the price of a good is not permitted by law to raise Price supports - -A price floor for agricultural products to benefit farmers Require the government to become an active buyer in the market A purpose of these price supports is to ensure prices high enough to provide adequate incomes for farm families In practice, they are costly and inefficient Price floor - -a minimum price for a good, established by law, and supported by government's offer to buy the good at that price The rationing and allocative functions of prices - -Prices ration existing supplies of goods - Scarcity Prices signal to direct productive resources among the different sectors of the economy Rationing function of price - -the process whereby price directs existing supplies of a product to the users who value it most highly - short run function MICROECONOMICS MICROECONOMICS Allocative function of price - -the process whereby price acts as a signal that guides resources away from the production of goods whose prices lie below cost toward the production of goods whose prices exceed cost - driving force behind the invisible hand - long run function Determinants of Demand - -Incomes Tastes Price of substitutes and complements Expectations Population Determinants of Supply - -Technology Factor prices The number of suppliers Expectations Weather Income and Demand - -Normal goods = quantity demanded rises as income rises Inferior goods = quantity demanded falls as income rises - abandon these goods for high quality substitutes Tastes and Demand - -Changes in preference or popularity of product/service Prices of Substitutes and Complements and Demand - -Substitutes: an increase in the price of one will tend to increase the demand for the other Complements: an increase in the price of one good decrease demand for the other good Expectations and Demand - -Expectations about future income and price levels also affect current purchase decisions Someone who expects a higher future income is likely to spend more today People will often accelerate their current purchases of goods whose prices are expected to rise in months to come Population and Demand - -In general, the number of people who buy a product grows as the number of potential buyers grows Technology and Supply - -The amount suppliers are willing to offer at any price depends primarily on their costs of production These costs are closely linked to technology Factor Prices and Supply - -Cost of labor, capital, wages, etc. The Number of Suppliers and Supply - -The more firm that can supply a good, the greater will be the quantity supplied of it at any given price MICROECONOMICS MICROECONOMICS Expectations and Supply - -If producers suspect a future price to be higher or a lack of availability, they will hold on to their inventories and offer the products to the buyers in the future, thus they can capture the higher price Weather and Supply - -For some products, specifically agriculture, nature has significant effects on the supply schedule Change in demand - -A shift in the entire demand curve Change in the quantity demanded - -A movement along the demand curve Change in supply - -A shift in the entire demand curve Change in the quantity supplied - -A movement along the supply curve An increase in demand - -will lead to an increase in both the equilibrium price and quantity A decrease in demand - -will lead to a decrease in both the equilibrium price and quantity An increase in supply - -will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity A decrease in supply - -will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity Rational Consumer Choice - -Underlies all individual purchase decisions Begins with the assumption that consumers enter the marketplace with well-defined preferences The Opportunity Set or Budget Constraint - -Budget constraints is the set of all bundles that exactly exhaust the consumer's income at given prices; aka budget line - slope of the budget constraint is "rise over run" - the minus sign signifies that it has a negative slope Bundle - -a particular combination of two or more goods - the first number of the pair in any bundle represents the good measured along the horizontal axis Flows - -amounts per unit of time - consumption is always measured as a flow Budget triangle - -the consumer is able to purchase any bundle that lies within the budget triangle bounded by it and the two axes MICROECONOMICS MICROECONOMICS Affordable set - -bundles on or below the budget constraint; bundles for which the required expenditure at given prices is less than or equal to the income available Budget shifts due to - -Price changes Income changes - the slope and position of the budget constraint are fully determined by the consumer's income and price of the respective goods; change any one of these factors and we have a new budget constraint Price Changes and Budget Shifts - -The rise in the price of one good rotates the budget constraint inward and the x/y intercept stays the same The fall in the price of one good leaves the x/y intercept unchanged and the budget constraint rotates outward Changing both prices by exactly the same proportion gives rise to a new budget constraint with the same slope as before (the opportunity cost also remains the same as before) The effect of double the prices of both food and shelter is to shift the budget constraint inward and parallel to the original budget constraint Income Changes and Budget Shifts - -The effect of a change in income is much like the effect of an equal proportional change in all prices The new budget is parallel to the old with an equal slope (shifts inward or outward depending on if the budget is decreasing or increasing) Budgets involving more than two goods - -The consumer has lots of options and is making decisions between N number of goods Hyperplane or Multidimensional Plane - -when we have more than three goods in the budget constraint Plane - -Three goods in the budget constraint Composite good - -in a choice between a good X and numerous other goods, the amount of money the consumer spends on those other goods this convention enables us to think of the composite good as the amount of income the consumer has left over after buying the good X and it is the amount the consumer spends on goods other than X Kinked Budget Constraints - -Sometimes budget constraints are kinked lines book example: the opportunity cost of electricity depends on how much the consumer has already purchased If the budget constraint is the same, the decision should be the same - -Even without knowing anything about the consumer's preferences we can use budgetary information to make certain inferences about how a rational consumer will behave MICROECONOMICS MICROECONOMICS The rational choice model makes clear that the decisions should be the same if the budget constraints and preferences are the same, but people sometimes choose differently; the difficulty is often that the way different situations are described sometimes causes people to overlook the essential similarities between them Consumer Preferences - -the personal likes and dislikes that make buyers more or less inclined to purchase a good Preference ordering - -a ranking of all possible consumption bundles in order of preference - preference ordering enables the consumer to rank different bundles but not to make more precise quantitative statements about their relative des