Microeconomics I summary
Microeconomics has two areas:
1. Analysing the behaviour of individuals and firms
2. Explaining the market structures and price settings
Supply depends on:
- Production technology
- Costs of inputs
- Market price
Demand depends on:
- Preferences of consumers
- Income of consumers
- Market price
- Prices of other goods
Supply > demand price
Supply < demand price
Budget is used to:
- Buy consumer goods
- Save (intertemporal decision making)
- Enjoy leisure (labour supply decision)
Assumptions on preferences:
1. Completeness: the consumer prefers one bundle over another or is indifferent
2. Transitivity: bundle A>B, bundle B>C, then the consumer prefers bundle A over C
3. More is better: if a bundle contains all goods of another bundle plus at least one
good more, then the consumer prefers the bundle with more goods over the other
Indifference curve = collection of all bundles of goods for which the consumer is indifferent.
- Non-increasing
- Indifference curves never cross
- Further away from the origin implies a higher utility
- Each bundle belongs to an indifference curve
Utility = the valuation of a bundle to a consumer
Marginal rate of substitution = extent to which goods can be traded against each other
without affecting utility
−∆ q y MU x
MRS= =
−∆ q x MU y
MRS is the derivative of the indifference curve.
When MRS is small, only few additional units of good Y are necessary to replace one unit of
good X.
, MRS = 0 or MRS = ∞ MRS = C
Marginal utility = how much utility increases if the amount of a good in the bundle increases
with one.
the more is better assumption implies that marginal utility cannot be negative
Marginal utility of good X:
∂ U (q x , q y )
MU x = >0
∂ qx
q y implies that the amount of good Y remains constant.
Budget = p x q x + p y q y ≤ B
Budget line:
p x q x + p y q y =B
1 p
q y = B− x q x
py py
Opportunity set = all bundles (qx, qy) that can be bought with the budget.
Marginal rate of transformation = how much the consumer should sell of good Y to be able
to buy one additional unit of good X within the same budget.
−∆ q y p x
MRT = =
∆ qx py
MRT determines the slope of the budget line.
MRT does not change if the budget increases.
MRT changes if the price of one good changes.
The bundle of goods is optimal if:
1. The bundle lies on the budget line: p x q x + p y q y =B
2. The marginal rate of substitution equals the marginal rate of transformation:
MU x p x
MRS= = =MRT
MU y p y
this gives the interior solution
Sometimes it gives more utility if you only buy one good (q x =0or q y =0).
this gives the corner solution
Concave indifference curves always give corner solutions.
Microeconomics has two areas:
1. Analysing the behaviour of individuals and firms
2. Explaining the market structures and price settings
Supply depends on:
- Production technology
- Costs of inputs
- Market price
Demand depends on:
- Preferences of consumers
- Income of consumers
- Market price
- Prices of other goods
Supply > demand price
Supply < demand price
Budget is used to:
- Buy consumer goods
- Save (intertemporal decision making)
- Enjoy leisure (labour supply decision)
Assumptions on preferences:
1. Completeness: the consumer prefers one bundle over another or is indifferent
2. Transitivity: bundle A>B, bundle B>C, then the consumer prefers bundle A over C
3. More is better: if a bundle contains all goods of another bundle plus at least one
good more, then the consumer prefers the bundle with more goods over the other
Indifference curve = collection of all bundles of goods for which the consumer is indifferent.
- Non-increasing
- Indifference curves never cross
- Further away from the origin implies a higher utility
- Each bundle belongs to an indifference curve
Utility = the valuation of a bundle to a consumer
Marginal rate of substitution = extent to which goods can be traded against each other
without affecting utility
−∆ q y MU x
MRS= =
−∆ q x MU y
MRS is the derivative of the indifference curve.
When MRS is small, only few additional units of good Y are necessary to replace one unit of
good X.
, MRS = 0 or MRS = ∞ MRS = C
Marginal utility = how much utility increases if the amount of a good in the bundle increases
with one.
the more is better assumption implies that marginal utility cannot be negative
Marginal utility of good X:
∂ U (q x , q y )
MU x = >0
∂ qx
q y implies that the amount of good Y remains constant.
Budget = p x q x + p y q y ≤ B
Budget line:
p x q x + p y q y =B
1 p
q y = B− x q x
py py
Opportunity set = all bundles (qx, qy) that can be bought with the budget.
Marginal rate of transformation = how much the consumer should sell of good Y to be able
to buy one additional unit of good X within the same budget.
−∆ q y p x
MRT = =
∆ qx py
MRT determines the slope of the budget line.
MRT does not change if the budget increases.
MRT changes if the price of one good changes.
The bundle of goods is optimal if:
1. The bundle lies on the budget line: p x q x + p y q y =B
2. The marginal rate of substitution equals the marginal rate of transformation:
MU x p x
MRS= = =MRT
MU y p y
this gives the interior solution
Sometimes it gives more utility if you only buy one good (q x =0or q y =0).
this gives the corner solution
Concave indifference curves always give corner solutions.
