Principles of Microeconomics

goods which, in principle, could be provided by the market but are offered by the public sector because their consumption is assumed to be desirable by society. Eg. education

• Allocation function: monopoly, public goods, externalities, asymmetric information
• Distribution function: social disparities, regional disparities
• Stabilization function: Economic crisis, growth problem

• Direct Tax: levied on income and wealth

• Indirect Tax: levied on the sale of goods and services

• Specific tax (tax on per unit of a good), ad valorem tax (tax levied as a percentage of the price of a good), Pigovian tax, value added tax,…, eg. tax on tobacco or alcohol

The fundamental cause of monopoly is barrier to entry

MR = MC

› Increased variety of goods

› Lower costs through economies of scale

› Increased competition

› Enhanced flow of ideas

› Economic growth

• Jobs
• National security
• Infant industry
• Unfair competition
• Environment and trade

A key resource is owned by a single firm (monopoly resource), the government gives a single firm the exclusive right to produce a good (government created monopoly), the costs of production make a single producer more efficient (natural monopoly). 

If a price of a product falls, people can afford more of it

If a price of a product falls, people substitute similar products with the cheaper one.

Giffen good: increase in price increases demand because of the income effect: if the price of bread rises, poor workers have less income available for meat and need to substitute with more bread

A good where an increase in price encourages people to buy more of it. This is because they think more expensive goods are better.

An inferior good means an increase in income causes a fall in demand. Eg. Tesco value bread. When your income rises you buy less Tesco value bread and more high quality, organic bread.

\(E_I=\frac{\Delta Q}{\Delta I} \cdot \frac {I}{Q}\)

0<E<1: normal good

E>1: luxury good

E<1: inferior good

\(E_{QbPm}=\frac{\text{% change in Q demanded for Good 1}}{\text{% change in price of Good 2}}=\frac{\Delta Q_b}{\Delta P_m}\cdot \frac{P_m}{Q_b}\)

E<0: complements

E>0: substitutes

• Satisfaction derived from the consumption of a certain quantity of a

product.

• Can only be ranked

• Can only be measured indirectly

• Can be revealed in people’s willingness to pay (WTP)

• WTP reflects the value of a good but not necessarily the level of

satisfaction

• Assumption: marginal utility per dollar spent must be the same for all

consumers

The limit of the consumption bundles that a consumer can afford. Efficient combinations lie on the budget line.

\(P_P \cdot Q_P+P_C \cdot Q_C=I\)

a curve that shows consumption bundles that give the consumer the same level of satisfaction

• Higher indifference curves are preferred to lower ones

• Indifference curves slope downward from left to right

• Indifference curves do not cross

Satisfaction is maximized when the marginal rate of substitution (of P for C) is equal to the ratio of the prices (of P to C)

A line showing the relationship between demand and levels of income.

• Bounded rationality: people make decisions with limited information and cognitive constrains in processing information => people are not rational
• People are not maximizers but satisficers (good enough).
• Pro-social behaviour and fairness: people do not only maximize their own utility but also care about fairness.
• Prospect theory: losses and gains are valued differently.
• Mental accounting (accounting for household, holidays, etc.) Endowment effect (value of something owned is greater then of the same thing not
• owned), sunk costs (you finish to watch a bad sports game since your
• already paid for the ticket),