Normative Analysis: How you want things to be / How things “should” be.

Positive Analysis: A factual statement / What is.

Arbitrage: An opportunity to make risk-free money.

(ex: borrowing money at 1% and lending at 5%)

If markets are working efficiently there should not be any arbitrage.

Calculating Growth Rate: (H2/H1 - 1) x 100

Establishes a difference between Real vs. Nominal numbers.

Ch. 2

How to calculate a curved slope using a derivative:

SUPPLY & DEMAND

P S

D Q

x elasticity of y = % ^ in y given a 1% change in x.

The price elasticity of demand = % ^ Qd / % ^ P (always negative)

The price elasticity of supply= % ^ Qs / % ^ P (always positive)

Income elasticity of demand= % ^ Qd / % ^ I (can be + or -)

Cross-price elasticity of demand= % ^ Qd of good A / % ^ P of good B (can be +, - or 0)

Good A and B must be related in someway. If the cross-price elasticity of demand is 0, then they are UNRELATED.

Positive= When I increase the price of good ‘B’ by 1%, the Qd of good ‘A’ goes up by 3%. SUBSTITUTE

* Make sure I can interpret the above.

Perfectly Inelastic Curve- It looks like an “I”. Perfectly vertical.

Perfectly Elastic Curve- Completely horizontal.

Straight line equations are y=mx - c

Mid-Point Method: We need it to calculate elasticity because

Calculate 9,1;1,9 and 1,9;9,1

Example:

Total demand for US wheat: Q= 3244 - 283P

Domestic demand for US wheat: Qd= 1700 – 107P

Supply of US wheat: Qs= 1944 + 207P

Export demand drops by 40%

What will happen to the price of wheat?

The demand for US wheat will fall, causing price to also fall.

1st Step: Find Equilibrium price before drop.

Put Qd to Qs 3244 - 283P=1944 + 207P 1300 = 490P > 1300/490P P*= $2.65

2nd Step: Export Demand Function before Drop

Qe (export quantity demand) = Q- Qd

Qe= (3244-283P) – (1700 – 107P) Qe= 1544-176P

3rd Step: Export Demand Function after Drop

Multiply above by .6 (1-.4)

(100-40/100)Qe = 0.6 x Qe 926.4-105.6P = Qe’

4th Step : Find New Total Demand for US Wheat

Qe’ + Qd = 2626.4 - 2012.6P

New equilibrium price: New Qs = Q’ 1944+207P=2626-212.6P P**= 1.63

Demand tells me the markets willingness and ability to buy a certain quantity of a good at a given price.

Willingness = tastes and preferences

Ability= income level

Consumer Behavior

Assumption about preferences (WELL BEHAVED PREFERENCES):

Completeness- ability to rank options

Transitivity- [ if A > B and B > C, then A > C]

If A ~ B (equally preferred) and B ~ C, then A ~ C

Non-satiation- more is better than less

Indifference Curve= Represents consumer preferences graphically.

If on the same Indifference Curve, level of satisfaction and utility will NOT change.

Indifference Curves DO NOT cross.

Marginal Rate of Substitution (MRS):

The slope of an Indifference Curve.

Your maximum willingness to give up Y for one more X

Diminishing Marginal Rates of Substitution (MRS)

A flat slope = a low MRS = unwillingness to substitute

Utility

The level of satisfaction

Marginal Utility

The additional utility (satisfaction) you get for consuming ONE more unit

New DEFINITION= Satisfaction from consuming a little bit more.

Utility Function

U = U (X, Y)

Marginal Utility (MU) of X = du/dx

Y 1/2 X½-1 = 1/2X-½ Y½

MU of Y = dU/dY = X½ 1/2 Y ½-1 SEE NOTEPAPERS dy/dx= Change in y when x changes by a little bit.

Derivative= slope of indifference curve

So, MS= dy/dx

Budget Constraint

Income: I

Price: Px

Quantity of X Consumed: Qx

See NOTES…