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.
How to calculate a curved slope using a derivative:
SUPPLY & DEMAND
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
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
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
The level of satisfaction
The additional utility (satisfaction) you get for consuming ONE more unit
New DEFINITION= Satisfaction from consuming a little bit more.
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
Quantity of X Consumed: Qx