Chapter 2: Budgets (Week 1) • Positive monotonic transformation: any function v = f(u) where the

slope dv/du > 0 when u > 0 will also be a utility representation of the
• Budget line affects feasibility: p1x1 + p2x2 = m
same preferences à MRS remains unchanged
• Desirability: maximising utility (ranked higher in a preference
relation)
Chapter 4: Individual Demands (Week 2)
Chapter 3: Preferences (Week 1) • Preference-maximising (interior) bundle occurs when the
indifference curve is tangential to the budget line:
• Preferences: ranking one commodity bundle over another
≥ or ≤ Weakly prefer
Slope of indifference curve (negative MRS) = slope of budget line
> or < Strictly prefer
~ Indifferent
• Main properties of preference:
o Completeness: for any two different bundles A and B, one of • Marginality principle:
the following is true:
§ A ≥ B, if true then A > B or
§ B ≥ A, if true then B > A or
§ A ≥ B and B ≥ A, if true then A ~ B
o Transitivity: for any three different bundles A, B and C
whenever A ≥ B and B ≥ C, then A ≥ C
• Indifference curve joins all combination of goods that give the same
utility level
• Marginal rate of substitution: slope of an indifference curve at a
point (in absolute value)
o Shows how much x2 a consumer is willing to give up in
exchange for one unit of x1 to remain on the same
• Corner solution: when only one good is consumed
indifference curve
o Corner solution along the x-axis à
indifference curve is steeper or the
same slope as the budget line
o Corner solution along the y-axis à
• Types of preferences:
indifference curve is as flat or flatter
o Linear
than the budget line
§ • Demand for linear preferences can either be: corner solutions (x or y
§ Preferences like these are called perfect substitute intercept) or along the budget line (when MRS = slope of budget line)
§ Neutral good – when a or b = 0 • Demands for Leontief preferences:
o Leontief o The highest indifference curve
attainable passes through the point
§
§ Goods are perfect complements (A), where this line intersect with
in consumption. I.e. no the budget line
substitution between goods are
possible à MRS is meaningless
§ Two goods are consumed in a • Demands for quasilinear preferences can be interior or corner
proportion of b units of good 1 o If x1 or x2 ≤ 0 à corner solutions, then the entire income is
and a units of good 2 spent on the good that is the interior solution
o For an interior solution to hold, x1 or x2 > 0
o Quasilinear • Budget set for labour, leisure and consumption:

§ Vertically parallel Expenditure = income

Consumption × price of consumption = wage × labour

Chapter 5: Consumer Comparative Statics (Week 3)

• Demand elasticity measure the responsiveness of the quantity
demanded to changes in different determinants of demand (e.g.
price of product, income, and prices of other goods)
• Own-price elasticity of demand is the % change
in the quantity demanded when there is a %
change in its own price
• Cross-price elasticity of demand for good i w.r.t
§ Horizontally parallel price j
§ For vertically parallel curves, f’(x1) decreases as x1
increases à diminishing marginal rates of substitution • Income elasticity of demand for good 1
o Cobb-douglas o If it equals zero à no income effect on
good 1
§
§ For positive levels of o If it is greater than 1, then good 1 is
utility, the indifference always a normal good
curves are allow • When p1 falls while p2 and m remain fixed, the quantity demanded
continouous subsitution for good 1 typically increases à price effect
between the two goods • Price effect can be broken into:
o Substitution effect – individual’s desire to purchase more of
the good that is relatively cheaper
• Level of utility has no significance, but preference ranking matters
 o Income effect – consumer’s desire to purchase more of the o When the effect of income effect is larger than the
good because a reduction in p1 increases the consumer’s substitution effect à demand for good 1 falls à violates the
purchasing power law of demand (giffen good)
• Hicks-Allen decomposition – steps:
1. Find the preference-maximising bundle A at the original
o o
budget B which yields the utility level u
2. Find the preference-maximising bundle C at the new budget
n n
B which yields the utility level u . For the good whose price
changed, the movement from A to C is the price effect
3. Using the new price ratio, find the bundle B that barely yields
o
the original utility, u
4. For the good whose price changed, the movement from A to
o
B (along the original indifference curve, u ), is the
o n
substitution effect. Movement from B to C (u to u ) is the
income effect

Chapter 8: Costs (Week 5)

• Let cost function be 𝑐 (𝑤, 𝑞) where output is 𝑞 and price is 𝑤
• Total fixed cost (TFC): cost incurred even when nothing is
produced: 𝑇𝐹𝐶 = 𝑐(𝑤, 0)
• Total variable cost (TVC): part of the cost function not including
the fixed cost: 𝑇𝑉𝐶 = 𝑐(𝑤, 𝑞) – 𝑐(𝑤, 0)
• Average cost (AC): cost of producing each unit of output when 𝑞
!(!,!)
units are produced: 𝐴𝐶 =
!
• Average fixed cost (AFC): the average expenditure on overhead
!(!,!)
• Slutsky decomposition – steps: when 𝑞 units are produced: 𝐴𝐹𝐶 =
!
1. Find the preference-maximising bundle A at the original • Average variable cost (AVC): the average expenditure on operating
o o
budget B which yields the utility level u expenses when 𝑞 units are produced:
2. Find the preference-maximising bundle C at the new budget 𝑇𝑉𝐶 𝑐(𝑤, 𝑞) – 𝑐(𝑤, 0)
n n
B which yields the utility level u . For the good whose price 𝐴𝑉𝐶 = = = 𝐴𝐶 − 𝐴𝐹𝐶
𝑞 𝑞
changed, the movement from A to C is the price effect • Marginal cost (MC): the cost of producing an additional unit of
3. Find the budget at the new price that passes through A. !"
output: 𝑀𝐶 =
calculate the preference-maximising bundle B for this budget !"
4. For the good whose price changed, the movement form A to • Relationship between AVC and MC: when the average is
B is the substitution effect. Movement from B to C is the increasing/decreasing/constant, the margin must be
income effect more/less/the same as the average
• When the MC = AVC, it is the minimum point of the AVC

Chapter 9: Competitive Firms (Week 5)

• Perfect competition consists of many potential sellers for an
identical product. There are many potential buyers who are price-
takers. There is also no market friction, nor entry/exit cost
• Profit = total revenue − total cost
𝜋 𝑞 = 𝑝𝑞 − 𝑐(𝑞)
• π = 0 (normal profits) – revenues earned are just enough to pay for
operating expenses. To make normal profits:
total revenue = total cost
𝑝𝑞 = 𝑐 𝑞
• With inferior goods, the income effect works in the opposite 𝑐 𝑞
𝑝=
direction to the substitution effect 𝑞
• Depending on the magnitude of the income effect, two cases are 𝑝 = 𝐴𝐶
possible: • π > 0 à supernormal profits, when 𝑃 > 𝐴𝐶
o Substitution effect encourages consumer to buy more of • π < 0 à losses, when 𝑃 < 𝐴𝐶
good 1 when it is relatively cheaper, but the negative income • Short-run profit maximisation
effect works against the positive substitution effect à law of o Take the first order condition of profit
demand holds § Rule 1: profits are maximised when 𝒑 = 𝑴𝑪
o Take the second order condition à 𝒄”(𝒒) > 𝟎
§ Rule 2: profits are maximised when firm produces at a
point where MC is rising
o Shutdown condition in the short run
§ Rule 3: Produce in the short-run if total revenue equals
or exceeds total variable cost OR when price ≥ AVC
𝑝𝑞 ≥ 𝑣(𝑞)
𝑣 𝑞
𝑝 ≥
𝑞
𝑝 ≥ 𝐴𝑉𝐶
• To calculate shutdown price (psd) and shutdown quantity (qsd), set
𝑴𝑪 = 𝑨𝑽𝑪
• (Supply graph) Within 0 ≤ p < 20, p < min AVC (rule 3 is violated),
therefore the quantity supplied = 0 at these price