CLASS REVIEW (Chp 5-Chp 7)
ECON 301 June 23, 2004
SUMMER 2004
XUE QIAO
Chapter 5: Applying Consumer Theory
► Deriving demand curve: For any given price, we can apply consumer constrained choice to derive the optimal consumption bundle. Find the combination of (), and plot it, then we derive the demand curve.
------To derive it numerically, use formula
which can also be rewritten as
The above formula will derive a equation about optimal consumption bundle, then put this equation back into budget constraint, then we can find
().
► Income change: cause Budget constraint to shift.
------optimal consumption
------Income-consumption curve
------Engle curve: upward sloping implies normal good,
downward sloping: inferior good.
------Income elasticity: : >0, then normal good
<0, then inferior good.
► Price change: Total effect = substitution effect + income effect
------Decompose TE into SE and IE:
Step 1: draw a budget line BL* parallel to the new BL, and tangent to
Initial indifference curve, then we have a new tangent point e*.
Step 2: The movement from (the tangent point between initial IC and
Initial budget constraint) to measures the SE.
Step 3: The movement from e* to ( the tangent point between new BC
And new IC) measures the IE.
Note: Be careful about the direction.
SE=
IE=
TE=
------Consider the case when price of good x drops:
Normal good: SE:
IE: Then TE >0
Inferior good: SE:
IE: Then TE > 0 if
TE < 0 if (Giffen good)
► Derive Labor supply curve
------H=24-N
------Derive leisure demand curve by applying consumer constrained choice
------Labor supply =24-demand curve of leisure
------Properties of leisure decides the shape of labor supply curve
When wage is low, people view leisure as an inferior good:
W increases, labor supply increase
When wage is high, people view leisure as a normal good:
W increases, labor supply decrease
So labor supply will increase first then start to decrease, i.e., upward
Sloping first, then downward sloping.
Chapter 6: Firm and production
► Production function is defined as the maximum output by using existing inputs, so this definition implies efficient production process.
------short-run: capital is fixed
------long-run: labor and capital can both be varied.
► Short-run production:
------TP, ,AP
------the shapes of these three definitions
------properties of these three definitions and how to show them graphically
------Diminishing marginal returns: is decreasing when L increases.
► Long-run production:
------isoquant:
------slope of isoquant: , and MRTS is decreasing
------shape of isoquant: straight line: perfect substitutes
right-angle : perfect complement
convex: imperfect substitutes
► Return to scales:
------Def:
------Tell the “return to scales” from graph: given several isoquants and
corresponding inputs bundles.
------Return to scales can be varied across firm’s size: IRS for small
CRS for moderate
DRS for large
Chapter 7: Costs
► Measuring cost: economical cost=explicit cost + opportunity cost
► Short-run cost: capital is fixed, so we have a nonzero FC.
------7 Defs: FC, VC, TC, AFC, AVC, AC, MC
TC=VC+FC, AC=AVC+AFC, AFC=FC/Q, AVC=VC/Q,
MC=
------Properties of these 7 curves and relationship among them
------Be able to show them graphically.
------Effect on cost of a government specific tax & franchise fee.
► Long-run cost: FC=0
------isocost line:
------slope of isocost:
------derive the cost-minimizing bundles of inputs:
or Lowest isocost line
or Last dollar rule.
------Shape of Long-run cost(LRC), Long-run Average cost(LRAC), MC
------depends on “return to scales”:
CRS: LRC: upward-sloping straight line
LRAC & MC: constant
IRS: LRC: increasing, but slope is decreasing
LRAC & MC: decreasing
DRS: LRC: increasing, but slope is increasing
LRAC & MC: increasing
------the part where LRAC is decreasing is called “economies of scale”
increasing “diseconomies ….”
Constant “ no economies …”
------Long-run expansion path and short-run expansion path
Read practice IV.
►