Midterm Review

Abstract Model: 1. Budget set 2. Preferences 3. Choice a) secrets of happiness b) Magic formulas

Budget set Budget set: Write down budget constraint Illustrate it geometrically (numbers) Interpret the slope (econ. and geom.) Changes: Price and Income Modifications: e.g. Taxes, Subsidies, Gifts

Budget set Graph, Slope, Price and Income Change Taxes, Subsidies, Gifts

Preferences Preferences: ranking of bundles Geometric representation – indifference c. Marginal rate of substitution Goods, Bads, Satiated preferences (slopes) Four examples of preferences Cob-Douglass Perfect Complements Perfect Substitutes Quasilinear Utility and MRS Monotone transformations

Preferences (4 examples) MRS (find, interpret, 0.000001)

Choice – well behaved preferences Given and Note: can be parameters Find optimal choice on the graph Secrets of happiness Geometric interpretation Economic Interpretation Analytical solution Magic formulas

Choice Graph, optimality conditions, twist interiority!

Extreme preferences Graph, optimality conditions, twist interiority, !

Magic formulas (Cobb Douglas)

Applications Applications of buying and selling model Labor Supply Intertemporal Choice Uncertainty

Applications

Uncertainty Two states, probabilities Bundle = lottery Bernouli and Von Neumann-Morgenstern U. Examples:

Risk Aversion (definition) Expected value of lottery: Examples Risk aversion better than

Risk Attitude

Uncertainty: Insurance Possibility of Flood Insurance contract Budget set

Uncertainty: Insurance Choice:

(Not) Fair Insurance Premium Fair premium Not fair premium

Markets and Exchange (key ideas) Edgeworth Box (apple-orange, IC, U) Pareto Efficiency Competitive Equilibrium Competitive Equilibrium Pareto efficient?

Edgeworth Box (and Efficiency)

Pareto Efficiency and Contract Curve

Competitive Equilibrium

Competitive Equilibrium

Competitive Equilibrium (Geometry)

Competitive E and Pareto Efficiency