## Model Based Policy Analysis (Fach) / 4. Review of microeconomic theory (Lektion)

In dieser Lektion befinden sich 10 Karteikarten

microeconomic theory needed for policy modeling

Diese Lektion wurde von **Moadscha** erstellt.

- Explain the principles of utility maximization. Principles of utility maximization - Individuals maximize their utility through consumption - There is a budget constraint - Non-satiation: all income is spent - Positive marginal utility --> more is always better - Individuals choose bundles of goods for which the rate of tradeoff between any two goods (marginal rate of substitution MRS) is equal to the ratio of the good’s markets prices - Demand functions can be mathematically derived using Lagrangian multiplier - Income and prices determine consumption decision
- What is an indirect utility function? Indirect utility function - Can be computed from the individual’s utility function - Gives the individual’s maximal attainable utility s.t. the good’s prices and the amount of income - Refers to the primary problem = utility maximization - The derivate of the indirect utility function leads to the Marshallian demand function (Roy’s Identity) - Maximizing the direct utility function leads to the optimal utility maximizing values for all goods considered. These goods in turn are indirectly dependent on a set of prices and income.
- What does expenditure minimization mean? Expenditure minimization - Dual problem - Minimize expenditure to reach a certain level of utility dependent on a set of prices - Leads to expenditure function: - The derivate of the expenditure function leads to the Hicksian demand function (Shepard’s Lemma) - Expenditure is the inverse of the indirect utility function at a specific utility level u
- Uncompensated vs. compensated demand Uncompensated vs. compensated demand - Uncompensated “Marshallian” demand: 1. Primary problem: result of utility maximization 2. Demand dependent on prices and income 3. Can be observed and is subject of most empirical studies 4. Substitution and income effect - Compensated “Hicksian” demand: 1. Dual problem: result of expenditure minimization with constant utility 2. Cannot be observed 3. Only shows substitution effects following a price change and therefore useful for decomposing price effects
- What are the properties of demand functions? Properties of demand functions Adding-up, Homogeneity, Symmetry, Negativity Homogeneity - Demand functions are homogenous of degree zero in all prices and income è Changing all prices and income proportionally will not change the physical quantities demanded è No money illusion through inflation
- What are income effects? Income effects - Income elasticity of demand: proportionate change in quantity demanded in response to a proportionate change in income - Normal goods: income elasticity ≥ 0 ; an increase in income will lead to an increase in demand - Luxury goods: income elasticity > 1 - Inferior goods: income elasticity < 0 ; increase in income leads to decrease of demand
- What are own price effects? Own price effects - Slutsky equation: Price changes always have two effects: 1. Substitution effect (always negative) 2. Income effect (positive or negative) - Income effect positive = normal good - Income effect negative = inferior good - Substitution effect + income effect is almost always < 0 à price increase leads to a lower quantity demanded - Exception: giffen goods, here a price increase leads to a higher quantity demanded. The income effect outweights the substitution effect.
- What is own price elasticity? Own-price elasticity - Is always negative (except for Giffen goods) - Own-price elasticity ??,?? = -1 : demand is unt elstic. A 1% price increase leads to a 1% decrease in quantity demanded. - Own-price elasticity ??,?? < -1 : demand is elastic. Quantity changes are proportionally larger than price changes. - Own-price elasticity ??,?? > -1 : demand is inelastic. Quantity changes proportionately smaller than price changes.
- Adding-up: Engel aggregation Adding-up: Engel aggregation - All income is spent à sum of budget shares = 1! - Sum of marginal budget shares (budget shares time income elasticity) = 1! - Weighted average of all income elasticities for all consumed goods must add up to 1 - Important rule for demand system in CGE
- What are cross-price-effects? What is cross-price-elasticity? Cross price effects - Gross cross price effect: income and substitution effect - Net cross price effect: substitution effect only Gross effects can be asymmetric due to income effects: I can be a gross substitute for j, but j can be a gross complement for i. Examples? Cross-price elasticity - Proportionate change in quantity demanded in response t a proportionate change in the price of another good