Microeconomics Week 1

Initial Endowment

The goods each person has before any exchange take place

Final Endowment

The goods each person has after all exchanges have taken place. Comparing initial and final endowments helps economists analyse the benefits of trade.

Classical Constitutional Conundrum

The problem of finding a set of laws, policies and social norms that allow people freedom to choose their actions while avoiding outcomes that none would have choses had they been able to coordinate.

Indifference Curves

Graphical representations of combinations of goods that provide the same level of utility to an individual. As utility increases, indifference curves move away from the origin and their slope represents the marginal rate of substitution.

Marginal Rate of Substitution

The willingness to pay for a small increase in one good(y) expressed as how much of another good a person would give up (x). Represented by the negative of the slope of the indifference curve.

Marginal Rate of Substitution - Willingness to Pay

The maximum amount of one good a person is willing to give up to obtain another good.

Feasible Frontier

Boundary of Possible allocations of goods in an economy, representing the maximum amount of one good that can be produced given the production of the other good. Its slope is the Marginal rate of transformation.

Marginal Rate of Transformation

The negative of the slope of the feasible frontier measuring the sacrifice of one good necessary to more of another good. It represents the opportunity cost of one good in terms of another.

Opportunity Cost

The value of the next best alternative foregone when making a choice. Represented by the marginal rate of transformation, measuring the sacrifice of one good necessary to get more of another.

Edgeworth Box

A graphical representation used to analyse the distribution and allocative efficiency of goods in an economy between two individuals with fixed total resources

Pareto Criteria

A principle stating that no one must be made worse-off to make anyone better-off. It helps avoid losers in economic decisions but can be too strong (leading to status quo bias) or too (allowing efficient but socially undesirable outcomes).

Status Quo Bias

An unwillingness to change current policies or institutions, potentially resulting from strict adherence to Pareto Criteria

Pareto Superior

An outcome that allows at least one party to be better off without anyone being worse off compared to the current allocation. A Pareto improvemet leads to a Pareto superior outcome.

Impartial Social Planner

A hypothetical third party that makes and enforces distribution decisions without being allocated any goods themselves, focusing on both procedural and substantive fairness.

Procedural Fairness

Concerns about the way in which an allocation is determined and whether the process itself is fair regardless of the outcome.

Substantive Fairness

Concerns about whether the outcome itself is fair, regardless of the process used to arrive at it.

Iso-Welfare Functions

Combination of utilities for different individuals that result in the same level of welfare for a social planner. The slope represents the social planner’s marginal rate of substitution between individuals’ abilities.

Utility Possibility Frontier

The boundary of the set of feasible utility pairs between two individuals, representing the maximum utility one person can achieve given the utility of the other person.

Pareto Efficiency Curve

A curve representing all points of tangency between two individuals’ indifference curves, showing all allocations of goods that are Pareto Efficient

Pareto Improving Lens

The region of possible allocations that would make at least one person better off without making anyone worse off compared to the initial endowment, bounded by participation constraints.

Diminishing Marginal Welfare

The concept that as an individual’s utility increases, the social welfare derived from additional units of utility for that person decreases.

Positive Marginal Utility

The concept that additional consumption of a good increases total utility even if by diminishing amounts.

Diminishing Marginal utility

The principle that as consumption of a good increases, the additional satisfaction derived from each additional unit decreases.

Fallback Position

The utility or outcome a person receives if they refuse to participate in an exchange or transaction. Serves as a minimum threshold that must be met for voulantary participation in any exchange.

Take it or Leave it Power

A form of bargaining power where one party makes a single offer that the other party can only accept or reject. The party with TIOLI power can capture all economic rents while respecting the other party’s participation constraint.

Take it or Leave it Power 2

A form of bargaining power where one person can dictate both price and quantity in an exchange, subject only to the other person’s participation constraint. Allows the powerful party to capture all economic rents while still achieving Pareto efficieny

Price-Setting Power

A weaker form of market power where one person can set prices but not quantities in an exchange. The party with this power must consider the other’s best response function when maximising their utility, typically leading to Pareto-inefficient outcomes.