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Chapter 1 Economics proceeds by developing Models of social phenomena. By a model we mean a simplified representation of reality. Exogenous variables: taken as determined by factors not discussed in a model. Endogenous variables: determined by forces described in the model. The optimization principle: People try to choose what’s best for them. The equilibrium principle: Prices adjust until demand and supply are equal. The demand curve: A curve that relates the quantity demanded to price. The reservation price: One’s maximum willingness to pay for something. From people's reservation prices to the demand curve. Fig. Similarly, the supply curve. Pareto efficiency: A concept to evaluate different ways of allocating resources. A Pareto improvement is a change to make some people better off without hurting anybody else. An economic situation is Pareto efficient or Pareto optimal if there is already no way to make any more Pareto improvement. Short run and long run in the short run (some factors are unchanged) and in the long run. Equilibria Chapter 2 * Vector variables and vector functions. * The inner product of two vectors. * With the price vector p = ( p1, …, pn ), the value of the commodity bundle x = ( x1, …, xn ) is pTx = Σi pixi. However, two goods are often enough to discuss. The budget constraint: p1 x1 + p2 x2 ≤ m. The budget line and the budget set (the market opportunity set). The slope of the budget line: d x2 /d x1 = – p1 / p2 . How the budget line moves when the income changes, or when a price changes. Budget line and budget set x2 m/p2 Budget line Slope = -p1/p2 Budget set m/p1 x1 Increasing income x2 m’/p2 Budget line m/p2 Slope = - p1/p2 m/p1 m’/p1 x1 Increasing price m/p2 Budget line Slope = - p1/p2 Slope = - p’1/p2 m/p’1 m/p1 Taxes, quantity taxes, value taxes (ad valorem taxes), and lump-sum taxes. A subsidy is the opposite of a quantity tax. Rationing. Their effects on the budget set.