EC1P1 T_T || A+ Graded Already.
Explain revealed preference correct answers If a consumer chooses good A over good B, that
must be because they preferred good A to good B and it brought them more utility/they have
higher welfare with good A than good B
Values of utility only have meaning when .... correct answers Being compared to each
other/relative to each other - the numbers have no literal meaning
It is assumed that u(c, o) increases with ______. We can make this assumption because .....
correct answers Assume that utility increases with consumption, ie the more goods one
consumes, the higher their utility
We make this assumption because: a) even if one had too many goods, they could just throw the
extra away, and at worst utility would still be weakly increasing, and b) we observe in society
that people work and sacrifice in order to be able to consume more
In the utility function u(c, o) = u^θo^1-θ, θ represents ... correct answers The consumer's
preference for the c good relative to the o good - if θ>0.5 then θ will be > 1-θ, so c goods will be
given a greater weighting than o goods in the utility function (checked by differentiating u wrt c,
and showing that this is always greater than/equal to zero)
Explain cardinal vs ordinal correct answers Cardinal = measured in units of goods, eg 6 apples is
factually double of 3 apples
Ordinal = measures that are only significant when comparing values relative to each other, the
numbers don't have literal meaning, eg with utility - 6 utils is not double the happiness of 3 utils
Units of utility are ___________ correct answers Unmeasurable
Define GDP, and what is it used for? correct answers The market value of goods produced
within a country in a given time period eg a year - aka output, GDI or GDE
Used to measure how well/badly countries are doing
GDP over time is typically measured on a log scale because ... correct answers It has increased
so dramatically
GDP is a measure of _____, not ______ correct answers It's a measure of consumption, not
utility/welfare - however we assume that utility increases with consumption, so CETERIS
PARIBUS greater GDP = greater welfare, but we never have complete ceteris paribus
We can't measure o (other goods) since it is comprised of everything else/all other factors - this
creates the issue of ______
& how to safeguard against this issue correct answers An omitted variable
,But: if this omitted variable is positively correlated with the observed variable (ie if other factors
- schooling, health, happiness, electricity, etc - that plausibly raise wellbeing are positively
correlated with GDP), then you will still get the right ordering/ratios of GDP will still give an
accurate estimate of well-being IN AN ORDINAL SENSE - just not cardinal
Revealed preference reinforces that higher GDP = better wellbeing since migrants
overwhelmingly choose to migrate to richer countries - thus their utility must've been higher in
this richer country A relative to poorer country B
Define household production, and how does this impact GDP? correct answers Household
production = goods and services produced within the household, eg subsistence farming, caring
for children/elderly, etc
GDP doesn't measure household production - thus GDP is arguably an UNDERestimate
Eg when dishwashers came about - the increase in ah didn't lead to any increase in GDP, but
well-being increased massively
Define structural transformation correct answers When labour moves from "subsistence sector"
to "capitalist sector", GDP increases but is overstated
If there are excess workers in cities, wages may stagnate and poverty persists. Welfare of
workers may not rise at all.
However as profit rises, firms demand more labour and allowing more to move. Finally reach the
"Lewis turning point" from dual to single integrated labour market. Welfare catches up to GDP
with time.
What assumptions are made when modelling household production as a choice of hours? correct
answers 1. There is a limited number of labour hours in the day, ie lc + lh = l
2. Every hour of labour yields some output, ie c = aclc and h = ahlh
(Where ac and ah are just constants that tell us how much output is yield by 1 hour of labour in
that sector)
If we have that θlh = (1-θ)lc, then the ratio of lc to lh is: correct answers θ:1-θ, ie you switch it
round
The ratio of household production to market goods (consumption) can be calculated by doing...
correct answers h/c. So derive an expression for h and an expression for c and divide - and then
interpret this expression eg does it have terms for productivity/yield in it? Does it have θ
representing preference in it? If yes say that it shows that [the more productive you are in a
certain sector, the more you want to work in that sector] and so on
What is a price index? correct answers An average of prices, which maps income (y) to utility
(u), so it measures cost of living
Unit changes make it change equi-proportionately, ie if you multiply every price by 100, the
price index will increase by 100 (eg converting pounds to pennies)
,The correct price index p will be such that nominal income (py) divided by it (p) leaves y, a
measure of real GDP which is equal to utility
So with the right price index, real GDP is a measure of utility
Inflation is measured as ... correct answers For the same nominal income py, how much does
utility fall as the price index rises (utility = py/p)
When comparing 2 dates in time, we use ....
When comparing 2 countries with different currencies, we use .... correct answers 2 dates: use
deflators, deflating the later date's income into the earlier date's utility units
2 countries: use purchasing power parity, putting them both in the same units of utility
Issue with CPI as a measure of inflation?
Why are consumption deflators a better measure? correct answers Keeping the basket of goods
fixed biases the estimate of how bad the cost of living inflation is by OVERestimating it.
This is because it doesn't take into account the substitution bias - ie the fact that if good c
increases by a greater proportion than good g, consumers will buy relatively less good c and
relatively more good g (substituting the relatively more expensive one for the relatively cheaper
one), reducing how much their welfare is damaged by the inflation - CPI basket of goods can't
take this into account
Consumption deflators (and all chain-weighted measures) are a better measure of the cost of
living as they average out one's share of the c good and the g good before and after the change in
price
Real GDP is always relative to an index point, but the longer you go/the more time you span it
over, ..... correct answers the more stretched it gets
eg a car nowadays is very different to one X years ago
eg price of a computer hasn't changed much over past 20 years, so per our calculations real GDP
and thus welfare hasn't changed much, but a modern computer is much better than one from 20
years ago
Increase in the cost of living tells you _______ correct answers By how much consumers are
worse off
If prices increase from pc and pg to p'c and p'g, a) what might have caused this price increase?,
and b) how would you calculate the overall increase in the cost of living? correct answers a)
either due to inflation, or going to a different country with different prices
b) create a new version of the price index p called p', where you substitute p'c in place of pc and
p'g in place of pg
divide this new price index p' by the original price index p
cancel out terms where possible
(can then take logs at this stage - log of the inflation gives the approx % of inflation)
, Then substitute in the values of θ and 1-θ and the price increases of each good (p'c/pc and p'g/pg)
to calculate the overall increase in the cost of living
^this is called the cost of living inflation measure, which is a weighted average of inflation in the
c good and inflation in the g good
Define hedonics correct answers Adjustments for quality, eg considering the fact that if the price
of a house increases from £100,000 to £200,000, whilst this may appear like a 100% increase in
value, in this time it's actually had its quality improved in many ways eg an extension, so it's not
the same house being sold / part of the price increase is due to a change in quality
This is why we introduce the parameters bc and bg, representing the quality of good c and good
g respectively
Explain the broken window fallacy correct answers Damage can stimulate the economy, as it
creates spending (eg buying new window), which might create a job for someone, etc (it will
multiply through the economy), so theoretically GDP increases and thus welfare appears to
increase overall in the economy
It's a fallacy because it ignores the opportunity cost (the goods the shopowner could've sold if
they didn't have to shut, and the items they could've bought with the money they instead spent on
the new window) - GDP actually falls and welfare is far lower. Employment may rise or fall.
This applies to natural disasters
There is difficulty measuring the effect on GDP of government spending/public goods
because .... correct answers Countries with unproductive systems (eg healthcare systems, eg
infrastructure, etc) may spend lots of money on these systems, making GDP increase and thus
welfare appear to increase, when in reality their systems are unproductive and money is wasted
on them and welfare is actually lower than in other countries that are spending less (where
welfare appears to be lower, but is actually not)
Also can't include public goods in GDP since we don't pay a price for them
Thus we use parameters in the utility function that represent the quality of goods/services
Measuring government value added: however much money the govt spends on public goods, is
how much __________ correct answers gdp increases by
We use the fact that the value added by the government is ______, because ..., but this is
problematic because .... correct answers GDP in terms of Value added by government is zero,
because any other number is viewed as biased and susceptible to manipulation by governments
But this is problematic because over time countries spending large amounts on
inefficient/unproductive systems will be viewed as having a large increase in GDP
