1. The Consumer Problem Flashcards
Why does a soda machine only dispense one bottle or can at a time, but a newspaper vending machine open up so that you could take as much as you want?
Taking decisions at the margin. Taking an extra newspaper provides no additional utility (marginal benefit), whereas a bottle does.
What is the law of completeness?
either a>b or b>a or a ~ b
assumes that every consumer can rank bundles (combinations) of consumption goods
What is the law of transitivity?
if a>b and b>c, then a>c.
assumes that consumers dont contradict themselves
What is the law of the more the better?
All else the same, more of a commodity is better than less.
In this regard, a “good” is different than a “bad.”
What does an indifference curve show?
the set of all bundles of goods that a consumer views as being equally desirable.
The graph to the right shows a graph for particular fictitious character, where both e, a, and c are indifferent to the consumer
–> Does not matter which point they consume at, they will be given the same satisfaction, this is called the INDIFFERENCE CURVE
What does the assumption of the more the better tell you about point e and f?
Assumption of the more the better tells you the point F is better than E, because consumption is greater on both sushi and pizza.
What are the 3 impossible indifference curves?
1) Crossing
2) Upward Sloping
3) Thick
Why is a crossing indifference curve impossible?
a is as good as e
e is as good as b
–> so a should be as good as b (transitivity)
But this is NOT possible, as b > a
So indifference curves crossing VIOLATES the law of transitivity, and thus they can NOT cross
Why is an upward sloping indifference curve impossible?
(b) Upward Sloping
-> This is also impossible, (the more the better assumption), as A and B would not grant the same satisfaction, one has a greater quantity
Why is a thick indifference curve impossible?
(c) Thick
as a and b lie on the same curve they should be indifferent to the consumer, however
b > a
-> the more the better assumption makes this impossible
What is the slope of an indifference curve also called?
The slope of an indifference curve is called Marginal rate of substitution (MRS).
- MRS of good Z for good S is the maximum amount of S that a consumer will sacrifice to obtain one more unit of good Z and be as well off as before.
What is the MRS between point a and b?
Here marginal rate of substitution is calculated as:
-> delta S / delta Z
(vertical change / horizontal change)
When moving on the indifference curve, it is essentially calculating the marginal rate of substitution in order to maintain the same satisfaction
-> moving from a to b, so giving up 3 Sushi but gaining 1 Pizza, ensures the consumer maintains the same satisfaction
Is a concave indifference curve impossible?
It is NOT impossible, but implausible…
Does not make sense as you’d be more inclined to give up more sushi for pizza the more abundant pizza becomes
eg. from from a to b you give up 2 sushi for 1 pizza, moving from b to c you give up 3!! sushi for 1 pizza, even though you already have more pizza than the point prior…
What are the 2 forms of special preferences you must remember?
1) Perfect Complements
2) Perfect Substitutes
What are “perfect complements”?
“Goods that a consumer is interested in consuming only in fixed portions”
What are “perfect substitutes”?
“Goods that a consumer is completely indifferent as to which to consume”
How would you draw an indifference curve between two perfect substitute goods?
“Goods that a consumer is completely indifferent as to which to consume”
-> eg. cannot taste the difference between pepsi and coca cola
-> Therefore the SLOPE of these indifference curves MUST be fixed, here is it -1
However, the slope does NOT have to be -1 at all times. a consumer can be indifferent to 1 cup of chlorox or 2 cups of generic bleach, in that case the slope of the indifference curve would be -1/2
How would you draw an indifference curve between two perfect complement goods?
“goods that a consumer is interested in consuming only in fixed portions”
-> eg. consumer does not like pie by itself, nor ice cream by itself, but does enjoy pie and ice together
Hence, whether she purchases 3 ice cream scoops and 1 slice of pie, she remains on indifference curve I1, as those 2 scoops of ice cream are “excess”
The utility here is measured as the minimum value between the two goods
U(x, y) = min(x, y)
eg. U(ice cream, pie) = min(3, 1) = 1
This is an estimated indifference curve for an average American consumer between food and clothing per year, what could be a reason for the change in the slope?
At lower quantities (I1), the indifference curves are almost right angles, essentially almost perfect complements.
The further we move away from the origin the flatter the slope of the indifference curve becomes, almost like perfect substitutes.
This can likely be explained by the fact that minimum levels of food and clothing are required to sustain life. So on I1, a large quantity of clothing but little food does not give greater utility than small quantities of both.
On the l4 curve however, the quantities of both are already very prevalent. At this stage the consumer becomes more indifferent as to whether to spend on food or clothing - its more optional, less life sustaining.
What is the utility function?
the relationship between utility measure and every possible bundle of goods
Example:
Preferences over bundles of Z = pizza and S = sushi for a consumer are summarized by U(Z,S) = √SZ
What should utility be on different points and a single indifference curve?
Utility should have the SAME value on every point on a single indifference curve
What should utility be on an indifference curve that is greater (in terms of quantity)?
Utility should be a GREATER value on an indifference curve that is larger (in terms of quantity)
What should utility be on an indifference curve that is smaller (in terms of quantity)?
Utility should be a LOWER value on an indifference curve that is smaller (in terms of quantity)
Is utility an cardinal or an ordinal measure?
Utility is an ordinal measure rather than a cardinal one.
–> We don’t really care that U(x) = 12 and U(y) = 13
we care that Y > X
ordinal refers to: “measuring a consumers relative ranking of two goods”
