2: budget constraint Flashcards
utility
set of numerical values informing about relative rankings of cons. bundle
utility function
describes IC location & form, assigns IC curve utility value
preferred bundle’s assigned utility level will be
higher
utility ordinal or cardinal
ordinal
ordinal
consumption bundle ranked (not measured)
positive monotonic transformation
utility function can be transferred into another as long as preferences are maintained
MRS
gradient of any point on IC curve
MRS def
max amount of one good consumer sacrifices to obtain another unit of diff good whilst maintaining utility level
for convex IC, MRS
diminishing
perfect substitutes graph
parallel downwards straight lines
perfect complements graph
L shaped
imperfect substitutes
downwards curve
perfect substitutes function
U(X+Y)
imperfect substitutes function
U(XY), Cobb Douglas
perfect complements function
U=min(X,Y)
budget constraint assumption
only 2 goods consumed are q1&q2, prices are p1&p2, M= income, no future saving
budget constraint written as
(p1 × q1 )+(p2 × q2 )≤M
if bundle sits on budget line
all income spent
if bundle is under budget line
less than budget spent
MRT
budget line gradient
consumer’s optimal bundle is which IC curve
the highest
to find optimal cons bundle
highest IC curve, tangency rule
tangency rule
MRS = MRT, and MU1/p1 = MU2/p2
perfect substitutes optimal bundle
corner solution
perfect complements optimal bundle
where vertex (L shape) hits IC curve
income transfers vs coupons
income transfers give higher utility, don’t distort relative prices, and give consumer flexibility.
do tax, subsidies, and quotas affect b.c.
yes
quasilinear utility function
IC curve hits one of the axes
