3_Consumer theory

Question 1

Assumptions in consumer theory

Answer 1

• Completeness: a consumer can rank every possible consumption bundle (is preferred to, is not preferred to, is indifferent between), consumption bundle is a set of goods
• Transitivity: if bundle A is preferred to B, and B is preferred to C, it follows that A is preferred to C
• (local) Non-satiation: if A is equal to B except that A has more of one good, A is preferred

Question 2

Indifference curve:

Answer 2

Different combinations of the same goods with a constant utility (more ice cream, less from the other good and the other way around -> trade one good for another); represents all combinations of market baskets that provide a consumer with the same level of satisfaction

Question 3

Consumption with budget constraints (constraints that consumers face due to a limited income)

Answer 3

• Budget line: all combinations of goods for which the total amount of money spent is equal to income
• Preferences reflect what individuals want
• But everybody has budget constraints
• Let’s assume that income Y is given (no time allocation problem)
• Let’s assume for simplicity that consumers spend all their money (no decision in time)

Question 4

Marginal rate of substitution

Answer 4

(to obtain the amount of one good that a consumer will give up to obtain more of another), (slope of indifference curve) can be obtained by setting the total differential U (Q1, Q2) equal to zero: if utility is constant, the change of utility is the same: Ū: dU = 0

Question 5

Cross-price elasticity

Answer 5