B Describe the Use of Indifference Curves, Opportunity Sets, Budget Constraints in Decision Making Flashcards
Describe the use of indifference curves, opportunity sets, and budget constraints in decision making
Indifference Curves (represents a consumers unique preferences over the two goods A and B)
Represents all combos of two goods such that the consumer is entirely indifferent among them.
Non-satiation: More is ALWAYS better: Ensures that all bundles lying directly above; directly to the right of; or both point A must be preferred to bundle A. Above and to the right: Preffered to bundle A set
Below and to the left: ‘dominated-by-bundle A’ set
A -Slope denotes that a decrease in one good leads to an increase in the other
Curvature reveals - (marginal rate of substitution) the strength of consumers willingness to trade off one good for the other - the indiff. curvature is convex from the origin indicating that the wilingness to give up A to obtain B diminishes the more B and the less A the bundle contains
MRS - the rate at which the consumer is willing to give up A to obtain a little B, holding utility constant - indicates a movement along the indifference curve.
Should convexity approach Y, the consumer is not willing to give up A for B and vice versa. Aka, the value being placed on B is diminishing as the slope of A/B becomes more positive
The MRSab is the negative of the slope of the tanger to the indifference curve at any given bundle. So, if slope indiff. = -n, that indicates consumer is willing to give up A to obtain B at a rate of [absolute value -n] parts A per parts B
Convexity assumption indicates that MRS diminishes as consumer moves toward more B and less A
Indifference Curves in Decision Making
Indifference curve map: The consumers entire utility function
*completeness assumption, transitive assumption
Price increase on Y axis - constraint becomes ‘flatter’
Price increase on X axis - Constraint becomes ‘steeper’ as it approaches the origin
Opportunity Sets (Consumption, Production, Investment)
Consumption: Budget constraint, -slope
Production: Budget constraint, -slope but concave as marginal opportunity cost increases as more A is produced resulting in fewer outputs for B
Investment: Can structure her investment opportunities as a frontier that shows the highest expected return consistent with any given level of risk…The investor’s choice of a portfolio on the frontier will depend on her level of risk aversion.
