Budget Constraints And Consumer Choice Flashcards
Assumptions for budget constraints?
Individuals cannot save or borrow
Consumers have a fixed amount of money to spend and must spent it now
Consumers are price takers
If there are only two goods and Y denotes income:
p1q1 + p2q2 = Y
What is the slope of the budget constraint called?
Marginal rate of transformation MRT
What is the MRT?
The marginal rate at which one good can be traded against the other in the marketplace
If income increases, consumers can..
Buy more of both goods
Where is the optimal bundle on a budget constraint graph?
The highest indifference curve that just touches the budget line
What does “just touching the budget line” mean?
Indifference curve is a tangent to the budget constraint
Utility is maximised when..?
The rate at which good A is willing to be traded for good B is equal to the rate at which she can trade them
So How Much You Willing To trade of Good A For B = how much CAN Be traded Good B
Where is maximised utility?
MRS = MRT
Lisa wants to maximise her utility subject to her budget constraint, mathematically, how?
2 ways:
Lagrangian method
Substitution method
What is the substitution method?
Substituting budget constraint into the utility function
What are corner solutions?
When a utility functions indifference curves touches on of the axes
Consumer only chooses to consume one type of good and not the other
If a utility function’s indifference curves don’t hit the axes what do you do?
Use an interior solution like the cobb Douglas
What functions are corner solutions possible for?
Perfect substitutes and quasilinear
What is a composite commodity?
In the real world, consumers choose from more than just two goods.
