Chap 3.3 Flashcards
whats a strict preference
between 2 bundles he chooses one when the other is also available
whats a weak preference
indifference to both bundles
whats completeness
indifference
whats transitivity
if he likes bundles A then he likes it over all bundles
whats utility
is the level of satisfaction that is obtained by consuming a commodity or undertaking an activity
what are the 2 measures of utility
cadinalist and ordinalist school
whats utlity measured w in the cardinalist theory
utils
what are the assumptions of cardinal utlity theory
- Rationality of consumers
- Utility is cardinally measurable
- Constant marginal utility of money
- Limited Money Income
- Diminishing marginal utility (DMU)
- The total utility of a basket of goods depends on the quantities of the
individual commodities. TU = f ( n X , X ……X 1 2 ) - The consumer possesses complete knowledge of market conditions (about
prices and tastes of goods and services).
whats total utility
is the total satisfaction a consumer gets from
consuming some specific quantities of a commodity at a particular time.
whats marginal utility
its the extra satisfaction additional utility
obtained from consuming an additional unit of a commodity.
whats the law of diminishing marginal utility
the extra or marginal utility received
from consuming each additional unit of the commodity declines. This is referred to as the law of diminishing marginal utility (LDMU).
what are the assumption of the LDMU
- The consumer is a rational utility maximizing person. The typical consumer does not have to behave irrationally.
- There is a single homogeneous commodity.
- There are no changes in the tastes (preferences) and the income of the
consumer within a given period of time. - There is no time gap in consumption of the good.
- The consumption of all other commodities remaining constant.
- Commodities are of ordinary type
what are the limitations of the cardinal approach
- The assumption of cardinal utility is doubtful because utility may not be
quantified.
Utility cannot be measured absolutely (objectively).
The assumption of constant MU of money is unrealistic because as income increases, the marginal utility of money changes
hows utlity expressed in ordinal
in relative terms
what are the assumptions of ordinal theory
- Consumers are rational
2.Utility is not absolutely measurable - Diminishing marginal rate of substitution
- total utility is measured by all consumed items
- preference is consistent
what are the properties of the indifference curves
- Indifference curves have negative slope (downward sloping to the right).
- Indifference curves are convex to the origin
- A higher indifference curve is always preferred
- Indifference curves never cross each other
what is the marginal rate of substitution
rate at which consumers are willing to substitute one commodity for another in such a way that the consumer remains on the same
indifference curve.
whats a budget line
it shows the constraint of the consumer by his/her income and prices of the two commodities. shows the combinations of 2 goods that they can purchase accordingly.
what are the assumptions of the budget line
There are only two goods bought in quantities, say, X and Y
Each consumer is confronted with market determined prices, PX
and PY
The consumer has a known and fixed money income
what are the factors responbsible for the shift in the budget line
change in income and price
why does change in income affect budget line
more income enables to buy more of a good
what happens when theres a proportional change in prices
rise in price w the same income will reduce the total quantity bought for goods, this leads to a shift towards budget line.
what happens when theres a change in relative prices
either one price changes or both but not the same amount. then budget line becomes steeper and the horizontal intercept changes.
what are the 2 conditions for consumer to maximize his utility
- marginal rate of sub = price
- indifference curve must be convex to the origin.
