Chapter 4

Question 1

What are the four basic assumptions about consumer preferences?

Answer 1

1. Completeness and rankability
2. For most goods, more is better than less
3. Transivity: impose logical consistency on preferences
4. The more consumer has of a good, the less she is willing to give up of something to get more that good. Consumers like variety.

Question 2

What does the assumption completeness and rankability entail?

Answer 2

Consumers can compare across all sets of goods and determine which he likes better.

Question 3

What is a consumption bundle?

Answer 3

Set of goods/services a consumer thinks about purchasing

Question 4

What is utility?

Answer 4

This is a measure of consumers’ satisfaction. You can rank options from bet to worst, but you cannot say how much more you like one option over the other.

Question 5

What is a utility function?

Answer 5

This is a mathematical expression describing the relationship between consumption and level of well-being. It represents consumers’ preferences and have to conform to the four underlying principles.

Question 6

What is marginal utility?

Answer 6

This is the extra utility gained by consumers when consumption increases with 1 unit.

Question 7

What does indifferent mean?

Answer 7

This means that the consumer has the same level of utility from two or more consumption bundles.

Question 8

What is an indifference curve?

Answer 8

This curve shows all the combinations of two goods providing the same level of utility.

Question 9

What are the four restrictions of the indifference curve?

Answer 9

1. We can always draw indifference curve (rankability and completenes)
2. We can figure out which curves have higher utility and explain downward slope (more is better)
3. Indifference curves never cross (transitivity assumption)
4. Indifference curves are convex to origin (middle is bend toward the origin)

Question 10

What is the marginal rate of substitution?

Answer 10

Rate at which consumer wnats to trade one good X for another good Y, while maintaining the same level of utility.

Question 11

What is the marginal rate of substitution?

Answer 11

This is the marginal utility of good X / Marginal utility of good Y

Question 11

What does the steepness of indifference curves indicate?

Answer 11

1. Steep curves mean that people will give up lot of Y for a little of good X
2. Flat curves means that people will give up a lot of good X to get a little of good Y.

Question 12

What does the curvature of indifference curves indicate?

Answer 12

1. Almost straight means that two goods are close substitutes
2. Very curved means two goods are close complements.

Question 13

What are perfect substitutes?

Answer 13

Goods that consumers can trade for other goods in fixed units and still receive same level of utility. These create linear indifference curves. The general form: U=aX +bY.
Marginal rate of substitution is equal at every point.

Question 14

What are perfect complements?

Answer 14

These are goods from which consumers receive utility dependent on it being used in a fixed proportion to another good. Mathematical expression: U=min{aX,bY}

Question 15

What are bads?

Answer 15

These are goods and services that provide consumers with negative utility

Question 16

What are the three assumptions to maximize consumer utility?

Answer 16

1. Each good has a fixed price and consumers can consume all they want against that price
2. Consumer has fixed income available to spend
3. Consumers cannot borrow or save, meaning all income has to be spent.

Question 17

What is a budget constraint?

Answer 17

This is a curve describing the entire set of consumption bundles to be purchased when spending all income. Mathematical formula: Income = PxQx + PyQy. This line is straight if prices remain equal regardless of Q.

Question 18

What is a feasible bundle?

Answer 18

Combination of goods on or below budget constraint that can therefore be purchased.

Question 19

What is an infeasible bundle?

Answer 19

Combination of goods above budget constraint rendering it beyond ability to purchase.

Question 20

What are the two types of nonstandard budget constraints?

Answer 20

1. Quantity discounts: cheaper after certain amount is purchased
2. Quantity limits: maximum amount of goods purchased. Everyhting within budget constraints above this limit becomes infeasible.

Question 21

What is a corner solution?

Answer 21

A utility-maximizing bundle in which the consumer buys only one of two goods

Question 22

What is an inferior solution?

Answer 22

This containts positive quantities of both goods.