Chapter 4 (Week 2) Flashcards
A consumer chooses between bundles of goods by…
Ranking them as to the pleasure the consumer gets from consuming each
Assumptions
People have ideas about the amount of pleasure they derive from specific goods and services (“preferences” or “tastes”)
People can’t get all what they want, they face limits (constraints)
Given these limits, people do the best they can “maximise pleasure/utility”
Completeness
rules out the possibility that the consumer can’t rank the bundles - you always know what you prefer - you can compare the bundles
Transitivity
eliminates the possibility of certain types of illogical behaviour - if bundle A is at least as good as B, and B is at least as good as C, then A is at least as good as C
More is better
more of a commodity is better than less of it
If a consumer is rational we can describe their preferences with
Indifference curves
A utility function
Indifference curve
the set of all bundles of goods that a consumer views as being equally desirable
Indifference map
a complete set of indifference curves that summarise a consumer’s tastes or preferences
- Curves farther from the origin are preferred over ones close to the origin - more is better
- Indifference curve goes through every possible bundle - completeness
- The curves can’t cross - transitivity and more is better
- They slope downwards - more is better - sacrifice one good to get more of another good
Slope of indifference curves
Marginal Rate of Substitution (MRS): the maximum amount of one good a consumer will sacrifice to obtain one more unit of another good
–> Declines along the curve
= - MUz / MUb
Perfect substitutes
goods that a consumer is completely indifferent as to which to consumer
MRS is constant and thus the indifference curve is straight
Perfect complements
goods that a consumer is interested in consuming only in fixed proportions
MRS is 0 and thus the indifference curve is hooked
Imperfect substitutes
MRS varies and thus the indifference curve is convex
Utility
Satisfaction or pleasure from a certain good
Utility function
The relationship between utility values and every possible bundle of goods
Marginal utility
The extra utility that a consumer gets from consuming the last unit of a good
Typically diminishes as more is consumed
Budget constraint
The bundles of goods that can be bought if the entire budget is spent on those goods at given prices
A parallel shift indicates a change in income
Budget line
Y = (Price of good A x Good A) + (Price of good B x Good B)
PaA + PbB
Opportunity set
All the bundles a consumer can buy, including all the bundles inside the budget constraint and on the budget constraint
Marginal rate of transformation
The amount of one good you have to give up to get another good - how you transform the two goods
Slope of the budget constraint
- Pz / Pb
Maximise utility when
- The indifference curve between the two goods is tangent to the budget constraint
- The consumer buys the bundle of goods that is on the highest obtainable indifference curve
- The consumer’s marginal rate of substitution (the slope of the indifference curve) equals the marginal rate of transformation (the slope of the budget line)
- The last dollar spent on good 1 gives the consumer as much extra utility as the last dollar spent on good 2
Endowment effect
People place a higher value on a good if they own it than if they are considering buying it
Salience
People are only likely to consider information of presented in a way that grabs their attention / easy to understand
