Chapter 6: individual choice Flashcards
How will individuals act to achieve their goals?
In a rational manner
maximizing well one being which can include loved ones and others
act in ways that are consistent with achieving objectives
How do economist analyse individual decision making (two ways)
Utility analysis (cardinal utility)
Indifference analysis
Utility analysis (cardinal utility)
Portray individuals as maximimising their measurable utility
Measurable concept of satisfaction
Indifference analysis (ordinal utility)
Weaker analysis is made on individuals’ capabilities of measuring their satisfaction
We cannot say they can measure it numerically (not quanitified)
We can only say that they measure it in a way that a a group of products gives them more satisfaction then another (ordinal utility)
Individuals rank utility bundles
includes budget constraint
includes indifference curve
Total utility
Measure of total satisfaction from consuming all amounts of goods and services
its calculated all over a period of time
increases when more amounts are consumed
Marginal utility calculation
Delta total utility / delta consumption
Marginal utility
Addition to total utility created when one more unit of a good or service is consumed
marginal utility declines with each additional unit consumed, but always remains positive
Consumer equilibirum
MU good 1 / P good 1
Marginal utility per dollar spent on each of the last unit of each good is equal
Same condition must be true for all pair of goods
greatest utility per dollar
MU good 2 / P good 2
if equality doesn’t hold, causer can increase Total Utility by making switches
In the real world, how is consumer behaviour observed?
Through the demand curve
Effect of price change on the demand of consumer can be seen through the condition that describes his or her equilibrium
If price of a certain good falls (considering a lot of different goods are present), then to restablish equilibrium condition, Marginal Utility of this good must also be lowered
This makes demand curve slope downwards since when more of this good is purchase, Marginal Utility also declines
Will lead to buying complementary goods and less substitutes
Law of demand
Other things being equal, more of a good is demanded at a lower price
Cantril ladder
Measure that compares utility levels
Lowest value signifies worst possible life
10 is highest possible quality of life
United Nations Human Development Index
Base don level of income
Health
Education
Budget constraint
The maximum amount an individual or organization can spend
Affordable set of goods and services
Bounded by the budget line
Depends on budget
Non affordable set of goods and services
Strictly above budget line
Non attainable with current budget
Indifference curve
Combination of goods and services that yield same level of satisfaction to consumer
Can determine wether products are substitutes or complements when price change
Indifference map
Set of indifference curves
Curves further from origin = higher satisfaction
describes consumer’s tastes for two goods over all consumption levels
What are the four properties of an indifference map
- Indifference curve further from origin = higher satisfaction
- Indifference curves are negatively sloped
If a consumer gets more of one good, then it
diminishes the consumption of the other to
remain indifferent - Indifference curves cannot intersect
If they were to intersect, we would have
two levels of satisfaction with same commodity
bundle, which is impossible - Indifference curves are convex when viewed at the origin
It shows a diminishing marginal rate of
substitution
What does the convex shape of indifference curve reflect
That when we have less of a certain good, each unit gives us more satisfaction
If we have a lot of it, each unit does not convey as much satisfaction
Level of satisfaction per unit decreases as we consume more
thats why it became flatter as it moves from left to right on the graph
its slope is the indifference curve or the budget line
Marginal rate of substitution
The slope of the indifference curve (negatively sloped)
less of one good requires more of the other to maintain level of satisfaction
Diminishing marginal rate of substitution
Higher marginal value being associated with smaller quantities of any good consumed
Consumer optimization
How to get highest level of satisfaction possible
The constraint is the budget line
gives our highest possible indifference curve
happens when budget line touches indifference curve (where they are tangent)
tangent: line touches curve at one point and never touches it again
What happens when the budget line touches the indifference curve at a single point
Constraint is tangent to the indifference curve
It requires that each slope be at the same point if tangency
optimization is reached
The slope of the budget constraint is the negative to what?
Negative to price ratio
What is the slope of the indifference curve
The marginal rate of substitution (MRS)
When does the consumer optimize
Consumer optimum
Marginal rate of substitution = slope of the price line
Consumption bundle is a point in which price ration = marginal rate of substitution (MRS)
when budget line touches the indifference curve at a single point
What happens when budget increases
If no price changes, the slope of budget line stays the same
It shifts outwards in parallel way
will reach higher indifference curve
consumer can afford more of both goods
Can have higher level of satisfaction
If price of goods increase and budget stays the same, what happens to budget line (budget constraint)
The slope become steeper and go a bit to the left
Cant consume as much
Can determine wether products are substitutes or complements
It also affect cross price elasticities ( it can show wether goods in a bundle are substitutes or complements)
reaches lower level of indifference curve, hence less satisfaction
What are two government policies that support low income families
Pure income transfers
Price subsidies
Increase purchasing power (unlike tax that reduces purchasing power)
What do the social assistance payments (welfare) or employment insurance provide
income Transfers
Provide an increase of income to the ones in need
Will shift the budget line outwards parallel (if all the rest stays the same)
What do the price subsidies do
Enable individuals to purchase goods or services at lower price
Ex: rent or daycare subsidies
Will rotate budget line so that only consumption is of good intended at first
government doesn’t want mans to buy random shit instead of daycare par ex
when prices decrease, what happens to budget constraint line
it becomes flatter
you can buy more
marketing tastes, what do they do to the indifference curves?
it defines where the indifference curve lies on the graph
if competitor of certain good attracts you more at a certain point, the indifference curve will shift towards their side
Indifference analysis: Tastes
counterpart of Total Utility and Marginal Utility variables
assume consumer prefers more to less
tastes can be represented graphically with indifference map
Income consumption curve
Curve is made by the points of each bundles of good chosen at each level of income
Price consumption curve
Shows how consumer consumption choices change when price of one good changes
