Choice Flashcards
What do you mean by optimal choice
Consumers aim to choose the best combination of goods they can afford, known as the optimal choice.the point where one of your indifference curves just touches your budget line. This point is called the optimal choice. At this point, you’re spending all your budget and getting the most preferred combination of goods.
How do indifference curves and budget lines help consumers make choices?
Indifference curves show combinations of goods that give equal satisfaction, while the budget line represents what the consumer can afford. The optimal choice occurs where the highest indifference curve touches the budget line.
What does it mean when the indifference curve is tangent to the budget line?
What are exceptions to the tangency condition for optimal choices?
It means the consumer is at their best affordable bundle. If the curve crossed the budget line, a better choice would exist, so tangency indicates the optimal choice.( But, in general, the tangency condition is only a necessary condition for optimality not a sufficient condition)
The exceptions are:
Kinky Preferences: When the indifference curve has a sharp bend, it doesn’t have a defined tangent.
Boundary Optimum: When the consumer only buys one good, not touching the budget line.
What is the significance of convex preferences in consumer choice?
If preferences are smooth and convex, the tangency condition ensures that the optimal choice is always found, and there will be only one optimal bundle on the budget line
What is the Marginal Rate of Substitution (MRS), and how does it relate to market prices?
MRS is the rate at which a consumer is willing to trade one good for another. At the optimal choice, MRS should equal the market’s price ratio; if not, the consumer can improve their choice by adjusting their consumption.
What is a consumer’s demanded bundle?
What does the demand function represent?
It is the optimal choice of goods 1 and 2 based on certain prices and income levels.
The demand function shows how the optimal choice (quantities demanded) changes with different prices and incomes, written as x1( p1,p2,m) and x2(p1,p2,m).
How do perfect substitutes affect consumer choices?
If one good is cheaper, consumers will buy only that good. If both goods are priced the same, any combination that fits the budget is acceptable.
What is the behavior of consumers with perfect complements?
Consumers always buy equal amounts of both goods, which means they will spend their entire budget on combinations along the diagonal where the two goods are equal
How do neutral goods and bad goods influence consumer behavior?
For a neutral good, the consumer spends all their money on their preferred good and buys none of the neutral good. If one good is considered a bad, the demand for it will be zero.
What happens with discrete goods in consumer choices?
If good 1 is only available in whole units, consumers choose how many to buy based on the price and the money they have.
How do consumers with concave preferences make choices?
They tend to spend all their money on one good or the other, rather than consuming both at the same time.
What are Cobb-Douglas preferences?What are the demand functions for Cobb-Douglas preferences?
They are characterized by a utility function of the form u(x1,x2) =xç1xd2 where the optimal choices can be calculated, and consumers spend fixed fractions of their income on each good.
The demand functions are:
𝑥
1
=
𝑐
𝑐
+
𝑑
𝑚
𝑝
1
x
1
=
c+d
c
p
1
m
𝑥
2
=
𝑑
𝑐
+
𝑑
𝑚
𝑝
2
x
2
=
c+d
d
p
2
m
These functions show how much of each good the consumer will buy based on their income and prices.
What is the primary goal when estimating utility functions based on observed demand behavior?
How can the estimated utility function be used in economic policy evaluation?
To determine the preferences that generated the observed consumer choices.
It can predict consumer behavior under new prices or income levels and evaluate the impact of proposed policy changes.
What is the implication of a consumer facing the same prices as others in the market?
They must have the same MRS for the goods being consumed, despite differing consumption levels.
What are some limitations of comparing quantity taxes and income taxes?
The results apply to individual consumers, the assumption of unchanged income post-tax is unrealistic, and supply responses to taxes are not considered.
