Consumer Behaviour Flashcards
What assumptions are made about consumer preferences?
- Complete
- Able to rank all possible bundles/options
- Transitive
- Choices are consistent and obey logic
- A > B, B > C therefore A > C
- Can never cross
- Monotonistic/Non-satiation
- More is better
What is true of MRS?
Indifference curves - Diminishing MRS
What special indifference curves are there?
- Useless goods
- Bad Goods
- Perfect Substitutes
- Perfect Complements
∆u =
∆u = MUx . ∆X
MRS =
MRS = MUx/MUy = Y/X
How does MUx/MUy = Y/X?
- MRS = MUx/MUy
- MUx = ∂u / ∂x = Y^1/2 1/2X^-1/2
- MUy = ∂u / ∂y = X^1/2 1/2Y^-1/2
- MRS = 2Y/2X = Y/X
What are the forms of the budget constraint?
- BC: Px.X + Py.Y = I
- BC: Y = (I/Py) - (Px/Py) . X
- Under assumption that all income is spent
What is Y,X max and the slope of the BC?
- Y,Xmax = I/Px,y
- Slope = -Px/Py
What is the U-maximising decision and what is it called?
- -Px/Py = (MRS = MUx/MUy = Y/X)
- MUx/MUy = Y/X: Willingness to trade between goods
- -Px/Py: Ability to trade between goods
- Interior Solution
What does the U-maximising decision imply?
- Eqbm: Px/Py = MUx/MUy : MUy/Py = MUx/Px
- Px/Py = Y/X: (Px)X = (Py)Y
- (Px)X = (Py)Y is the ratio of goods at equilibrium
How is the optimal bundle calculated?
- BC: PxX + PyY = I
- Sub [(Px)X = (Py)Y] (optimal bundle goods ratio) into this and work out X or Y
- As in (PxX + PxX = I) or (PyY + PyY = I)
- Plug this into (Px)X = (Py)Y to solve for other good
What are SE and IE for an inferior good if price increase/decreases?
- If price falls, SE: ↑X(↓Y) IE: ↓X(↑Y) TE: ↑X
- If price increases, SE: ↓X(↑Y) IE: ↑X(↓Y) TE: ↓X b/c SE > IE
If SE > IE what does this imply about the goods in question?
↑Py → X↑ means substitutes SE > IE
What do food stamps achieve?
- Only buy food - non transferable
- Effectively, ↓Pfood
- ↓Pfood → SE → Food↑, AOG↓
- ↓Pfood → IE → Food↑, AOG↑
How is a cash transfer different from food stamps?
- Relative prices of food and AOG remains constant so no SE
- Consumer’s choice: better
- More Efficient
What does the difference between food stamps and cash transfers imply?
- Owing to this, lump sum taxes are more efficient than a tax on a single commodity
What is CV?
keep new prices, but ensure that they have the same utility as before policy change
What is EV?
- Look at how much the individual would be willing to
pay so that the policy change does not go through- Original price ratio/BC1
- New level of u (u2)
What do substitutes imply about the demand curve?
- Goods that have close/many substitutes will have a large S.E
- This produces a relatively flat demand curve
What do complements imply about the demand curve?
- V.small substation effect - demand is relatively steeper
What is true of food/shelter?
- Changes in prices of food/shelter lead to small SE
- ↑Pshelter → ↓real wealth
- Because shelter/food make up a large proportion of budget, IE is relatively large
- Demand curve is flatter than we would otherwise expect
What is the difference between the Marshallian and Hicksian demand curves?
- Hicksian is much stepper because only has substation effect
- A better demand curve, as a constant utility is maintained in the presence of price changes
- But, we don’t see substitute only, we see the whole picture, therefore needs to be represented
- Theoretically would prefer Hiskian
- Using these, we would have a perfect measure of utility change when price changes
What is consumer surplus?
- Difference between willingness to pay and market price we pay
- A good approximate of CV and EV
- Assume singular market P and consumers are price takers
- CS = ∑WTP-P
What is the worth/value of a good?
Expenditure + CS
What is PED?
= (%∆Q)/(%∆P)
What does a good’s PED mean?
- eQP = |1|: Unit elastic
- eQP > |1|: Elastic
- QD is more responsive to/than price
What are the determinants of PED?
- Substitute availability
- More available: More elastic
- Time
- Longer time: More Elastic
What is special about the PED for a linear demand curve?
- PED of demand at any point (P,Q) on a linear curve:
- eQP = b(P/Q)
- where b is the slope of the demand curve
- PED is not constant along a linear demand curve
- Midpoint of demand curve is unit elastic
- eQP > |1| for Q than unit midpoint
What is total expenditure?
- TE = P * Q
What are the components of the relationship between total expenditure and elasticity?
- Price Effect
- Quantity Effect
What does PED imply about total expenditure?
- If D is elastic: |eQP| > 1, for a 1%∆P → Qd ∆ > 1%
- TE = P↑ * Q↓↓
- Quantity Effect > Price Effect
- P↑ → TE↓
- If D is inelastic: |eQP| quantity effect
- P↑ → TE↑
- If D is Unit elastic: |eQP| = 1 TE is unchanged
What is IED?
- = (%∆Q)/(%∆I)
- eQ,I > 0: normal good
- eQ,I > 1: luxury good
What is CPE?
- = (%∆Q)/(%∆P’)
- eQ,I > 0: substitute goods
What are the demand equation transformations?
- y = a + bx = y-intercept +slope(x) = P
- Inverse Demand Curve: e.g. P = 50 - 0.5Q
- Demand Curve: e.g. Q = 100 - 2P
What is the MRS of perfect subs?
a/b I.E MUx/MUy DUH!
What is true of a price change where x is an inferior good?
All outcomes the same except the income effect for X is opposite, but since SE > IE this doesn’t affect TE.
However, (for P(x) increase) the diagram must show A to B (SE) moving as a decrease in X and B to C (IE) as an INCREASE in X, with Y increasing as normal.
i.e. the A to B needs to be massive and the B to C needs to be tiny (I curve needs to be EXTREMELY flat)
How can preferred consumption be determined solely from a utility function and prices?
MUx/Px vs MUy/Py
Y/X is the MRS OF….
x for y
sqr(xy) =
x^(1/2) y^(1/2)
If a question asks how many of one good are needed to compensate for another….
MRS!
How do we determine wether someone is optimising?
- MRS (Y/X) Px/Py
2. MUx/Px MUy/Py
What is point PED?
b(P/Q)
