Consumer Behaviour Flashcards by Nick Hartman

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

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What is true of MRS?

Indifference curves - Diminishing MRS

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What special indifference curves are there?

Useless goods
Bad Goods
Perfect Substitutes
Perfect Complements

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∆u =

∆u = MUx . ∆X

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MRS =

MRS = MUx/MUy = Y/X

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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

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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

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What is Y,X max and the slope of the BC?

Y,Xmax = I/Px,y

- Slope = -Px/Py

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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

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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

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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

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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

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If SE > IE what does this imply about the goods in question?

↑Py → X↑ means substitutes SE > IE

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What do food stamps achieve?

Only buy food - non transferable
Effectively, ↓Pfood
↓Pfood → SE → Food↑, AOG↓
↓Pfood → IE → Food↑, AOG↑

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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

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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

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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?

1. MRS (Y/X) Px/Py | 2. MUx/Px MUy/Py

What is point PED?

b(P*/Q*)