Consumer Choice

Question 1

3 axioms of choice

Answer 1

Comparison
Transitivity
Monotonicity

Question 2

Transitivity

Answer 2

Ability to be consistent when making preferences
E.g if A>B and B>C, it would also mean A>C

Question 3

Monotonicity

Answer 3

More is better than less.

Question 4

Indifference Curve

Answer 4

A curve that passes through all combinations of goods that a consumer enjoys equally (everywhere on the point yields and equal utility)

Question 5

What is the assumption for anywhere left and under the indifference curve, and right and above?

Answer 5

Left and under-less utility
Right and above-better

Question 6

Marginal rate of substitution

Answer 6

Slope that tells us how much of good X we would be willing to give up in exchange for one more unit of good Y

Question 7

How does diminishing marginal utility link to rate of substitution

Answer 7

Starts steeper at a smaller quantity, as we value the first units more so less willing to give them up

Question 8

Marginal rate of substitution formula

Answer 8

MU of X/MU of Y or MUx/Px=MUy/Py

Question 9

BuDGET CONSTRAINT

Answer 9

The set of possibles bundles that can be afforded with a fixed amount, no money saved.

Question 10

Why do we always operate along the budget constraint, not inside or outside

Answer 10

Not inside due to monotonicity, we assume we save none

Not outside as we can’t afford it

Question 11

The effect following a change in income and how is it shown on a graph and evaluate…

Answer 11

Max quantity of each good that can be consumed falls/increases

Shown by a parallel inward/outward shift as price ratio (slope) hasn’t changed

However… this assumes goods are normal not inferior as if one were inferior, we would consume less of one which is against monotonicity

Question 12

The effect of a change in price of one good

Answer 12

Max consumption for the one good increases/decreases, while other remains the same

Shown by an extension/shortening in the slope quantity of the one good

Question 13

What is the rule for inferior goods

Answer 13

There can only be one inferior good, as for monotonicity we want to spend all our money, and if both were inferior, following a change in income will mean less money is spent overall

Question 14

The effect following a change in income on an inferior good and how is it shown on a graph

Answer 14

Budget constraint shifts out parallel as more can be consumed overall

Consumption for the normal good will increase following the rise in income, however for the inferior good consumption would fall

Question 15

What do we draw for 2 normal goods following a rise in income

Answer 15

An income expansion path to show the change in consumption as income increases

Question 16

What happens to good Y when price of good X falls? (both normal) and what does this all depend on

Answer 16

Max consumption for good X increases.

For good Y, consumption may fall, or as they feel richer they may consume more of both goods

This is all determined by the income and substitution effect

If income effect is greater than substitution effect, more of both goods are consumed overall
If substitution effect is greater than income effect, more of one good increases, however consumption of one good falls.

Question 17

Substitution effect

Answer 17

Substitution effect-change in consumption following change in relative prices of goods

Question 18

Income effect

Answer 18

Income effect-change in consumption following a change in a consumers purchasing power

Question 19

Why do we draw a dotted budget constraint

Answer 19

TO SEE NEW PRICES ON THE ORIGINAL INDIFFERENCE CURVE AND SEE THE SUBSTITUTION EFFECT MOST IMPORTANTLY

Question 20

Price consumption curve

Answer 20

At each price, we find the
consumer’s optimal consumption
point
Joining these gives the price-
consumption curve/demand curve

Question 21

What does the indifference curve meeting the budget constraint at a point of tangency mean?

Answer 21

MRS=Price ratio.

Question 22

What is the price ratio

Answer 22

The slope of the budget constraint.

How much of one good we need to give up for an additional unit of the other good