Consumer Choice Theory

Question 1

What are the axioms of Consumer Theory?

Answer 1

1. ) Preferences are complete.
2. ) Preferences are reflexive.
3. ) Preferences are transitive.
4. ) Preferences are monotonic.
5. ) Preferences exhibit dimnishing marginal rates of substitution. That is, averages are preferred to extremes.

Question 2

Indifference Curve

Answer 2

An indifference curve through the bundle X, is the set of all bundles Y such that X ~ Y.

Question 3

What are the properties of of indifference curves for most “goods”?

Answer 3

1. ) Bundles on indifference curves that are further to the “northeast” are preferred to bundles on indifference curves closer to the origin.
2. ) There is an indifference curve through every possible bundle.
3. ) Indifference curves cannot cross, because of the transitivity axiom.
4. ) If preferences are monotonic, indifference curves slope downward.

Question 4

Why are indifference curves generally “convex”?

Answer 4

This is because for most goods we have a diminishing marginal rate of substitution.

Question 5

Marginal Rate of Substitution (MRS)

Answer 5

The marginal rate of substitution (MRS) is the maximum amount of one good a consumer will sacrifice in order to obtain one more unit of another good.

Question 6

What is the Marginal Rate of Substitution the slope of?

Answer 6

The marginal rate of substitution is actually the (minus of) the slope of the indifference curve.

Question 7

What is the utility function meant to communicate?

Answer 7

The utility function gives a number that indicates the happiness a consumer experiences by consuming a specific bundle of goods.

Question 8

Marginal Utility

Answer 8

1. ) The marginal utility of one goods is the additional utility one receives from consuming a little bit more of the other good, holding the first good constant.
2. ) The marginal utility is the slope of the utility function.

Question 9

The Budget Constraint

Answer 9

The budget constraint is the set of all feasible bundles of goods an individual can consume given the prices of the goods and their income.

Question 10

The Marginal Rate of Transformation

Answer 10

The marginal rate of transformation is the trade-off the consumer faces in terms of the amount of one good the consumer must give up to obtain more of the other good.

Question 11

What happens if in the basic model of the budget constraint there is an increase or decrease in the individual’s income or the price of a or both goods?

Answer 11

There would be a parallel shift or rotation of the budget constraint.

Question 12

What is an in kind transfer?

Answer 12

Where we give a individual a certain amount of a good without having that individual directly pay for it. (Es: Food Stamps) Cannot consume in the manner associated with a cash increase in income.