consumer preference Flashcards
what is consumer preference ?
tells us how the consumer would rain any two baskets of goods, assuming they are free.
who do you denote…
a. a strict preference of A over B
b. a weak preference of A over B
c. an indifference between A and B
a. A > B
b. A >/ B
c. A s B
what is
a. complete preference
b. transitive preference
a. and good over another or an indifference
b. if a consumer prefers A over B and B over C then transitively we can assume that they prefer A over C
what are the assumptions in consumer preference ?
monotonic - more is better; if a basket has more of one good and no less of any other it is obviously preferred.
complete - able to rank clearly
transitive
what are the ways that we order preferences ?
a. ordinal - tells us what order they are ranked in, don’t actually care about the number
b. cardinal - tells us the intensity of the preference , cares about the exact numbers
we use ordinal rankings
what is a utility function ?
measures the level of satisfaction a consumer gets from any basket of goods and services.
assigns a number to a good, the higher, the more prefered
U is a function of the quantity of the good
what implications can be drawn from a utility function ?
the precise number has no contextual significance
cannot compare the numbers across individuals
any transformation of the function that preserves the original ranking is an equally good representation
e.g. U = 4y vs U = 4y + 3
what is marginal utility and how do you calculate it ?
the additional utility the consumer gets from consuming another unit, the rate at which total utility rises as consumption rises
MUy = change u / change y OR du/dy
what is diminishing/constant/increasing marginal utility ?
states how much more or less this unit added or took away from total utility than the last unit.
worked out by double differentiation of the utility function.
what is an indifference curve ?
a curve/set is all the baskets for which the consumer is indifferent ( same utility )
a map illustrates a set of indifference curves for the same consumer.
as you move to the north east, there is more utility.
what do the assumptions of preference mean for the indifference curve ?
monotonicity - negatively sloped, thin
transitivity - curves do not cross
completeness - each basket is on only one ic
what is the marginal rate of substitution ?
the rate at which you substitute one good for another and keep the same level of utility.
MRSx,y = - changeY / changeX
it is the negative of the slope of the indifference curve and it equals the price ratio
what is the diminishing marginal rate of substitution ?
the differential of the marginal rate of substitution and it is the rate at which the mrs decreases.
name 4 different types of special function forms ?
a.
b.
c.
d.
a. cobb-douglas : u=AX^dY^b d + b = 1 all + constants
b. perfect substitutes : u=AX + BY
c. perfect complements : u=Amin(x,y)
d. quasi-linear : u=V(x) +AY
define
a. budget set
b. budget constraint
c. budget line
a. set of baskets that are affordable
b. set of baskets that the consumer may chose given the limit of income
c. set of baskets one can purchase when spending all available income
what is the equation for the budget constraint ?
Px.X + Py.Y = i expenditure = income
on a diagram with the budget line, where is it and where is the budget set ?
the budget line is a downward sloping line and the budget set is the area under neath it
what is the slope of the budget line ?
-Px / Py
what shifts the budget line ?
income increases, BL shifts out
income decreases, BL shifts in
how do price changes effect the slope of the budget line ?
Px increases , slope increases , x intercept moves in
Py increases , slope decreases , Y intercept moves down
what are the consumer choice assumptions ?
- only non negative quantities
- rational choice (max Uwithin budget constraint problem)
what is the interior optimum ?
the optimal basket is at the point where the budget line is tangent to the indifference curve
where MRSx,y = Px /Py
MUx /MUy = Px /Py
the rate at which the consumer is willing to exchange X for Y is = to the rate at which they are exchanged for at the market place
what is a corner point ?
a point on the indifference curve where one good is not being consumed at all, so the optimal is on one of the axises
what is a composite good ?
a good that represents the collective expenditure on every other good except the commodity being considered
how do you solve a composite good optimum basket ?
for corner solutions you can’t make MRS = PriceRatio so you must therefore figure out which good is preferable and chose the basket that spends all the income on that baskets.
example, if the MRS is diminishing in X then the optimal basket is at the Y intercept.
what does the indifference curve for perfect substitutes look like ?
it is an L shape with the regular budget line only ever touching the corner of the L
how does an income subsidie effect the ic ?
as the subsidie can be spent on anything, it shifts the while ic to the right
how does a non composite coupon effect the ic ?
only the part below the top of the original ic curve shifts, the rest is flattened.
what is the dual problem ?
it is the mirror image of the constrained optimisation problem. min Px.X+Py.Y subject to U(x,y) = U* U* is the target U level.
what is revealed preference ?
a. weak
b. strong
when a good is purchased its preferred, to all other affordable baskets.
a. when A is purchased and B costs the same
b. when A is purchased and its more expensive than B
which direction is all strictly preferred ?
all baskets to the NE
assumes that consumers don’t make mistakes always chose optimum and preference doesn’t change.
what is an individual demand curve and how do we construct one ?
knowing how individuals consumption changes as prices change will allow us to derive individual demand curves.
to create the individual demand curve we must find the consumers price consumption curve. set of optimal consumption bundles at different prices
its the relationship between price and quantity optimal.
how do you calculate willingness to pay ?
set one of the price stop one and it gives you the amount of one good the consumer is willing to give up for another unit of income ? not sure tbh
