Consumer preferences and the concept of utility Flashcards
Define basket/bundle.
A combination of goods and services that an individual might consume.
Define consumer preferences.
Indications of how a consumer would rank (compare the desirability of two baskets, assuming that the baskets were available to the consumer at no cost).
What are the three assumptions about consumer preferences?
1) Preferences are complete, the consumer is able to rank any two baskets. 2) Preferences are transitive - consistent with each other. 3) More is better.
What is ordinal and cardinal ranking?
Ordinal rankings give information on the order in which a consumer ranks baskets. Cardinal rankings give information on the intensity of a consumers preferences.
What is a utility function?
A utility function allows us to measure the amount of satisfaction a consumer gains from a basket of goods.
What is marginal utility? How is it represented graphically?
Marginal utility is the rate at which total utility changes as the level of consumption rises. The marginal utility at a particular point is represented as the slope of a line that is tangent to the utility function.
What is the principle of diminishing marginal utility?
After some point, as consumption of a good increases, the marginal utility of that good will begin to fall. The more is consumed, the less additional satisfaction is gained from consuming each unit.
What is an indifference curve?
An indifference curve is a curve connecting a set of consumption baskets that yield the same levl of satisfaction to the consumer.
What are the properties of an indifference curve?
1) When the consumer likes good x and good y, the indifference curves have a negative slope. 2) Indifference curves cannot intersect. 3) Every consumption basket lies on one and only one indifference curve. 4) Indifference curves are not ‘thick’.
What is the marginal rate of substitution?
A consumer’s willingness to substitute one good for another. The marginal rate of substitution is the slope of the tangent to the indifference curve at any point. (negative of the slope of the indifference curve). If MRS = 5 this means the consumer would be willing to give up 5 units of y in exchange for one unit of x.
What is the principle of the diminishing marginal rate of substitution?
For many but not all goods, MRS diminishes as the amount of x increases along an indifference curve. Thus the slope of the indifference curve gets flatter as x increases and the indifference curve is bowed to the origin.
What is the forumal for the Marginal rate of Substitution?
