Consumer theory 1 Flashcards
What are the assumptions about consumers?
Consumers are rational, more is preferred to less, consumers seek to maximise utility, consumers act in self interest.
Define the following;
a) total utility
b) marginal utility
c) diminishing marginal utility
a) total satisfaction gained from consuming the good
b) additional utility gained from consuming 1 extra unit
c) as extra units are consumed, utility falls (explains why the demand curve is downward sloping)
What is equi marginal principle in consumption?
Whereby the ratio of the marginal utility is equal to the ratio of prices.
What is an intertemporal choice?
A choice whereby the cost is incurred immediately but satisfaction is acheived over a longer period of time. E/g conusmer durables.
What is the budget constraint?
A limit on consumption bundles that a consumer is able to afford.
What is the infeasible region of the budget constraint?
Area beyond the budget constraint that cant be reached due to inadequate income
What is the formula for the budget constraint and what does it depend on?
Depends on; income, price of good and the amount of the good.
M= XPx + YPy where X/Y is the amount of the good and Px/y = price of good and assumes that all income is spent so income = consumption.
What is the slope of the budget constraint and what does it mean?
YPy = M-Xpx (equation of straight line), solve for Y = M/Py - XPx/Py so slope = -Px/Py. Slope of the line = relative price of the 2 goods measuring the rate at which one good can be traded for another.
How does income effect the budget constraint?
Shifts the budget constraint parallelly.
How does a change in price affect the budget constraint?
Budget constraint will pivot on the axis of the good that didnt change in price.
What does an indifference curve show?
Consumers preferences of consumption bundles that give the same level of satisfaction at any point on the curve.
What are the properties of indifference curves?
Higher indifference curves are preferred (consume more of X and Y
downward sloping (imperfect substitutes) there is a trade off between the two goods
they dont intercept as otherwise one point would be on two different IC curves despite having the same utility.
Convex shaped -
Why are IC convexed shaped?
Due to the decreasing marginal rate of substitution, people are more willing to trade away goods that they have abundance off and less likely to with goods they have little of. So by consuming one more of good x they will give up fewer and fewer of good y. So the MRS is the slope of the indifference curve.
What is the MRS equal to?
Marginal utility of good a / Marginal utility of good b
What is consumer optimisation?
Where consumers want the combination of goods on the highest indifference curve. It occurs where the indifference curve and budget constraint are tangent. Possible for their to be a higher indifference curve but consumers cant acheive this as they are restricted by income.
