Consumer Theory

Question 1

What are the 5 axioms of consumer theory?

Answer 1

Completeness
Transitivity

(these 2 = assume rational consumers)

Continuity
Monotonicity
Convexity

(these 3 = ‘well-behaved’ preferences)

Question 2

Describe the completeness axiom

Answer 2

We can compare all bundles

e.g.
if A is weakly preferred to B > we prefer B, we’re content with A

if A is strictly preferred to B > A will always better than B

Question 3

Describe the transitivity axiom

Answer 3

All bundles can be ranked consistently

e.g.
if A is preferred to B and B is preferred to C, A is preferred to C

Question 4

Describe the continuity axiom and the importance of it

Answer 4

Similar bundles have similar rankings

e.g.
If A is strictly preferred to B and B is ‘close’ to C, if A is no longer available, A is (weakly) preferred to C

We need this axiom since we can’t have decimal units of a good, e.g. 4.241 units of beer

Question 5

Describe the monotonicity axiom (axiom 4)

Answer 5

More is preferred to less

e.g.
if A has more of both goods than B, A is strictly preferred to B

Question 6

Describe the convexity axiom

Answer 6

Averages are preferred to extremes

e.g.
if A is indifferent to B and C is on a line connecting A and B, C is (weakly preferred) to A and B

Question 7

What does a budget constraint show?

Answer 7

Shows which bundles are affordable, given income

Question 8

What is the interior solution?

Answer 8

The optimal choice for individuals are where the budget constraint is tangential to the indifference curve

Question 9

What does the income-consumption curve show?

Answer 9

How consumption varies with income

Question 10

Distinguish between an upward sloping and downward sloping indifference curve

Answer 10

Upward: indifference when somebody’s got more of both goods

Downward: indifference curve = trade-off between 2 goods

Question 11

Bads

Answer 11

Increasing the Q lowers utility

Question 12

Bliss point

Answer 12

Bundle with maximum possible utility