Consumer Theory Flashcards
What does indifference mean?
Indifference= doesn’t bother/mind compared to current predicament, any point is the same utility
What does it mean below the indifference curve?
Below the indifference curve= not preferred,
What does it mean above the indifference curve?
above = preferred (marginal benefit
What do we expect of a rational buyer?
All bundles can be compared and all bundles can be ranked consistently
Why do we have axioms
- Have simplest possible theory
- Make clear hidden assumptions
- Develop testable predictions
What do we expect of most people most of the time?
SImilar bundles should have similar rankings
More is better
Averages preffered to extremes
How many axioms do we have?
5
- Completeness (all bundles can be compared
- Transitivity (all bundles can be ranked consistently)
- Continuity (similar bundles have similar rankings)
- Monotonicity (more is preferred to less)
- Convexity (averages preferred to extremes)
What are the well behaved prefences?
Axiom 3- continuity
Axiom 4- Monotonicity
5- Convexity
Describe axiom 1 - completeness
AXIOM 1: COMPLETENESS (all bundles can be compared)
For bundles A and B:
either A is (weakly) preferred to B or vice versa
● Weak preference versus strict preference
What are axioms for?
rational consumers
Describe axiom 2 transitivity
AXIOM 2: TRANSITIVITY (all bundles can be ranked consistently)
For all bundles A, B and C:
If A is preferred to B and B is preferred to C, then A is preferred to C
EXAMPLE: A = Porsche B = Ford C = Vauxhall If A1 and A2 hold, we say a preference ordering exists
Describe axiom 3- continuity
‘Well behaved’ preferences
AXIOM 3: CONTINUITY (similar bundles have similar rankings)
For all bundles A, B and C:
If A is strictly preferred to B and B is ‘close’ to C, then A is (weakly) preferred to C
Describe axiom 4- monotonicity
‘Well behaved’ preferences
AXIOM 4: MONOTONICITY (more is preferred to less)
For all bundles A and B:
If A has more of both goods than B, then A is strictly preferred to B
Describe axiom 5- convexity
AXIOM 5: CONVEXITY (averages preferred to extremes)
If A is indifferent to B and C is on a line connecting A and B, then C is (weakly) preferred to A and B
What is utility?
The number assigned to a bundle is called total utility- how much satisfaction a bundle yields, often in ‘utils’ as the unit
Utility is only an ordinal concept (only ranking matters)
For axiom 1, 2 and 3 what can be used to represent them?
AXIOM 1, 2 & 3: indifference curves can be used to represent preferences
What does the indifference curve for axio 4 look like?
AXIOM 4 Monotonicity: indifference curves are downward sloping
What does an upward sloping indiffierence curve suggest?
An upward sloping Indifference curve suggest indifference when somebody’s got more of both goods
What does a downwards sloping indifference curve suggest?
A downward sloping indifference curve suggests a tradeoff between the two goods
Graph to show upwards sloping and downward sl;oping indifference cruves
How are indifference curves bowed?
What shape does axiom 5 convexity have?
AXIOM 5 Convexity (averages are preferred to extremes): indifference curves have familiar shape
What does it mean if indifference curves cross?, graph too
What does axiom 2, trasivity say about indifference curves?
They cannot cross
What are indifference curves for perfect susbitutes and what does this indicate? Graph too
What are indifference curves for perfect complements and what does this indicate? graph too
What are bads indifference curves and draw graph?
What is a bliss point indifference curve? Graph too
Summary notes for indifference curves
What is a buyers choice cosntrained on?
by what they can afford
What is a consumer?
A price taker
What does being a price taker constitute?
Price is constant no matter how much one buys
WHat does a budget constraint show? Graph too
Graph to show an increase in income on the budget constraint
Graph to show a price increase on the budget constraint
What does the slope show on a budget constraint? Graph too please
Slope shows the rate at which an individual can trade one good for another
When is a budget constraint linear?
Only linear if the price per unit is the same for all units
Diagram to show budget constraints, quantity discounts
Graph to show non linear budget constraints, quality rationing
What does putting indifference curves and budget constraints together show?
What is the optimal point?
Is at a point where the budget constraint is tangent to the indifference curve. At this point the slope of the udget constraint equals the slope of the indifference curve
What does the slope of the indifference curve show?
The rate at which an individual will trade one good for another- the slope shows the worst acceptable terms of trade for an individual to substitute one for another
Graph to explain the slope of an indifference curve
As ∆X gets smaller, ∆Y/∆X approaches the slope of the indifference curve is = MRS
Recall that the slope of the indifference curve is MRS
What is the slope of the indifference curve?
Maringal rate of substitution (MRS)
At the optimal choice…
The slope of the budget constraint is the same as the slope of the indiffence curve
Graph to show the properties of the interior solution
What are corner solutions and graph to show
Summary notes for constrained opitmisation
What does the income consumption curve show?
The income consumption curve shows how consumption varies with income
What does increasing income do to the budget cosntraint curve?
Shifts it to the right
What does decreasing income do to the budget constraint curve?
Shifts it to the left
Graph to show income consumption curve
Describe the income consumption curve for an inferior good
It is downards sloping
Graph to show the income-consumption curve of an inferior good
What can we use to illustrate the relationship between income and consumption of a good?
Indifference curves
What is the slope of th engel curved linked to and why?
The income elasticity of demand because we are looking at how the increase in income affects the demand of good x or y
What is the engel curve?
Engel Curves are the locus of all points representing the quantities demanded of the goods at various levels of income, when prices and preferences are held constant
Diagram to show the engel curve
What does the price consumption curve show?
How consumption varies with price
What does decreasing the price of good X do to the budget constraint?
Pivots the budget constraint outwards from the origin
Diagram to show a decrease of price on the budget constraint
Diagram to show how the price consumption curve can be used to show how consumption varies with price
Why can the Diagram to show how the price consumption curve can be used to show how consumption varies with price
Thisderivestheconsumer’s demand curve which can then be used to derive the market demand curve
What is the income effect?
1) INCOME EFFECT
People feel poorer:
They cannot buy as much with their fixed income
What is the substitution effct?
2) SUBSTITUTION EFFECT
People change their consumption:
They buy similar but rival products or they spend their money on other products
How can the income effect be dervied from the indifference framework?
1): how price change affects consumption holding relative prices constant
How can the substitution effect eb derived using the indiffernce framework?
how price change affects choice holding utility constant
Indiffrerence diagram to show the subsitution effect from an increase in the rpice of good X
Indiffrence diagram to derive the income effect from an increase in the price of good x
For inferior goods, hwo do the income and subsitiution effcts work?
In opposite directions
Diagram to shwo the income and subsitution effects for an inferior good
How do the substituion and income effects work for normal goods?
In the same direction
What is a giffen good?
A Giffen good is a special kind of inferior good. The income and substitution effects work in opposite directions, and the income effect dominates
Indifference curve for giffen good
Summary notes of rincome and substituion
What is the equation for income?
Diagram to show optimal choice of lesire and work
Diagram to show how an increase in wages affects the work and leeisure balance
Diagram to show the deriviation of the relationship between wage and labour
Diagram to show backwards bending labour supply curve
Diagram to show the income and substitution effcts on a backwards bending labour supply curve
Diagram to show how income tax rates affect the leisure and income diagram
Diagram to show how unemployment benefits impact the lesiure income diagram
Summary notes for the consumption leisure model
