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Microeconomics 2316 > Consumer theory > Flashcards

Consumer theory Flashcards

1
Q

What are the assumptions of a budget set?

A

Has an endowment to spend
Chooses a bundle made up of multiple goods
Each good has a constant price

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2
Q

What is the budget set?

A

I>XPx + YPy

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3
Q

What is the slope of the budget line?

A

-Px/Py

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4
Q

What is a utility function?

A

Assigns a number to every choice in a budget set

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5
Q

What is the formula for a utility function?

A

U(X,Y)=X^a Y^b

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6
Q

What is marginal utility?

A

It is the additional utility the consumer gets from consuming one more unit

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7
Q

How do you derive the marginal utility on a graph?

A

We take the partial derivative of X and it is equal to the slope of the tangent of the point

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8
Q

What do the points on the same indifference curve represent?

A

The consumer gets the same utility from the different points on the same utility curve
Points on a higher indifference curve gives more utility than any other point

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9
Q

Why do indifference curves slope downwards?

A

Because the consumer likes both goods

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10
Q

What does the slope of the IC show?

A

It shows the marginal rate of substitution - describes how a consumer is willing to substitute one good for another

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11
Q

What does MRS measure?

A

The value that the individual places on 1 extra unit of a good in terms of another

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12
Q

What is non-satiation?

A

When we assume that more is better than less

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13
Q

Why are the indifference curves convex?

A

We can expect that a consumer will prefer to give up fewer and fewer units of a second good to get additional units of the first one

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14
Q

What are perfect substitutes?

A

When the MRS of one for the other is a constant
The graph consists of straight lines

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15
Q

What are perfect complements?

A

When the indifference curves for both goods are shaped as right angles

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16
Q

What are ‘bad’ goods?

A

Less of the goods is preferred to more - ie. air pollution

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17
Q

How does the utility change when we vary X and Y a little?

A

We use total derivative
The change in utility is MUx dX+MUy dY=0
Just multiply X and Y by the marginal utility of each one and add them

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18
Q

What happens to the budget line when the income changes?

A

If the budget doubles, the curve shifts outwards, and if it halves, the curve shifts inwards

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19
Q

Which 2 conditions should the maximizing market basket satisfy?

A
  1. It must be located on the budget line
  2. It must give the consumer the most preferred combination of goods/services
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20
Q

What is the corner solution?

A

When one of the goods is not consumed, the consumption bundle appears at the corner of the graph

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21
Q

What is revealed preference?

A

If a consumer chooses one market basket over another, and if the chosen market basket is more expensive than the other, then the consumer must prefer the chosen market basket

22
Q

What is marginal utility?

A

Measures the additional satisfaction obtained from consuming one additional unit of good

23
Q

What does the following equation tell us?
MUf/Pf = MUc/Pc

A

Tells us that utility maximization is achieved when the budget is allocated so the marginal utility per dollar of expenditure is the same for each good

24
Q

When does utility maximization occur on a graph with the budget line and the IC?

A

It is at the point at which an indifference curve is tangent to the budget line

25
Q

What is the slope of the optimal bundle?

A

Slope of BL = Slope of IC
Px/Py = MUx/MUy

26
Q

What does Px/Py show us?

A

The tradeoff between goods the market is accepting: in exchange for 1 unit of X, the price ratio is the number of units of Y she can get

27
Q

What does MUx/MUy show us?

A

The tradeoff between goods that makes the consumers indifferent: in exchange for 1 unit of X, the MRS is the amount of Y she needs to get to be indifferent

28
Q

What does Px/Py>MUx/MUy show us?

A

If the consumer gives up a unit of X, the market is willing to give her more Y than she requires to be indifferent - trading away X for Y will increase utility so her current bundle is not optimal

29
Q

What does Px/Py<MUx/MUy show us?

A

If the consumer takes an additional unit of X, the market will accept less Y than she would be willing to give up and remain indifferent - trading away Y for X will increase utility so her current bundle is not optimal

30
Q

What is the optimal bundle’s equation?

A

Px/Py=MUx/MUy

31
Q

What does MUy/Py>MUx/Px show us?

A

A dollar spent on Y gives more utility than a dollar spent on X - improve utility by shifting spending away from X towards Y

32
Q

What does MUy/Py<MUx/Px show us?

A

A dollar spent on X gives more utility than a dollar spent on Y - improve utility by shifting spending away from Y towards X

33
Q

What is the IC graph for when a consumer likes X but dislikes Y?

A

It is upwards facing - either linear or concave

34
Q

What is the utility function for goods which have a constant marginal utility?

A

U(X,Y)= X+Y
Both goods have an MU = 1 so the MRS is constant

35
Q

What is the IC graph for perfect substitutes?

A

It is downwards sloping

36
Q

What is the solution with perfect substitutes?

A

It is the corner solution - where the consumer chooses X = 0

37
Q

What is the IC graph for perfect complements?

A

It looks like right angles and can be represented by the utility function U(X,Y)=min{X,Y}

38
Q

What is one solution with perfect complements?

A

When the vertex lies on the budget line

39
Q

What is another solution with perfect complements?

A

The price equal to Px+Py so the solution is to buy a quantity of 1/Px+Py

40
Q

What happens to the budget set when the interest rate falls?

A

It becomes flatter

41
Q

What are the effects of the interest rate falling for a borrower?

A

They become better off since they can borrow for a cheaper amount

42
Q

What are the effects of the interest rates falling for a saver?

A

They are worse off since they used to get more money from saving but now they receive less for the same amount

43
Q

If a person has MRS < 1+r at E, should they borrow or save?

A

They should save since they value future consumption relatively highly

44
Q

What is a kinked budget set?

A

If the interest rate is higher for borrowing than saving, the budget line has a concave kink

45
Q

What is the substitution effect?

A

Consumers tend to buy more of the good that has become cheaper and less of the goods which are relatively expensive

46
Q

What is the income effect?

A

Because one of the goods is now cheaper, consumers enjoy an increase in the real purchasing power

47
Q

What is the backward-bending labour supply?

A

At low wages, we expect people to work more as their wage increases:
- substitution effect dominates
-upward-sloping labour supply
At higher wages, people work less as their wage increases:
- they have enough money
- income effect dominates
- backward-bending labour supply

48
Q

What is welfare economics?

A

Allows us to think about distribution/equity

49
Q

What is the Edgeworth Box?

A

If trade is beneficial, which trade occurs and which trades will allocate the goods efficiently is shown on the diagram

50
Q

What is the contract curve?

A

It’s a swigly line through the Edgeworth box, which shows all allocations from which no mutually beneficial trade can be made

51
Q

What is the first fundamental theorem of Welfare Economics?

A

If consumers are price takers and there are no externalities, the market outcome is efficient

52
Q

What is the second fundamental theorem of Welfare Economics?

A

If consumers are price takers and there are no externalities, then any efficient outcome can be generated by markets, as long as we make the right pre-market tax/transfers

Microeconomics 2316 (4 decks)

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