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EC109 - Micro > Consumer Theory > Flashcards

Consumer Theory Flashcards

1
Q

Define loss aversion

A

The disutility of giving up an object is higher than the utility of acquiring it

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2
Q

Define bounded rationality theory

A

That our behaviour is influenced by our environment and the info we have poor feedback restricts info

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3
Q

What is a binding budget constraint?

A

A budget that limits the consumer optimisation

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4
Q

What does the slop of a budget constraint represent?

A

The price ratio

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5
Q

What does a change in income do to a budget constraint (graphically)?

A

Shifts

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6
Q

What does a change in prices do to a budget constraint (graphically)?

A

Trasformation

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7
Q

Define marginal rate of transformation.

A

Marginal rate of transformation is the market’s rate of substitution between x1 and x2, and depends upon price ratio - it is a measure of the opportunity costs

MRT = - ∆x2 / ∆x1 = - p1/p2

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8
Q

What are the 5 main assumptions about consumer preferences?

A
  1. Monotonicity: more goods is better
  2. Convexity: an average of 2 bundles on the same indifference curve will be (at least weakly) preferred to the
    extremes for any 0Y or Y>X or Y∼X
  3. Transitivity: if X≥Y and Y≥Z then X≥Z
  4. Continuous: If X≥Y and Z is very similar to Y (lies in a small radius of Y) then X≥Z (aka. tiny changes in bundles will not change preference ordering)
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9
Q

What is a revealed preference?

A

Observing consumer behavior ignorer to understand and reveal preferences, instead of using assumptions > if a bundled is chosen over other affordable bundles, it is preferred.

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10
Q

Define utility

A

Utility: a measure of usefulness/welfare a consumer gets from consuming a good

(x1,x2 )>(y1,y2 ) iff u(x1,x2)>u(y1,y2)

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11
Q

What are the 4 features of indifference curves?

A

Indifference curves…
Are continuous
Are normally convex to origin (due to averages being preferred)
Are downwards sloping (due to monotonicity)
Never cross

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12
Q

What do indifference curves represent?

A

A level curve of utility (utility is constant)  normally the further from the origin the higher the utility

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13
Q

What is the equation for, MRS, and shape of indifference curve of, perfect complements?

A

U(x1,x2)=min(ax1,bx2)

Shape : L

MRS: undefined at kink, 0 on horizontal and -∞ on vertical

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14
Q

What is the equation for, MRS, and shape of indifference curve of, imperfect substitutes complements?

A

U(x1,x2) = x1^α . x2^1-α

Cobb-douglas shape

MRS: diminishing -α/(1-α) .x2/x1
MRS depends on the ratio of the 2 goods

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15
Q

What is the equation for, MRS, and shape of indifference curve of, perfect substitutes complements?

A

U(x1,x2)=ax1+bx2

Straight line

MRS: constant (–b/a)

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16
Q

Define marginal rate of substitution?

A

MRS: the rate at which a consumer is is willing to substitute x1 for x2 at a given point

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17
Q

What is the equation for marginal rate of substitution?

A

MRS(x1 x2) = - Δx2 / Δx1
= -MU1 / MU2
= - ∂ux1 / ∂ux2

(the gradient of the indifference curve at a given point)

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18
Q

What are homothetic tastes?

A

As income increases, demand increases by the same proportion (x1,x2)>(y1,y2) then (tx1,tx2)>(ty1,ty2)

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19
Q

What does MRS of homothetic tastes depend upon?

A

MRS depends upon ratio of 2 goods + is constant along ray from the origin (IC are diagonal shifts)

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20
Q

What are quasilinear tastes?

A

As income increases, demand for one good stays the same (tastes are linear in one good)

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21
Q

What does MRS of quasilinear tastes depend upon?

A

MRS depends upon consumption of 1 good + is constant along any vertical ray form the x-axis (IC are vertical shifts)

22
Q

What is the equation for elasticity of substitution?

A

σ=| %∆(x2/x1) / %∆MRS |

23
Q

Define elasticity of substitution

A

Measure of the rate of substitutability between the 2 goods.

The higher = the more substitutable.

24
Q

What is a constant elasticity of substitution function?

A

A general utility function we can use + manipulate to show all values of σ

25
Q

What is the equation for a CES function?

And what values mean what?

A

u(x1,x2 ) = [αx1^-ρ + (1-α) .x2^(-ρ)] ^(-1/ρ)

As ρ approaches ∞, σ approaches 0 - complements

When ρ = 0, σ = 1 - Cobb-Douglas

As ρ approaches -1, σ approaches ∞ - substitutes

26
Q

What is the elasticity of substitution for a CES function?

A

σ=1/(1+ρ)

27
Q

What is the tangency condition?

A

Consumer will optimize where MRS = the gradient of the budget constraint
aka. where the indifference curve touches the budget constraint.

MRS= - MU1 / MU2
= - ∂ux1 / ∂ux2
= - Px1 / Px2

Tangency condition is necessary for optimization (if both goods
are consumed) , but not sufficient unless the IC is convex

28
Q

What is the Lagrange equation?

A

maxL(x1,x2,λ) = U(x1,x2) -λ[P1x1+P2x2-M]

29
Q

How do you solve for Marshalian demands?

A

Then solve for Marshallian demands (optimum no. of each) : x*(p1,p2,M)
Find FOCs of the Lagrange equation; use simulations equations to find x, y and λ
Divide first 2 FOC..get MRS and price ratio

30
Q

What does the tangency condition imply?

A

λ^*= MU1 / P1 =⋯=MUi/Pi =⋯=MUn/Pn

λ* is the marginal utility of income (£1 of extra income will increase utility by λ)

31
Q

What does the price of a good show?

A

Price is the consumer’s evaluation of the utility of the last unit consumed
Consumers will continue to buy goods until the marginal utility of the good is less than the marginal utility of money (λ*)

Pi = MUi / λ

32
Q

What is the income-consumption/offer curve?

A

The relationship between income + optimum bundle - which shows what type of good the good is / what the income effect is

(Connect the optimum bundles at different income levels)

33
Q

What is the engel curve?

A

Shows the relationship between income + demand of a good - is derived from the income-consumption curve by seeing income and optimum level of good x and plotting

34
Q

What does the engel curve for a normal good look like?

A

Normal good – income rises + quantity demanded rises – upwards slope

35
Q

What does the engel curve for an inferior good look like?

A

Inferior good – income rises past a curtain point + quantity demand falls – backwards bending curve

36
Q

What does the engel curve for an Quasilinear good look like?

A

Quasilinear – income rises + quantity is unchanged - straight vertical line

37
Q

What is the price-consumption / offer curve show

A

How the optimum bundle changes following a change of price of one of the goods

38
Q

What does the shape of a price-consumption / offer curve depend on?

A

On how responsive demand is to a change in the price of the good

39
Q

How does one derive the demand curve?

A

From the price-consumption curve - plotting price and quantity demanded at that price

40
Q

How does one derive the price-consumption curve?

A

Shift price of 1 good, find optimum bundle - repeat - join dots

41
Q

What does the demand curve show?

A

How quantity demanded changes following a price change

42
Q

What is the law of demand?

A

As the price of a good goes down, the quantity of demand goes up

43
Q

What is the substitution effect?

A

as Px decreases, good Y becomes relatively more expensive + less attractive to the consumer  is always positive

44
Q

What is the income effect?

A

As Px decreases, real income rises. The consumer now feels richer, so quantity demanded changes - direction of the income effect depends upon the type of good

45
Q

What is the primal problem?

A

Utility optimisation - find marshalian demands - which depend on price + income

46
Q

What is the indirect utility function, and how do you find it?

A

Indirect utility function - function of utility thats depends indirectly on prices + income

v(p1,p2,M)=U[x1(p1,p2,M),x2(p1,p2,M)]

Marshallian demands are plugged into the utility function to find the indirect utility function  where optimal level of utility depends indirectly on prices + income

47
Q

What are the properties of a indirect utility function?

A

It is non-increasing in every price, decreasing in at least one price - if prices goes down quantity goes down for at least 1 good and therefore utility increases

Increasing in income - increase income increases demand + therefore utility

Homogeneous of degree 0 in price + income

48
Q

What is the dual problem? And how do you find it?

A

Expenditure min.  find Hicksian demands (depend on prices + target utility)

49
Q

What is a compensated budget, and how do you find it?

A

Plug Hicksian demands into the expenditure function to find the compensated budget  where minimal expenditure indirectly depends prices + utility

M=E(p1,p2,v)=p1H1(p1,p2,v)+p2,H2(p1,p2,M)

50
Q

What are the properties of a compensated budget?

A

It is non-decreasing in every price, increasing in at least one price

Increasing in utility

Homogenous of degree 1 in all prices p

EC109 - Micro (1 decks)

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