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EC204 Micro Notes > Consumer Theory > Flashcards

Consumer Theory Flashcards

1
Q

What assumptions are made to give rationality to define a utility function?

A 
Non-satiation
Transivity 
Completeness
Continuity 
Convexity
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2
Q

What does non-satiation mean?

A

More is preferred to less

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3
Q

What does transivity mean?

A

if X>Y and Y>Z then X>Z

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4
Q

What does completeness mean?

A

Consumers will always be able to rank goods -> they will always know what good they prefer

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5
Q

What does continuity mean?

A

Small changes to a consumer’s bundle will not change their preferences relating to it

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6
Q

What does convexity mean?

A

An bundle where an average of 2 goods is included is preferred to an extreme bundle (having a lot more of one good than the other)

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7
Q

What shape is the IC for a perfect substitute good and why?

A

The IC will have a constant gradient -> the IC will be linear. This is because the MRS is constant at all points on the IC

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8
Q

What does this mean about the utility attributed with consuming perfect substitute goods?

A

Utility comes from the sum of both goods in the bundle in whatever ratio that may be

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9
Q

What is the shape of the IC for a perfect complement good and why?

A

The IC is L-shaped because utility is conditioned by the quantity of the lowest consumed good in the bundle

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10
Q

What does the Cobb Douglas function show?

A

It shows the preferences between 2 goods that lie in between the 2 extremes mentioned above

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11
Q

What is the formula for the Cobb Douglas function?

A

U(x1,x2) = x1^a.x2^(1-a)

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12
Q

What does the Cobb Douglas formula show?

A

That the substitutability of the 2 goods adds up to 1

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13
Q

How will the size of (a) in the Cobb Douglas determine the shape of the IC?

A

The higher is a the quicker the IC converges to the x-axis, the lower is a the quicker the IC converges to the y-axis

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14
Q

What is a monotonic transformation and why is it different?

A

It means that a transformation can be made to a utility function that may create an entirely new utility function, but the preferences of the consumer will remain constant after the transformation

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15
Q

Lagrange method

A

Check notes -> can’t be put on flash cards

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16
Q

How do revealed preferences help economists?

A

They reveal the preferences of the consumer, meaning that no assumptions about those preferences have to be made

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17
Q

Diagram of these preferences

A

Check notes

18
Q

What is the difference between WARP and SARP?

A

WARP allows you to make direct comparisons between bundles, stating which one you prefer
SARP allows you to make indirect comparisons between bundles -> leads to transivity (assumptions)

19
Q

What are homothetic tastes?

A

This is where consumer preferences depend on the ratio of one good in the bundle to another

20
Q

What do homothetic tastes mean the IC looks like at all levels of consumption?

A

It will have the same MRS -> when M increases, the proportional increase in X and Y will be the same

21
Q

What are quasilinear tastes?

A

Means that at all levels of consumption and income, the quantity consumed of a good will be constant

22
Q

What does that mean that IC shifts will look like for Quasilinear tastes?

A

The IC will only shift vertically -> it can shift out and right but the consumer has no increase in utility by consuming more units of that good than the desired constant amount

23
Q

What does the Engel curve show?

A

It shows the relationship between income and the quantity of a good that is consumed. For a normal good it will have a positive gradient, for an inferior good it will be negatively sloped and for a quasilinear good it will be vertical

24
Q

What is expenditure minimisation?

A

It is finding the cheapest expenditure, given a new price ratio, where utility will be the same as for the original bundle

25
Q

What 2 effects come from a price change?

A

Substitution and income effect

26
Q

What does the Hicksian Substitution effect attempt to work out?

A

It tries to find the change in income required to keep utility constant after a price change

27
Q

What happens to real income in this effect?

A

It is kept constant

28
Q

Lagrange working

A

Check notes

29
Q

What does the Marshallian Demand curve show?

A

It shows that as the price of x decreases, the consumer will reach a higher IC -> accounts for both the sub and income effect

30
Q

What is the Marshallian Demand Curve also known as?

A

The uncompensated demand curve

31
Q

What does the Slutsky Substitution effect attempt to work out?

A

What change in income is required to make the original bundle affordable given the new prices

32
Q

What is the relation of the Slutsky effect and Hicksian effect after a price increase?

A

The Slutsky effect will be larger

33
Q

How does the proportion of the Hicksian Effect to the Slutsky effect differ when price decreases?

A

The Hicksian effect will be larger

34
Q

What is the respective ratio of the Hicksian and Slutsky Substitution effects?

A

The difference in the effects will be the same in each case, the roles have just reversed

35
Q

What does the Compensating Variation work out?

A

How much money the government (or firm) would have to give consumers after the price change to ensure they remain just as well off

36
Q

Diagrammatically what is the Compensating Variation showing?

A

How much money is needed to shift the new budget line out so that it touches the original IC again

37
Q

What does the Equivalent Variation work out?

A

How much money needs to be taken away from consumers before the price change

38
Q

In other words, what is the Equivalent Variation working out?

A

What are you willing to pay to avoid the price change?

39
Q

Diagrammatically what is the Equivalent Variation showing?

A

How much money needs to be taken away to shift the new budget line in to touch the original IC again

40
Q

What is the key difference between these 2 variations?

A

The compensating variation happens after the price change, whereas the equivalent variation happens before the price change

41
Q

Diagrams

A

Check slides

EC204 Micro Notes (5 decks)

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