Consumer Theory (Weeks 3-4) Flashcards
Define each part of the general equation of a line:
Y = A0 + A1(X)
A0 is the y intercept, or where the line intersects the vertical axis
A1 is the slope, or the vertical distance the line travels for each one-unit increase in horizontal distance
Y is the outcome or dependent variable
X is the input or independent variable
What are the two influences on purchasing goods from the consumer perspective?
This question could also be stated as what are the two limitations on consumer choice?
- The budget constraint
- The preferences regarding goods
What are the two influences on purchasing goods from the market perspective?
- Supply
- Demand
What influence affects purchasing of goods from both the consumer and market perspective?
Price of goods
True or false: rational individuals will maximize their utility subject to their budget constraint
True
What is the line for a budget constraint equation using the following terms:
Budget (or income)
Px
Py
Qx
Qy
Budget (or income) = PxQx + PyQy
Rewrite the budget constraint equation to solve for Qy
Budget = PxQx + PyQy
Qy = (income/Py) - (Px/Py)(Qx)
What is the slope of the budget constraint line if the equation is
Budget = PxQx + PyQy
Negative price ratio
- (Px/Py)
What is the amount of a good that can be consumed if all of the income is spent on that one good?
The x or y intercepts
True or false: every bundle on an indifference curve provides the same utility?
Provide a reasoning for your answer
True
Because each point requires a trade off, you are able to maintain the same utility at different amounts of each good
True or false: indifference curves closer to the origin are more favorable than indifference curves farther from the origin
Provide reasoning for your answer
False
Indifference curves farther from the origin are more favorable because by the “more is better” concept, you can obtain higher utility with curves farther away
True or false: indifference curves can cross each other
Provide a reasoning for your answer
False
Indifference curves cannot cross each other because it defies the “more is better concept” because it prevents all bundles on the same IC from having the same utility
True or false: indifference curves cannot be concave
Provide a reasoning for your answer
True
ICs cannot be concave because it defies the “more is better” principle because it prevents all bundles on one IC from having the same utility
True or false: indifference curves cannot be upward sloping
Provide a reasoning for your answer
True
ICs cannot be upward sloping because then every bundle does not have the same utility as there is no trade off
What are the four properties of indifference curves?
- Higher ICs are preferred to lower ones
- ICs are downward sloping
- ICs do not cross
- ICs are convex to the origin
What is the slope of the indifference curve?
Marginal rate of substitution (MRS)
What is the rate at which the consumer is willing to substitute one good for the other?
Marginal rate of substitution (MRS)
What is the name of this concept?
The Marginal Rate of Substitution (MRS) approaches zero as we move down and to the right along an indifference curve
Diminishing marginal rate of substitution (MRS)
What shape is the indifference curve when two goods are perfect substitutes?
Provide an example
Straight line
Trade rate for nickels and dimes. It is always 2 nickels for 1 dime
What is the MRS when two goods are perfect substitutes?
Constant. Equivalent to the trade rate
What shape is the indifference curve when two goods are perfect complements?
Provide an example
Shaped like an L
Left and right shoes. You always need a 1:1 ratio
What is the MRS when two goods are perfect compliements?
MRS = 0 for horizontal fragment
MRS = infinity for vertical fragment
Abstract measure of the satisfaction or happiness that a consumer receives from a bundle of goods
Utility
Where is an optimum bundle located?
Where MRS = PR
What is MRS as defined by MU?
MRS = - (MUx / MUy)
The increase in utility the consumer gets from an additional unit of a good
Marginal utility
What is the slope of the utility function?
Marginal utility
The additional increment to utility obtained by consuming an additional unit of good decreases as we consume more and more of that good
Diminishing marginal utility
What are the x and y axes for a budget constraint line?
X: quantity of good
Y: quantity of good
What are the x and y axes for a graph of marginal utility?
X: quantity of good
Y: marginal utility
What are the x and y axes for a graph of total utility?
X: quantity of good
Y: total utility
What are the x and y axes for an indifference curve?
X: quantity of good
Y: quantity of good
True or false: an individual can have multiple utility functions
False, they only have one
True or false: indifference curves are graphical representations of the utility function
True
Each indifference curve represents one value of a utility function for that individual
Mathematical representation of the combination of foods a person can afford given their incomes
Budget constraint
The loss of potential gain from other alternatives when one alternative is chosen
Opportunity cost
Mathematical mapping of individual choices over goods into their level of well-being
Utility function
Maximizing their well-being (utility) subject to their available resources
Constrained utility maximization
At which condition is the optimal bundle when comparing the budget constraint and indifference curve
MRS = - Price Ratio (Px/Py)
Express MRS in MU
MRS = - MU ratio (MUx/MUy)
What is the expression for the utility maximizing condition?
MUx MUy
——- = ——-
Px Py
If your marginal utility for x is larger than y, should you purchase more x or more y to reach your optimal bundle?
Need to buy more x
A good for which an increase in income raises the quantity demanded
Normal good
A good for which an increase in income decreases the quantity demanded
Inferior good
How do changes in price affect the budget constraint?
Rotate the budget constraint
How do changes in income affect the budget constraint?
Shift it towards or farther away from the origin
True or false: income changes change the shape of the IC?
False
True or false: price changes change the shape of the IC?
False
An increase in the price of a good will typically cause an individual to choose less of all goods because the income can purchase less than before
Income effect
What does the income effect affect?
Purchasing power
Is income effect exhibited as shifting the indifference curve or moving along the indifference curve?
Shifting the indifference curve
Is substitution effect exhibited as shifting the indifference curve or moving along the indifference curve?
Moving along the indifference curve
An increase in the price of a good makes the consumer substitute away from that good, holding other prices and the consumer’s utility constant
Substitution effect
