Decision making and Utility theory pt2

Question 1

“The Margin” and Optimisation

Answer 1

In this case, the rule is for utility maximisation, a consumer must consume a good up to the point where MU=P (Marginal utility=Price)

Question 2

MU>P

Answer 2

This tells me that the utility gained from consuming an extra unit is greater than the price, so it makes sense to go for the extra unit

Question 3

MU<P

Answer 3

This tells us that the marginal utility gained is less than price so it is not worth buying.

Question 4

Asymmetric information

Answer 4

This is where one party in a transaction has less relevant information than the other.

Question 5

Adverse selection

Answer 5

A market phenomenon that occurs when the parties in a transaction have asymmetric information. This can lead to an imbalance as the party with the advantage can use superior information to make decisions that benefit them selves and not the other party.

Question 6

Utility maximisation

Answer 6

Demand theory assumes that the rational individual will seek to maximise utility. This includes a combination of minimising the bad bits while maximising the good bits.

Question 7

Constraints of maximisation

Answer 7

-Limited income - no one has unlimited wealth so choices must be made
-Limited time - even if goods are free, limited time makes us choose
-Opportunity cost - can only get more of good x by giving up some of good y