Exam 1 Definitions

Question 1

Assumptions

Answer 1

a consumer will choose the best bundle of goods and services that they can afford

Question 2

Ex ante

Answer 2

before fact

Question 3

ex past

Answer 3

after the fact

Question 4

Bundle

Answer 4

collection of good/services & quantity of each

Question 5

Best

Answer 5

consumer preferences

Question 6

can afford

Answer 6

budget constraint

Question 7

Budget Constraint Equation

Answer 7

Px * x + Py * y = M

Question 8

Marginal rate of transformation

Answer 8

The rate at which a consumer is able to trade one food for another. Specifically it’s the amount of good y that a consumer must give up in order to obtain an extra unit of good x.
Slope of budget constraint

Question 9

Marginal rate of transformation value

Answer 9

-Px/Py

Question 10

Notation

Answer 10

typically use lowercase letters of alphabet to represent bundles of goods and the higher letters of the alphabet to represent the goods

Question 11

Indifference curve

Answer 11

shows a set of bundles which all make the consumer equally well off

Question 12

Utility function

Answer 12

A mathematical way to represent a consumer’s preferences
Will represent a consumers preferences if the following property holds
U(A) > U(B) iff A is preferred to B

Question 13

Ordinal

Answer 13

ranking

Question 14

Cardinal

Answer 14

Number

Question 15

Marginal Utility

Answer 15

The extra utility gained by a consumer from consuming an additional unit of a good

Question 16

Marginal rate of substitution (MRS)

Answer 16

The rate at which a consumer is willing to trade one good for another. Specifically it is the amount of good y that a consumer is willing to give up in order to obtain an extra unit of good X. It is the slope of the indifference curve.

Question 17

Marginal rate of substitution (MRS) value

Answer 17

-MUx/MUy

Question 18

Law of diminishing utility

Answer 18

as you consume more of a good, at some point the extra utility that you get from consuming an extra unit of the good begins to decrease

Question 19

Cobb-douglas utility function

Answer 19

U(X,Y)=(x^alpha)(y^beta)

Question 20

Cobb-douglas utility generates…

Answer 20

strictly convex indifference curves

Question 21

Perfect complements function

Answer 21

U(X,Y) = MIN (underscore alpha A, underscore beta Y)

Question 22

Perfect complements generates

Answer 22

L shaped indifference curves

Question 23

Perfect substitution

Answer 23

U(X,Y) = underscore alpha A + underscore beta Y

Question 24

Perfect substitution generates

Answer 24

linear indifference curves

Question 25

True or false: MRS = MRT

Answer 25

true

Question 26

logic lesson

Answer 26

necessary and sufficient conditions

Question 27

Proof by contrapositive

Answer 27

to prove the statement “if A then B”, begin by assuming “not B” and show that this must mean “not A”

Question 28

Price consumption curve (PCC)

Answer 28

shows how the consumers optimal bundle changes when the price of a good changes while holding the prices of other goods and income constant

Question 29

Income consumption curve (ICC)

Answer 29

shows how the consumer’s optimal handle changes when the consumer’s income changes while holding the prices of the goods constant

Question 30

Engel curve

Answer 30

shows the relationship between the amount of money that the consumer has available to spend (m) and the quantity of a good that a consumer chooses to buy in their optimal bundle

Question 31

Substitution effect

Answer 31

if the price of good x is now relatively less expensive than other goods, so the consumer will substitute good x for other goods

Question 32

Income effect

Answer 32

if the price of good x decceases, the consumer can purchase the same bundle as before and now have more money left over. The consumer can purchase more of all normal goods with this extra money, The price decrease has the effect of increasing the consumes real income
Buying power of consurer’s money goes up

Question 33

Slutsky income/substitution effect

Answer 33

Holds the consumer’s buying power constant

Question 34

Hicksion income/substitution effect

Answer 34

Holds the consumer’s utility constant

Question 35

Compensated budget constraint

Answer 35

Has same slope as new (after price change) budget constraint since slope is determined by relative prices of goods
Is tangent to original indifference curve since consumer’s utility is being held constant

Question 36

Indirect Utility function

Answer 36

shows the maximum utility that a consumes can get as a function of the prices of the goods and the amount of money that they have available to spend
V(Px,Py,M)

Question 37

Compensating variation

Answer 37

How much extra money would a consumer need after a price increase to get them back to the utility level that they had before the price increase?

Question 38

To calculate the Compensating Variation

Answer 38

use the expenditure function to find out how much money the consumer would need at the new prices to get the original level of utility.
The CV is the difference between this and the original amount

Question 39

Equivalent variation

Answer 39

How much money would a consumer be willing to pay to avoid a price increase?

Question 40

To calculate the Equivalent Variation

Answer 40

use the Expenditure Function to find how much money the consumer would need at the original prices to get the new level of utility.
The EV is the difference between the original amount and this amount.

Question 41

Equivalent budget constraint

Answer 41

Has the same slope as original (before price change) budget constraint
Tangent to the new indifference curve