Exam 1 Definitions Flashcards
Assumptions
a consumer will choose the best bundle of goods and services that they can afford
Ex ante
before fact
ex past
after the fact
Bundle
collection of good/services & quantity of each
Best
consumer preferences
can afford
budget constraint
Budget Constraint Equation
Px * x + Py * y = M
Marginal rate of transformation
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
Marginal rate of transformation value
-Px/Py
Notation
typically use lowercase letters of alphabet to represent bundles of goods and the higher letters of the alphabet to represent the goods
Indifference curve
shows a set of bundles which all make the consumer equally well off
Utility function
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
Ordinal
ranking
Cardinal
Number
Marginal Utility
The extra utility gained by a consumer from consuming an additional unit of a good
Marginal rate of substitution (MRS)
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.
Marginal rate of substitution (MRS) value
-MUx/MUy
Law of diminishing utility
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
Cobb-douglas utility function
U(X,Y)=(x^alpha)(y^beta)
Cobb-douglas utility generates…
strictly convex indifference curves
Perfect complements function
U(X,Y) = MIN (underscore alpha A, underscore beta Y)
Perfect complements generates
L shaped indifference curves
Perfect substitution
U(X,Y) = underscore alpha A + underscore beta Y
Perfect substitution generates
linear indifference curves
True or false: MRS = MRT
true
logic lesson
necessary and sufficient conditions
Proof by contrapositive
to prove the statement “if A then B”, begin by assuming “not B” and show that this must mean “not A”
Price consumption curve (PCC)
shows how the consumers optimal bundle changes when the price of a good changes while holding the prices of other goods and income constant
Income consumption curve (ICC)
shows how the consumer’s optimal handle changes when the consumer’s income changes while holding the prices of the goods constant
Engel curve
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
Substitution effect
if the price of good x is now relatively less expensive than other goods, so the consumer will substitute good x for other goods
Income effect
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
Slutsky income/substitution effect
Holds the consumer’s buying power constant
Hicksion income/substitution effect
Holds the consumer’s utility constant
Compensated budget constraint
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
Indirect Utility function
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)
Compensating variation
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?
To calculate the Compensating Variation
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
Equivalent variation
How much money would a consumer be willing to pay to avoid a price increase?
To calculate the Equivalent Variation
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.
Equivalent budget constraint
Has the same slope as original (before price change) budget constraint
Tangent to the new indifference curve
