L1 - Consumer Choice & Demand Flashcards
When it comes to Consumer Preferences what is our primary objective?
To develop an economic model that we can use to explain how consumer make decisions/choices
What 2 key factors determine individuals’ choices?
1 - Preferences
• What goods does the consumer like?
2 – Constraints
• How much money do you have, what are the prices of the goods?
What are the Comparison Assumptions?
1 - Completeness
2 - Transitivity
3 - More is better
Comparison Assumptions - What is Completeness?
Consumer can compare goods and rank them based on their preferences
Comparison Assumptions - What is Transitivity?
- Holding consistent rankings of bundles
- If an individual prefers bundle A to bundle B & he also prefers bundle B to bundle C, then if transitivity is applied he must also prefer bundle A over bundle C.
Comparison Assumptions - What is More is Better?
For most goods, more is better than less
Why do we use Indifference Curves?
to model consumer preferences, to describe an individual’s willingness to trade one bundle for another.
If a consumer prefers good A to good B, then which good will he receive more utility from consuming?
Good A
If a consumer is indifferent to good A and good B, which will he prefer to consume?
Neither, because he is Indifferent he will receive the same amount of satisfaction from consuming both goods.
What do Indifference Curves show us?
All the combinations of consumption bundles, that will provide the consumer with the equal level of satisfaction (utility)
What are the 4 characteristics of Indifference Curves?
1 - They can be drawn
2 - Consumers prefer higher Indifference Curves
3 - Indifference curves never cross
4 – Diminishing Marginal Returns of a Good
4 Characteristics of Indifference Curves - They can be drawn.
Satisfies the consumer preference assumption of completeness.
4 Characteristics of Indifference Curves - Prefer higher Indifference Curves.
Satisfies the consumer preference assumption of More is Better.
4 Characteristics of Indifference Curves - Curves never cross.
Satisfies the consumer preference assumption of Transitivity.
4 Characteristics of Indifference Curves - Diminishing Marginal Returns of a Good.
• The more a consumer has of a certain good, the less they are willing to give up of something else to get more of that good.
What does the Marginal Rate of Substitution show us?
Tells us how willing an individual is to give up one good for another good.
The slope of an Indifference Curve is the ….
Marginal Rate of Substitution (MRS)
What is the Equation for MRS
MRS = (Change in Y) / (Change in X)
What does the equation for MRS (Change in Y / Change in X) tell us?
Describes the rate at hich an individual is willing to trade off or substitute exactly 1 unit of good X for more of good Y, without reducing Utility.
What does the steepness of the Indifference Curve imply about consumer preferences?
Steeper Curves - Imply consumer is willing to give up a lot of good Y to get one unit of good X.
Flatter Curves - Imply the consumer would require a large increase in good X to give up one unit of good Y.
Generally, a well-behaved indifference curve exhibits …
Diminishing Marginal Rate of Substitution
What does the shape of the Indifference Curve inform us about?
The relationship between the products
Relationship between products - What kind of product relationship does a straight indifference curve show us?
Shows that these goods are substitutes.
Relationship between products - What kind of product relationship does an indifference curve that is convex towards the origin show us?
Shows us that the goods are more complimentary to each other
For a Perfect Substitute Indifference Curve MRS is …
Constant
For perfect compliments individuals consume these in …
Constant Proportion
What does Constrained Optimisation mean?
Is when consumers try to make the best decisions (optimisation) given the constraints they face such as the price (constraint) of a good.
Define Consumption Bundle.
A set of goods or service a consumer considers purchasing
Define Utility Function.
Is a mathematical function that describes the relationship between what consumer actually consume and their level of well-being.
