Lecture 2- Consumers and their preferences Flashcards
What is a consumption bundle?
A consumption bundle is a set of goods that a consumer may choose to consume. Suppose the only goods available in the world are tea and coffee. Then a consumption bundle is any combination of cups of tea and coffee that the person could choose, and you can write
What are the three types of preference relations and their symbols?
1) Strict preference (>) - one bundle strictly preferred over another
2) Indifference (~) - consumer equally satisfied with either bundle
3) Weak preference (≥) - consumer prefers or is indifferent between bundles
What is the completeness assumption in consumer preferences?
Consumers can rank all affordable consumption bundles and compare any two bundles (X and Y) in one of three ways: X≥Y, Y≥X, or both (indifference)
What is the reflexivity assumption in consumer preferences?
Any bundle is at least as good as itself (X≥X). Every bundle belongs to at least one indifference set, containing at least itself
What is the transitivity assumption in consumer preferences?
If X≥Y and Y≥Z, then X≥Z. If consumer prefers X to Y and Y to Z, they must prefer X to Z
What is an indifference curve?
A locus of all combinations of goods that yields the same level of satisfaction for a consumer. All points on the curve denote equal levels of satisfaction
What are the five main characteristics of indifference curves?
1) Convex to the origin
2) Never touches either axis
3) Higher curves indicate higher satisfaction
4) Cannot intersect with each other
5) Negatively sloped
What is an indifference map?
A series of indifference curves showing different levels of satisfaction, where higher curves represent higher satisfaction levels
What are perfect substitutes and how do their indifference curves look?
Goods that can be used in place of another at a constant rate. Their indifference curves are straight lines with constant marginal rate of substitution (MRS=1)
What are perfect complements and how do their indifference curves look?
Goods always consumed together in fixed proportions (like left and right shoes). Their indifference curves are right angles, with best points at the corners
How do indifference curves for ‘bad’ goods look and what do they indicate?
Upward sloping curves, indicating consumer needs more of a good good to compensate for having to consume more of the bad good
What is a neutral good and how do its indifference curves look?
A good where more or less doesn’t affect satisfaction. Horizontal lines if X is neutral, vertical lines if Y is neutral
What is the point of satiation?
The highest point of satisfaction from consuming a good, beyond which additional consumption becomes bad
What does monotonicity of preferences mean?
Consumers always prefer more of any product compared to less, resulting in downward-sloping indifference curves
What is the convexity assumption?
Averages are preferred to extremes. A mixture of commodity bundles is at least weakly preferred to the extreme bundles themselves
What is Marginal Rate of Substitution (MRS)?
The rate at which a consumer is willing to exchange one good for another while maintaining the same level of satisfaction. It’s typically negative and diminishing
What is a budget line?
A line showing all possible combinations of two goods that can be purchased given the consumer’s income and the prices of goods. Expressed as: PxQx + PyQy = M
What determines the set of possible consumer choices?
1) The income/budget of the individual
2) The prices of available goods and services
How can you determine if a consumption bundle is feasible?
A bundle is feasible if it falls on or inside the budget line. Bundles outside the budget line are infeasible as they cost more than the available income
What makes preferences ‘well-behaved’?
Two attributes: 1) Monotonicity (more is better) and 2) Convexity (averages preferred to extremes)
