Lecture 2- Consumers and their preferences

Question 1

What is a consumption bundle?

Answer 1

A complete list of goods and services involved in a consumer’s choice problem

Question 2

What are the three types of preference relations and their symbols?

Answer 2

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

Question 3

What is the completeness assumption in consumer preferences?

Answer 3

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)

Question 4

What is the reflexivity assumption in consumer preferences?

Answer 4

Any bundle is at least as good as itself (X≥X). Every bundle belongs to at least one indifference set, containing at least itself

Question 5

What is the transitivity assumption in consumer preferences?

Answer 5

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

Question 6

What is an indifference curve?

Answer 6

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

Question 7

What are the five main characteristics of indifference curves?

Answer 7

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

Question 8

What is an indifference map?

Answer 8

A series of indifference curves showing different levels of satisfaction, where higher curves represent higher satisfaction levels

Question 9

What are perfect substitutes and how do their indifference curves look?

Answer 9

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)

Question 10

What are perfect complements and how do their indifference curves look?

Answer 10

Goods always consumed together in fixed proportions (like left and right shoes). Their indifference curves are right angles, with best points at the corners

Question 11

How do indifference curves for ‘bad’ goods look and what do they indicate?

Answer 11

Upward sloping curves, indicating consumer needs more of a good good to compensate for having to consume more of the bad good

Question 12

What is a neutral good and how do its indifference curves look?

Answer 12

A good where more or less doesn’t affect satisfaction. Horizontal lines if X is neutral, vertical lines if Y is neutral

Question 13

What is the point of satiation?

Answer 13

The highest point of satisfaction from consuming a good, beyond which additional consumption becomes bad

Question 14

What does monotonicity of preferences mean?

Answer 14

Consumers always prefer more of any product compared to less, resulting in downward-sloping indifference curves

Question 15

What is the convexity assumption?

Answer 15

Averages are preferred to extremes. A mixture of commodity bundles is at least weakly preferred to the extreme bundles themselves

Question 16

What is Marginal Rate of Substitution (MRS)?

Answer 16

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

Question 17

What is a budget line?

Answer 17

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

Question 18

What determines the set of possible consumer choices?

Answer 18

1) The income/budget of the individual
2) The prices of available goods and services

Question 19

How can you determine if a consumption bundle is feasible?

Answer 19

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

Question 20

What makes preferences ‘well-behaved’?

Answer 20

Two attributes: 1) Monotonicity (more is better) and 2) Convexity (averages preferred to extremes)