Lesson 3 Consumer Choice Theory

Question 1

What is the consumer’s budget constraint

Answer 1

1) shows the amount of 2 items that a person can buy (similar to how a PPF looks)
2) the line = budget constraint, shows the consumption bundles that a consumer can afford
3) person cannot satisfy their desires bc they are limited by income + market prices

Question 2

Slope of Budget Constraint Graph

Answer 2

1) Equals relative price of two goods
2) relative price = price of one good compared with price of another (trade-offs)

Question 3

How can budget constraint shift

Answer 3

1) increase income –> line shifts outward in both axes (since can buy more of each)
2) decrease in price of one object –> shifts upward ONLY on that axis

Question 4

Indifference curve

Answer 4

1) shows various bundles of consumption that make consumer equally happy
2) two points on same indifference curve make consumer equally happy

Question 5

Marginal rate of substitution

Answer 5

1) the rate at which a consumer is willing to trade one good for another
2) MRS not same at all points since it’s a curved line (take absolute value of slope)
3) this rate changes based on the quantities of the other items person is consuming

Question 6

Different indifference curves

Answer 6

1) for example if you prefer higher consumption, any indifference curve that is higher up is more preferred

Question 7

Four properties of indifference curves

Answer 7

1) higher indifference curves preferred to lower ones
2) indifference curves slope downward
3) indifference curves do not cross
4) indifference curves bowed inward

Question 8

Prop 1: higher indiff curves preferred to lower

Answer 8

1) people prefer to consume more than less
2) higher indifference curves –> higher quantities of goods –> consumer prefers them

Question 9

Prop 2: indiff curves slope downward

Answer 9

1) usually consumer likes most goods SO if one good decreases then other must increase for consumer to be equally happy
2) therefore indiff curves downward

Question 10

Prop 3: indiff curves don’t cross

Answer 10

1) if indiff curves crossed then that means that the higher points would bring equal satisfaction as lower points –> contradicts prop #1
(A on top, B intersection, C on bottom SO if B = A and B = C, A = C BUT C is higher so it’s false)

Question 11

Prop 4: Indiff curves bowed inward

Answer 11

1) Slope = Marginal Rate of Substitution
2) people more willing to trade goods they have in abundance –> causes it to bow inward
3) Initially have very little of x axis SO to give up one of x-axis –> need a lot of y-axis BUT later as x-axis increases, you will give it up for far less

Question 12

Extreme examples of indiff curves

Answer 12

1) perfect substitutes
2) Perfect complements

Question 13

Perfect Substitutes

Answer 13

1) goods are perfectly substitutable –> marginal rate of substitution is constant SO you get straight lines
2) ex = nickels and dimes

Question 14

Perfect complements

Answer 14

1) when items are more important as pairs rather than individually –> get right angles
2) ex = shoes, 5 lefts 7 rights and 7 lefts 5 rights and 5 rights 5 lefts are equal since you care about pairs
3) result = multiple right angles in indiff curves