Price Elasticity of Supply and Consumer Behavior Flashcards
Assumptions of Consumer Theory
OIBN
- Optimization
- Information
- Bundling
- Non-satiation
Assumed that all individuals make consumption decisions with the goal of maximizing their total satisfaction from consuming various goods and services.
Optimization
In consumer theory, it doesn’t allow consumers to either spend less than their income (meaning no savings is allowed) or to spend more than their incomes (meaning no borrowing is allowed).
Optimization
The basic model of consumer theory seeks to explain how consumers make their purchasing decisions when they are completely informed about all things that matter.
Information
The consumer is expected to know all the products and services available.
Information
It is assumed that consumers know the prices of the goods and their income during the time period in question.
Information
Consumer theory requires that consumers can rank various combinations of goods and services according to the level of satisfaction associated with each combination.
Bundling
What do you call the combination of goods?
Consumption Bundles
States that consumers must be able to rank the bundles according to the level of satisfaction they would enjoy from consuming the bundles.
Complete
What happens when a consumption bundle offers more utility?
It would be ranked higher than another bundle.
What happens when two bundles give consumer the exact same amount of utility?
They would have the same ranking and the consumer is said to be indifferent to them.
When do you say that the consumer’s preferences are complete?
When a consumer can rank all conceivable bundles of commodities.
It means that the consumer’s choices are consistent in the following way:
Bundle A > Bundle B
Bundle B > Bundle C
Bundle A > Bundle C
Transitive
Why do consumer preferences must be transitive?
Inconsistent preferences would undermine the ability of consumer theory to explain or predict the bundles consumers will choose.
It prevents consumers from being caught in a perpetual cycle where they never make a choice.
Transitive
This concept assumes that consumers would always prefer to have more of the good, rather than less.
Non-satiation
It implies that if Bundle A has more goods than Bundle B, Bundle A would be preferred.
Non-satiation
This is a set of points representing different combinations of goods and services, each providing an individual with the same level of utility.
Indifference Curve
Characteristics of an Indifference Curve
- They are downward sloping.
- They are convex.
- They are bowed towards the origin.
When more of Good X is added, some of Good Y is taken away to maintain the same level of utility.
Indifference curves are downward sloping.
It means that as consumption of Good X is increased relative to consumption of Good Y, the consumer is willing to accept a small reduction in Y for an equal increase in X in order to stay at the same level of utility.
Convex shape
Consumers prefer a bit of everything rather than a lot of just one thing.
Bowed towards the origin.
Other Concepts in Consumer Theory
- Marginal Utility
- Marginal Rate of Substitution
It’s the additional utility that comes from consuming one more unit of a good, holding constant the amounts of all other goods consumed.
Marginal Utility
What do economists typically assume as the consumption of a good increases?
That the marginal utility from an additional unit of a good diminishes.
What are the two utilities that cannot be plotted on the same graph?
Total Utility and Marginal Utility
U is often called as what?
Utils
This is a measure of the number of units of Y that must be given up per unit of X added to maintain a constant level of utility.
MRS
Marginal Rate of Substitution
It restricts consumer behavior by forcing the consumer to select a bundle of goods that is affordable.
Budget Constraints
This is the line showing all bundles of goods that can be purchased at given prices if the entire income is spent.
Budget Line
What bundle of goods do we want to find when analyzing consumer choice?
- Maximizes satisfaction
- Allows the consumer to live within the budget constraint
What are the two conditions that a maximizing bundle must satisfy?
- Must be on the budget constraint.
- Must give the consumer the most preferred combination.
Applications of Indifference Curves
- Gifts and Gift Certificates
- Income and Leisure: Workers
- Corner Solutions
