Public Finance - Chapter 2

Question 1

What are Theoretical tools of Public Finance?

Answer 1

The set of tools designed to understand the mechanics behind economic decision making.

Question 2

What are Empirical tools?

Answer 2

The set of tools designed to analyze data and answer questions raised by theoretical analysis.

Question 3

What is a Utility function?

Answer 3

A mathematical function representing an individual’s set of preferences, which translates her well-being from different consumption bundles into units that can be compared in order to determine choice.

Question 4

What is Constrained utility maximization?

Answer 4

The process of maximizing the well-being (utility) of an individual, subject to her resources (budget constraint).

Question 5

What are Models?

Answer 5

Mathematical or graphical representations of reality.

Question 6

What is Indifference curve?

Answer 6

A graphical representation of all bundles of goods that make an individual equally well off.

Because these bundles have equal utility, an individual is indifferent as to which bundle he consumes.

Question 7

Consumers prefer _____ indifference curves.

Answer 7

higher

Question 8

Indifference curves are always ______ sloping

Answer 8

downward

Question 9

What is the utility function mathematical representation?

Answer 9

U = f(X_1,X_2,X_3,…)

Question 10

What is X_1,X_2,X_3,… ?

Answer 10

They are the quantities of the goods consumed.

Question 11

What does the f mathematical function describe?

Answer 11

How consumption of each good translates to utility.

Question 12

What is marginal utility?

Answer 12

The additional increment to utility obtained by consuming an additional unit of a good.

Question 13

What is Diminishing marginal utility?

Answer 13

The consumption of each additional unit of a good makes the individual less happy than the consumption of the previous one.

Question 14

What is a Diminishing marginal utility example?

Answer 14

The first bite of pizza is often the tastiest.

Question 15

What is Marginal rate of substitution (MRS)?

Answer 15

The rate at which a consumer is willing to trade one good for another.

Question 16

What is the MRS equal to?

Answer 16

The MRS is equal to the slope of the indifference curve, the rate at which the consumer will trade the good on the vertical axis for the good on the horizontal axis.

Question 17

What is a Budget constraint?

Answer 17

A mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income.

Question 18

What is Opportunity cost?

Answer 18

The cost of any purchase is the next best alternative use of that money, or the forgone opportunity.

Question 19

When a person’s budget is fixed, if he buys one thing he is, by definition, reducing the money he has to spend on other things. What does this purchase have the same effect as?

Answer 19

Indirectly, this purchase has the same effect as a direct good-for-good trade.

Question 20

What is the Substitution effect?

Answer 20

Holding utility constant, a relative rise in the price of a good will always cause an individual to choose less of that good.

Question 21

What is the Income effect?

Answer 21

A rise in the price of a good will typically cause an individual to choose less of all goods because her income can purchase less than before.

Question 22

For Normal goods, how do changes in income affect demand?

Answer 22

Goods for which demand increases as income rises.

Question 23

For Inferior goods, how do changes in income affect demand?

Answer 23

Goods for which demand falls as income rises.

Question 24

What is a Market?

Answer 24

The arena in which demanders and suppliers interact.

Question 25

What is Market equilibrium?

Answer 25

The combination of price and quantity that satisfies both demand and supply, determined by the interaction of the supply and demand curves.

Question 26

The study of the determinants of well-being, or welfare, in society.

Answer 26

Welfare economics

Question 27

What is a Demand Curve?

Answer 27

A curve showing the quantity of a good demanded by individuals at each price.

Obtained by finding the utility-maximizing bundle at each price.

Question 28

What is the Elasticity of demand?

Answer 28

The percentage change in the quantity demanded of a good caused by 1% change in the price of that good.

Question 29

Quantity demanded falls as price ____.

Answer 29

rises

Question 30

Elasticities of demand are typically not constant along a ________.

Answer 30

demand curve.

Question 31

What is cross-price elasticity?

Answer 31

The effect of one good’s prices on the demand for another good is the cross-price elasticity

Question 32

When the elasticity of demand is zero, the demand curve is perfectly ______

Answer 32

inelastic

Question 33

When the elasticity of demand is infinite, the demand curve is perfectly ______

Answer 33

elastic

Question 34

When the demand curve is perfectly inelastic, the demand curve is _____, and quantity demand does not change when price rises

Answer 34

vertical

Question 35

When the demand curve is perfectly elastic, the demand curve is _____.

Answer 35

horizontal

Question 36

When the demand curve is perfectly elastic, quantity demanded

Answer 36

Changes infinitely for even a very small change in price