quiz 1 - consumer choice, demand curves, elasticity

Question 1

people don’t have the same preferences. why is this important?

Answer 1

If everyone had identical preferences, there would be no reason to trade/exchange goods. As we will see later in the course, exchange is based on different valuations on the same goods

Question 2

transitivity

Answer 2

A > B
B > C

therefore A > C

indicates that consumers are consistent

however, they aren’t always; sometimes, people display the endowment effect – once you have something it seems worth more to you then before you had it.

Question 3

how to think of an indifference curve

Answer 3

it is a combination of two utility curves (utility curves for two different goods)

Question 4

what is the slope of an indifference curve

Answer 4

the marginal rate of substitution (how much of one good you must give up to get another unit of the second good whilst staying on the same indifference curve)

Question 5

what is the slope of a budget constraint

Answer 5

the price of the good relative to the other good

Question 6

in which direction do indifference curves bow

Answer 6

inwards

Question 7

what does a straight-ish indifference curve mean? how about a bowed one

Answer 7

straight means the goods are perfect substitutes and the MRS is constant

bowed means the goods are complements and the MRS is decreasing

if indifference curve is linear, then it’s a special case = perfect substitutes; in this case, MRS = constant

Question 8

3 main assumptions of indifference curves

Answer 8

completeness
transitivity
more is better

Question 9

completeness

Answer 9

Consumers can compare and rank all possible baskets. For any two market baskets A and B, a consumer will prefer A to B, will prefer B to A, or will be indifferent

Question 10

more is better

Answer 10

Goods are assumed to be desirable—i.e., to be good. Consequently, consumers always prefer more of any good to less. In addition, consumers are never satisfied or satiated; more is always better, even if just a little better (non-satiation)

Question 11

what do budget constraints show?

what do indifference curves show?

Answer 11

whilst budget constraint emphasizes the scarcity that a consumer faces, indifference curves represent his preferences

Question 12

what is a demand curve in words?

Answer 12

it is a reflection of a consumer’s preferences and budget constraint; in fact, it is derived from the interaction of a consumer’s budget constraint and indifference curve at different prices

they express a consumer’s attempts to maximize utility through his decisions

Question 13

what does “change in demand” mean

Answer 13

it means a shift of the demand curve, not a movement along it

Question 14

name 3 kinds of elasticity

Answer 14

price elasticity of demand (aka own price elasticity) - how D is affected for 1% change in its price
cross price elasticity - how D is affected by 1% change in price of another good
income elasticity - how D is affected by 1% change in income

Question 15

income elasticity of demand

Answer 15

for a normal good, it is positive because quantity demanded of a normal good should increase with 1% increase in income

for inferior goods, it’s negative

Question 16

price elasticity of demand

Answer 16

aka own price elasticity of demand or just elasticity

the one they usually mean

how sensitive quantity demanded of a good is to its own price

it is not constant; it changes even on a linear demand curve

always negative (but we often use the absolute value of this # in conversation)

Question 17

how does own price elasticity change over time (from short term to long term)

Answer 17

short term, there are no substitutes, so it’s relatively inelastic

longer term, substitutes emerge, so it’s more elastic

Question 18

which has greater own price elasticity (price elasticity of demand) (note: assume absolute value)

luxury goods vs. necessities

short run vs. long run

brand vs. category

greater share of expenditure vs. lower

Answer 18

luxury goods

long run

brand

greater share of expenditure

Question 19

how does own price elasticity of demand affect firm revenue

Answer 19

when demand is elastic, revenue is reduced with an increase in price

when demand is inelastic, revenue increases with an increase in price

firm revenue is maximized when own price elasticity is unitary

Question 20

cross price elasticity of demand

Answer 20

% change in quantity demanded for %1 increase in price of another good

if price of a substitute increases, quantity demanded will increase (positive)

if price of a substitute decreases, quantity demanded will decrease (negative)

if price of a complement increases, quantity demanded will decrease (negative)

if price of a complement decreases, quantity demanded will increase (positive)

Question 21

do utility curves consider scarcity

Answer 21

no