quiz 1 - consumer choice, demand curves, elasticity Flashcards
people don’t have the same preferences. why is this important?
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
transitivity
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.
how to think of an indifference curve
it is a combination of two utility curves (utility curves for two different goods)
what is the slope of an indifference curve
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)
what is the slope of a budget constraint
the price of the good relative to the other good
in which direction do indifference curves bow
inwards
what does a straight-ish indifference curve mean? how about a bowed one
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
3 main assumptions of indifference curves
completeness
transitivity
more is better
completeness
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
more is better
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)
what do budget constraints show?
what do indifference curves show?
whilst budget constraint emphasizes the scarcity that a consumer faces, indifference curves represent his preferences
what is a demand curve in words?
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
what does “change in demand” mean
it means a shift of the demand curve, not a movement along it
name 3 kinds of elasticity
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
income elasticity of demand
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
price elasticity of demand
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)
how does own price elasticity change over time (from short term to long term)
short term, there are no substitutes, so it’s relatively inelastic
longer term, substitutes emerge, so it’s more elastic
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
luxury goods
long run
brand
greater share of expenditure
how does own price elasticity of demand affect firm revenue
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
cross price elasticity of demand
% 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)
do utility curves consider scarcity
no
