Rational Consumer Choice

Question 1

What is the equation of the line for the relative price of good Y?

Answer 1

Y= M/Py - Px/Py X
(Y= a + bx)

Question 2

What does the absolute value of the gradient of a indifference curve represent?

Answer 2

• The relative price of good x
• How much of of good y you forego for one more unit of good x

Question 3

What will shift a budget line?

Answer 3

• Changes in income
• If the change in good x prices is equal to the changes in good y prices

Question 4

What will change the gradient of a benefit curve?

Answer 4

• If the change in price of one good is greater of less than the other

Question 5

Explain Economic Indifference

Answer 5

• The Utility gained from good x consumption is the same as the Utility gained from good y consumption

Question 6

Name the 5 Properties of Preference

Answer 6

1. Completeness- You can compare any two consumption bundles and rank them- as utility is known
2. Transitivity- If the consumer prefers X>Y and Y>Z, X>Z naturally
3. More-Is-Better- If bundle X has more of everything than Y, X>Y
4. Continuity- If X>Y and X~Z then Z>Y
5. Convexity- Bundles in the middle are preferred to extreme values
   - 1/2(X+Y)

Question 7

What are the 4 properties of Indifference curves?

Answer 7

• Indifference Curves never touch
• Downwards sloping
• Getting more shallow
• Any point over the curve you will accept, but any point below you will not

Question 8

What does the Slope of an Indifference Curve represent?

Answer 8

• The Marginal Rate of Substitution (MRS)

Question 9

What is the Marginal Rate of Substitution (MRS) ?

Answer 9

• Maximum amount of good Y consumption that will be given up for one more unit of good X
• For every additional unit of shelter, the rate of change in food consumption (|x|)

Question 10

What is the optimal point of consumption? (refer to indifference curves)

Answer 10

• The highest possible indifference curve that comes into contact with the budget line

Question 11

What is the best outcome? (referring to MRS)

Answer 11

• MRS=Px/Py (MB=MC)

Question 12

Describe the indifference curves of a Perfect Compliment

Answer 12

• If Y=aX (where a is a constant), these are perfect compliments
• This will give an L-shaped curve, where the MRS is either ∞/0
• If the indifference curve is more deep, the stronger the compliments they are

Question 13

Describe the indifference curves of a Perfect Substitute

Answer 13

• If a consumer is always able and willing to give up food for the same amount of shelter, these are perfect substitutes
• This creates a downward sloping straight line, where MRS is constant

Question 14

Explain what the gradient (shape) of the indifference curve means in relation to the MRS

Answer 14

• If the curve is less steep (i.e- flatter), then the MRS will be low and they will value the consumption of good Y over the consumption of good X
• If the curve is more steep (i.e- less flat), then the MRS will be high and they will value consumption of good X over the consumption of good Y