Rational consumer choice Flashcards
Preference ordering
A ranking of all possible consumption bundles in order of preference
Properties of preference orderings
- Completeness
- More-is-better
- Transitivity
- Convexity
- (Cardinal vs Ordinal Utility)
Completeness
A preference ordering is complete if it enables the consumer to rank all possible combinations of goods and services
More-is-better
More of a good is preferred to less of that good
Transitivity/Consistency
If you prefer bundle A to bundle B and bundle B to bundle C, you prefer bundle A to bundle C
Convexity
- Mixtures of goods are preferable to extremes
- The more more of a good a consumer has, the more willing he/she is to trade it for another good
Indifference curves
A set of bundles among which the consumer is indifferent
Indifference map
A representative sample of the set of a consumer’s indifference curves, used as a graphical summary of his/her preference ordering
Properties of indifference curves
- Infinite number
- Negative slope
- Convex in relation to the origin
- Cannot cross
- More utility the further from the origin
- Slope becomes less from left to right
Marginal rate of substitution (MRS)
- The rate at which the consumer is willing to exchange good Y for good X
- Equal to the absolute value of the slope of the indifference curve
- = Change in Y / Change in X
Diminishing marginal rate of substitution
- Consumers are more willing to give up a good they have a lot of, to obtain more of a good they have little of
- The MRS decreases as you have more of good X (from left to right)
Movement between 2 points on indifference curve
0= 〖MU〗_Y (∆Y)+ 〖MU〗_X (∆X) 〖- MU〗_Y (∆Y)= 〖MU〗_X (∆X) -∆Y/∆X= 〖MU〗_X/〖MU〗_Y -∆Y/∆X=MRS of Y for X MRS = 〖MU〗_X/〖MU〗_Y
Budget line
- The set of all bundles that exactly exhaust the consumer’s income at given prices. Also called the budget constraint
- Slope = reverse price ratio of the goods - relative price of X in terms of Y
- Change in price of one product changes the slope of the budget line
- Equal proportionate change in both products’ prices lead or change in income to parallel shift of the budget line
Composite good
In a choice between a good X and numerous other goods, the amount of money the consumer spends on those other goods
Best feasible bundle
- Highest utility level given the budget constraint
- Where the budget line is tangent to the indifference curve
- MUy/MUx = Change in X/Change in Y
- MUy/MUx = Py/Px
- MUy/Py = MUx/Px
Kinked budget line
- When the relative price of one good changes in terms of the other
- If the relative price of X decreases, inward bend
- If the relative price of X increases, outward bend
Corner solution
In a choice between two goods, a case in which the consumer does consume only one of the goods
Cash or Food Stamp
- If the consumer usually spends less than the food stamp on food cash would be beneficial
- If the consumer usually spends more than the food stamp on food the consumer would be indifferent between cash and a food stamp
- Study p 76 to p 77
Marginal utility
Change in total utility if an extra unit of the good is consumed
Utility function
For each possible bundle of goods, a utility function yields a number that represents the amount of satisfaction provided by that function
Study last 2 slides
Study last 2 slides
Ordinal utility
People are able to rank each bundle in order of preference and does not require to make quantitative statements about how much they like the various bundles
Cardinal utility
People are able to rank each bundle in order of preference and requires you to be able to give a specific value to your level of satisfaction
