Rational consumer choice

Question 1

Preference ordering

Answer 1

A ranking of all possible consumption bundles in order of preference

Question 2

Properties of preference orderings

Answer 2

• Completeness
• More-is-better
• Transitivity
• Convexity
• (Cardinal vs Ordinal Utility)

Question 3

Completeness

Answer 3

A preference ordering is complete if it enables the consumer to rank all possible combinations of goods and services

Question 4

More-is-better

Answer 4

More of a good is preferred to less of that good

Question 5

Transitivity/Consistency

Answer 5

If you prefer bundle A to bundle B and bundle B to bundle C, you prefer bundle A to bundle C

Question 6

Convexity

Answer 6

• 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

Question 7

Indifference curves

Answer 7

A set of bundles among which the consumer is indifferent

Question 8

Indifference map

Answer 8

A representative sample of the set of a consumer’s indifference curves, used as a graphical summary of his/her preference ordering

Question 9

Properties of indifference curves

Answer 9

• 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

Question 10

Marginal rate of substitution (MRS)

Answer 10

• 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

Question 11

Diminishing marginal rate of substitution

Answer 11

• 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)

Question 12

Movement between 2 points on indifference curve

Answer 12

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

Question 13

Budget line

Answer 13

• 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

Question 14

Composite good

Answer 14

In a choice between a good X and numerous other goods, the amount of money the consumer spends on those other goods

Question 15

Best feasible bundle

Answer 15

• 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

Question 16

Kinked budget line

Answer 16

• 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

Question 17

Corner solution

Answer 17

In a choice between two goods, a case in which the consumer does consume only one of the goods

Question 18

Cash or Food Stamp

Answer 18

• 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

Question 19

Marginal utility

Answer 19

Change in total utility if an extra unit of the good is consumed

Question 20

Utility function

Answer 20

For each possible bundle of goods, a utility function yields a number that represents the amount of satisfaction provided by that function

Question 21

Study last 2 slides

Answer 21

Study last 2 slides

Question 22

Ordinal utility

Answer 22

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

Question 23

Cardinal utility

Answer 23

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