Remaining Terms Flashcards
Example of Utility (Perfect Substitutes)
U(x,y) = ax + by
Examples of Utility (Perfect complements)
U(x,y) = min{ax,by}
Examples of Utility (Cobb-Douglas Function)
U(x,y) = A(x^y)(y^c)
Examples of Utility Function (One good is bad)
U(x,y) = -ax + by
For utility functions MRS is…
the slope of the indifference curve.
If the utility function is
u(x,y) = x(y^2)
x(y^2) = C y = Square Root(c/x)
What is the budget constraint generally?
Px * x + Py * y
Whats the slope of the budget line?
Marginal Rate of Transformation
Px/Py
Why do budget lines shift?
Because of shifts in income
Why do budget lines rotate?
Because of a change in the price of one good.
Perfectly Elastic
Infiniti
elastic
Ed > 1
Inelastic
Ed
Unit Elastic
Ed = 1
Price Elasticity of Supply
Income/Cross Price Elasticity = tell about sensitivity of curve behavior in response to changes in income and other input factors
Sales Tax
Ad Valorem Tax (Tax is fraction of good’s total price)
Specific/Unit Tax
Gas tax (added per unit of the good sold)
What is the major tradeoff in economics?
Efficiency vs. Equity
What are the key differences between a perfectly inelastic demand curve and a perfectly elastic demand curve?
- ) Perfectly inelastic demand is characteristic of a good with no substitutes.
a. ) Insulin - ) Perfectly elastic demand is characteristic of a good with perfect substitutes.
a. ) Cola wars
What does elasticity represent about consumers’ responses?
Their response to a change in price.
If the elasticity is between 0 and -1 then firms can…
raise revenues by raising the price (since consumers will still buy the good in significant quantities
If the elasticity is less than -1 then…
raising the price results in a decline in firm revenue.
What are the three imposed assumptions about consumer preferences?
- ) Preferences are complete.
- ) Preferences are transitive
- ) Preferences cannot be satiated.
What are the four assumptions made about indifference curves stemming from the three imposed assumptions about indifference curve.
- ) Consumers prefer higher indifference curves.
- ) Indifference are downward sloping
- ) Indifference curves never cross
- ) there is one indifference curve through every consumption bundle.
Utility function is a function that…
transfers bundles of goods into a scale of utils; however, it provides only an ordinal ranking not a cardinal ranking.
A general assumption that is made…
is diminishing marginal utility: as more is consumed the consumer receives less utility.
or
a.) The consumer receives less utility with each consecutive unit that is consumed.
MRS =
(MUx)/(MUy)
- The ratio of marginal utilities.
- The utilities diminish as you move along the indifference curve
An increase in price has two effects
- it makes the consumer relatively poorer (income effect)
2. ) It also makes specific goods less attractive relative to alternatives (substitution effect).
The substitution effect can be interpreted as the shift in…
goods consumed from the original point to the optimal point for a budget for a budget constraint that has the new slope, but is tangent to the old indifference curve.
- ) Substitution effect is always…
2. ) Income effect can be…
- ) negative.
2. ) positive or negative.
1.) Accordingly, the overall effect of price increase on a normal good can be…
1.) Negative or positive.
A good with a positive own-price elasticity is known…
as a Giffen good
If the good is inferior then the income effect..
is larger than the substitution effect
income and substitution effects can be used to analyze…
labor supply
Leisure
(time not spent working) is a consumption good, and the price of that good is the wage, since that is the opportunity cost of time not spent working.
When the wage rate increase, this has both an income effect and a substitution effect.
- Expand
- Income effect: each worker is now richer, and may want to work less (represented by an increased consumption of leisure)
2.) Substitution Effect: returns to working are higher, each worker may want to work more.
(Policy Implication = if the income effect more than offsets the substitution effect, labor supply may go down when income increase.)
How does the marginal rate of substitution change as you move along a non-linear indifference curve?
- It’s downward sloping
- A non-linear indifference curve is concave to the origin, and the marginal state of substitution is declining as you move along the indifference curve to the right.
What is an appropriate intuitive explanation of the principle of diminishing marginal utility?
Everyone gets tired of consuming the same thing eventually.
How do “normal” and “inferior” goods differ in regard to their income effects?
‘Normal’ and ‘inferior’ are descriptive terms that can be used to describe whether the income effect is positive or negative, but they are not separate components of an overall price effect.
How can it be explained when consumption falls when the price increases?
Consumption falling when price increases is the most common case of own-price effect, where the substitution effect dominates the income effect.
When we model the consumer’s trade-off between consumption and leisure, what is the slope of the budget constraint?
The wage rate.
If the income effect dominates the substitution effect in the labor supply decision, what happens when the wage increases?
Workers work less.
Why would a worker work more after getting a raise if the income effect dominates?
When the wage increases, there is both an income effect (each worker feels relatively richer) and a substitution effect (each hour of work has higher returns.) A richer worker will want to consume more leisure (since it is a normal good), and thus will work less. On the other hand, the fact that each hour of work has higher returns may impel a worker to work more. If the first (income) effect dominates, then workers will work less at a higher wage.
If rural households in Vietnam begin to earn more money for their crops and become richer, what will happen to the supply curve for their children’s labor? (Hint: assume that education is a normal good.)
- It will shift left
- If education for children is a normal good, families will consume more of it (i.e., school attendance will increase) when their income increases. Accordingly, the supply curve for child labor will shift left because children are spending more time in school
What is the key difference between a weakly preferred set and a strictly preferred set in relation to the indifference curve?
The weakly preferred set includes the indifference curve and everything to the northeast whereas a strictly preferred does not include the indifference curve and consists solely of everything to the northeast.
