The Rational Choice Model

Question 1

Rational Choice Model

Answer 1

Two items on a graph to get the rational choice model
Downward sloping budget line
Budget line = Opportunity cost of an additional unit of good X
- Below the line = affordable
- Above the line = inaffordable
Budget line = (Px x X) + (Py x Y) = I
Change in one good - change in line
Change in both - proportionate change = budget constraint shifts parallel to original
Change in income = budget constraint shifts parallel to original

Question 2

Consumer Preferences

Answer 2

Budgets sets’ what consumers can afford, not what is best
- Preference Ordering= Ranking all possible consumption bundles

Question 3

CP: Completeness

Answer 3

Consumers prefer either bundle A or B or are indifferent
- Indifference curve passes through every possible bundle
(graph)

Question 4

CP: Transitivity

Answer 4

If bundle A > bundle B and bundle B > bundle C, therefore bundle A > bundle C
(graph)

Question 5

CP: More-is-better

Answer 5

More of a good is always preferred to less of a good
(graph)

Question 6

CP: Continuity

Answer 6

Small changes in a good is preferred rather than a jump in preference
(graph)

Question 7

CP: Convexity

Answer 7

Mix of goods is better than extremities on either end
(graph)

Question 8

Marginal Rate of Substitution

Answer 8

Measures the willingness to pay on the vertical Y and the good on the horizontal X.
- MRS = change in Y/ change in X
Is equal to the absolute value of the slope on the indifference curve
- Indifference curve is convex, therefore MRS is diminishing as it goes along indifference curve

Question 9

Indifference Curve

Answer 9

• Downward sloping
• Convex to the original
• Goes through ever consumption bundle
• As indifference curve increases, utility (level of satisfaction consumer gets from bundle) increases

Question 10

Utility Functions

Answer 10

Assigns a no. to every possible bundle, the higher the preference the higher the number.
- Total utility increases as no. of goods increases

Question 11

Marginal Utility

Answer 11

Measures change in utility if consumption changes by 1 unit
- Principle of diminishing marginal utility: MU decreases and consumption increases

Question 12

Optimal Consumer Choice

Answer 12

Utility is maximised when benefit of consumption = opportunity cost
- Equal marginal principle: slope of an indifference curve = slope of budget constraint
If a consumer maximises utility by consuming 1 of the 2 goods this is a ‘corner solution’