The Theory of Individual Behaviour Flashcards
Consumer Behavior
What are consumer opportunities (budget constraints)?
What are consumer preferences (indifference curves)?
What are consumer opportunities (budget constraints)?
- Set of possible goods and services consumers can afford to consume.
What are consumer preferences (indifference curves)?
- Determine which set of goods and services will be consumed.
Properties of Consumer Preferences (4)
Completeness:
For any two bundles of goods either:
- π΄β»π΅.
- π΅β»π΄.
- π΄βΌπ΅.
More is better
- If bundle π΄ has at least as much of every good as bundle π΅ and more of some good, bundle π΄ is preferred to bundle π΅.
Diminishing marginal rate of substitution
- As a consumer obtains more of good X, the amount of good Y the individual is willing to give up to obtain another unit of good X decreases.
Transitivity:
For any three bundles, π΄, π΅, and πΆ, either:
If π΄β»π΅ and π΅β»πΆ, then π΄β»πΆ.
If π΄βΌπ΅ and π΅βΌπΆ, then π΄βΌπΆ.
β» means better than ; βΌ means indifferent
Properties of Consumer Preferences
What is an indifference curve? (3)
What is the marginal rate of substitution?
Indifference curve:
- A curve that defines the combinations of two goods that give a consumer the same level of satisfaction.
- Can indifference curves intersect?
NO - The higher the better, so in terms of utility,
III > II > I
Marginal rate of substitution (MRS):
- The rate at which a consumer is willing to substitute one good for another good and still maintain the same level of satisfaction.
Properties of Consumer Preferences - Indifference curves
Basic Characteristics (4)
What are perfect substitutes and perfect complements and examples of those?
Basic Characteristics:
- Higher indifference curves are better
- Indifference curves do not intersect
- Indifference curves slope downward
- Indifference curves are convex
Perfect substitutes are products that satisfy the same need.
e.g., car models.
Perfect complements are products consumed together.
e.g., cars and tires.
The Budget Constraint
What is it?
Formulas (2)
Basic Characteristics (2)
Market rate of substitution?
Effects of Changing Income and Prices (2)
Budget constraint
- Restriction set by prices and income that limits bundles of goods affordable to consumers.
Basic Characteristics
- Show affordable combinations of X and Y.
- Slope of βPX/PY reflects relative prices, also represents the market rate of substitution.
Market rate of substitution
The rate at which one good may be traded for another in the market; slope of the budget line.
Effects of Changing Income and Prices
- Budget increase (decrease) causes parallel outward (inward) shift.
- Relative price change alters budget slope.
The Budget Constraint In Action
The Market Rate of Substitution
The Budget Constraint - Effects of Changing Income and Prices
Example
The Budget Constraint in Action
Consumer Equilibrium
What is it (2)
Formula
- Consumption bundle that is affordable and yields the greatest satisfaction to the consumer.
- Consumption bundle where the rate a consumer choses (marginal rate of substitution - MRS) to trade between goods X and Y equals the rate at which these goods are traded in the market (ratio of prices).
Consumer Equilibrium in Action
Picture of graph
The curveis the marginal rate of substitution. (utility)
The Straight line is the market rate of substitution. (budget)
Comparative Statics - Price Changes and Consumer Equilibrium
Rule?
Goods X and Y are? (2)
Price increases (decreases) reduce (expand) a consumerβs budget set.
The new consumer equilibrium resulting from a price change depends on consumer preferences:
Goods X and Y are:
- substitutes when an increase (decrease) in the price of X leads to an increase (decrease) in the consumption of Y.
- complements when an increase (decrease) in the price of X leads to a decrease (increase) in the consumption of Y.
Price Changes and Consumer - Substitute goods case
Price Changes and Consumer - Complement goods case
From Indifference Curves to Individual Demand (picture)
From Individual to Market Demand (picture)
