Theory Of Consumer Choice

Question 0

What are the assumptions of the standard economic model

Answer 0

Buyers are rational
More is preferred to less
Buyers seek to max utility
Consumers act in self interest and don’t consider utility of others

Question 1

Standard economic model

Answer 1

Theory of consumer choice which examines how consumers facing these trade offs make decisions

Question 2

What is the budget constraint?

Answer 2

Limit on the consumption bundles that a consumer can afford

Question 3

What the consumer wants: what is the choice set

Answer 3

Set of alternatives available to the consumer

Question 4

What the consumer wants: indifference curves

Answer 4

A curve that shows consumption bundles that give the consumer the same level of satisfaction

Question 5

Indifference curves: the axiom of comparison

Answer 5

2 bundles of goods, A and B representing consumer choice
Consumer can compare bundles so that A is preferred to B
Or the consumer is indifferent between A and B

Question 6

Indifference curves: the axiom of transitivity

Answer 6

3 bundles, A, B and C
If consumer prefers A to B, and B to C, then he must prefer A to C
If consumer is indifferent between A and B, and B an C, then he is between A and C

Question 7

What are the 4 properties of indifference curves

Answer 7

1) higher indifference curves (further right the curve is ) are preferred to lower ones
2) indifference curves are downwards sloping
3) indifference curves do not cross
4) indifference curves are bowed inward

Question 8

What is the marginal rate of substitution

Answer 8

The rate at which a consumer is willing to trade one good for another

MUx/MUy (MU=marginal utility)

Question 9

What are perfect substitutes?

Answer 9

2 goods with straight line indifference curves

Question 10

What are perfect compliments

Answer 10

2 goods with 90* curves

Question 11

What is the consumers optimal choice

Answer 11

Consumers are constrained by resources available (shown by budget constraint)
- consumer chooses point on budget constraint that lies on highest indifference curve

Question 12

What does the MRs equal at optimum

Answer 12

MRs=MUx/MUy
And at opt. MRs=Px/Py
So

MUx/MUy = Px/Py

Question 13

What is the income effect

Answer 13

Change in consumption that results when a price change moves the consumer to a higher or lower indifference curve

Question 14

Substitution effect

Answer 14

Change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution

Question 15

Deriving the demand curve: what is the price-consumption curve

Answer 15

A line showing the consumer optimum for 2 goods as the price of 1 changes, assuming incomes and the price of the good are held constant

Question 16

What is the engel curve

Answer 16

Line showing relationship between demand and levels of income

Question 17

What is a giffen good

Answer 17

Good where an increase in price raises the Qd

Question 18

What is bounded rationality

Answer 18

The idea that humans make decisions under the constraints of limits and sometimes unreliable info

Question 19

Why are people not rational

Answer 19

They are overconfident
Give too much weight to a small no. Of vivid observations
Reluctant to change their minds
Natural tendency to look for examples which consider their existing view
Use rule of thumb- heuristics

Question 20

What are heuristics

Answer 20

Short cuts that people use in decision making

• anchoring (people start with something familiar)
• availability (decisions made based on assessment of risks of likelihood something happening)
• representativeness (judgements by comparing how representative it is to stereotype)
• persuasion(linked to various attributes that a consumer attaches to a product/brand)
• Simulation (people use mental processes to establish likely outcome)

Question 21

What is expected utility theory

Answer 21

The idea that preferences can and will be ranked by buyers