Theory of the consumer

Question 1

What is a consumption bundle?

Answer 1

A bundle that contains different quantities of the various goods a consumer would like to consume

Question 2

What is utility?

Answer 2

Utility is the satisfaction that a consumer derives from consuming a particular consumption bundle

Question 3

What assumptions does consumer demand theory make around utility?

Answer 3

Completeness (bundles can be ranked in terms of their utility)
Transitivity (the utility ranking of bundles is internally consistent)
Preference for ‘more’ to ‘less’

Question 4

Define diminishing marginal rate of substitution

Answer 4

In order to hold utility constant, diminishing quantities of a good or service need to be sacrificed so as to obtain successive equal increases in the quantity of another good. The assumptions regarding utility and the principal of diminishing MRS gives us the indifference curve.

Question 5

What is a budget constraint?

Answer 5

All possible bundles the consumer can afford with her money income. Income (y) = Price of good y x Quantity of good y + Price good x x Quantity good x

Question 6

What happens to consumption of a normal good when income changes?

Answer 6

Consumption increases when income increases (and vice versa)

Question 7

What happens to consumption of an inferior good when income changes?

Answer 7

Consumption falls when income increases (and increases when income falls)
Inferior goods would be fast food and cheap groceries etc

Question 8

What is Bertrand competition?

Answer 8

A market structure where it is assumed that there are two firms, who both assume the other firm will keep prices unchanged. Therefore, each firm has an incentive to cut prices, but this actually leads to a price war. If products are perfect substitutes this assumes the price will be driven down to marginal cost. This is allocatively efficient (P=MC) but firms may not cover their fixed costs.

Question 9

What is an oligopoly?

Answer 9

Oligopoly markets are markets in which only a few firms compete, where firms produce homogeneous or differentiated products, and where barriers to entry exist that may be natural or constructed. Three main types: Bertrand, Stackelberg and Cournot

There are different possible outcomes for oligopoly:

Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price competition.
Price wars (competitive oligopoly)
Collusion- leading to higher prices.

Question 10

What is Stackleberg competition?