Topic 1/2 - Consumer Theory/Utility, Preference, Indifference Curves Flashcards
Outline basic ideas of standard economic theory of consumer behaviour
- tastes/prefernces determine the pleasure they derive from consuming goods/services
- optimise subject to constraints
- aim to maximise utility, no mistakes are made so we do not make random choices
- we tend to not maximise utlity because of time constraints; the choice make now gives us utility in short temr but we incurr a cost in the long term
Equation for budget constraint and basic idea of BC
M >= X(Px) + Y(Py)
m is income and x and y are a bundle of two goods
- any bundle below the budget constraint is affordable, on the line is just affordable, beyond is unaffordable
What does slope of the budget constraint measure
- trade off the market imposes on consumer
- THE AMOUNT OF ONE GOODS A CONSUMER MUST GIVE UP TO OBTAIN MORE OF ANOTHER GOOD
- aka opportunity cost / marginal rate of transformation
- the slope is -p1/p2 where 1 represents price of goods on x axis and p2 is price of goods on y axis
is income and budget exogenous or endogenous?
income : exogenous as it is set outside of the model
bduegt: endogenous
Define opportunity cost in context of the budget constraint
- Opportunity cost if the cost of something measured in terms of the next best
alternative - if you want to
increase your consumption of one good, you have to reduce your consumption of
the other good. - The opportunity cost is therefore how many units of the other good you have to sacrifice
- this depends on the price of the two goods
What are the three types of preference
- strict preference: > clear preference
- weak preference >= (prefer but also idm)
- indifference ~ (idrc)
we only care about ordinal relations (ranking all based on liking rather than saying how you like them individually)
5 assumptions of preference
These are assumed if the consumer is said to be rational
completeness, transivity, continuous, monotonicity, convexity
A preference is only well behaved if monotonicity and convexity is shown
What is completeness
completeness: the consumer can always compare/rank bundles and make a decision (they are not stucl they either have a strict/weak preference or indifference)
What is transivity
if you like x more than y and you like y more than z then theoretically, x is liked more than z
What is “continuous”
Tiny changes in bundles will not change the preference ordering
What is monotonicity
if one bundle Y (y1,y2) has at least as much as both goods and more of one then this bundle is preferred to the other X (x1, x2)
AKA MORE IS BETTER! (non-satiation)
What is convexity
- averages are better than extremes where there is a mix of goods rather than just loads of one
- an avaergae of two bundles, whereby (x1,x2) ~ (y1,y2) will be (at least weakly) preferred, for any 0<t<1
What do indifference curves show
- Utility dervied from consuming a good
- ICs are continuous
- most people’s indifference curves are convex to the origin
- IC are downward sloping
- IC curves are made up of connecting dots representing different bundles which yield the same utility
- the further the IC from origin, the higher the utility
What happens if indifference curves cross
- it gives irrational behaviour as transivity is violated
What factprs affect utility
- psychological attitudes
- peer group pressures
- personal experiences
- general culture environment; e.g clothes celebrtit
- time; we discount future, today is more valuab;e
CETERIS PARIBUS
- only consider choices among quantifiable options
- hold constant other things that affect behaviour; we can’t change everything
