topic 4 - consumer theory 1

Question 1

in a consumption bundle how many possible good do we assume there to be (for introduction to economics module)

Answer 1

2 goods

Question 2

axioms of consumer theory means?

Answer 2

assumptions of consumer therory

Question 3

state the 5 axioms (assumptions) of consumer theory

Answer 3

1. competetivness
2. transitivity
3. monotonicity
4. locan nonsatiation
5. convexity

Question 4

1 of the 5 axioms:
1. Completeness…

Answer 4

A consumer can rank bundles (A preferred to B) or be indifferent)

Question 5

1 of the 5 axioms:
2. Transitivity…

Answer 5

A consumer’s preferences are logically consistent.

Question 6

1 of the 5 axioms:
3. Monotonicity:

Answer 6

more is better

Question 7

1 of the 5 axioms:
4. Local Nonsatiation…

Answer 7

A weaker form of monotonicity; you can always find a better, more preferred bundle.

Question 8

1 of the 5 axioms:
5. Convexity…

Answer 8

People prefer variety.

Question 9

notation for notation theory:
x ≽ y means…
x ≻ y means…
x ~ y means…

Answer 9

x ≽ y means that bundle x is weakly preferred to bundle y

x ≻ y means that x is strongly preferred to bundle y

x ~ y means that the two bundles are equivalent to each other (consumer is indifferent to bundles x and y)

Question 10

what do we say is the objective of the consumer when dealing with consumer theory? (when axioms 1 and 2 are followed)

what is utility?

how can it be written?

Answer 10

obtain the highest utility

the benefit the consumer gets (call it ‘happiness’ he receives)

U(x, y) (may need to pit more information form flash card 11)

Question 11

utility functions are considered to be ______ or _____

a utility is a c_____ measure if….
a utility is a o_____ measure if…

we normal think of utility as _____ because…

Answer 11

cardinal or ordinary

if we can give numbers to
different levels of utility AND therefore make absolute comparisons (e.g utility of 100 > utility of 50)

if only the ranking between
different bundle matters.
(We cannot make absolute comparisons)

it is hard to put a unit on ‘happiness’

Question 12

definition of indifference curve is…

draw a indifference curve on a graph where the utility function is defined as:
U(x, y) = xy = C
where (C is constent)
1. where c = 6
2. where c = 12

Answer 12

combination of all bundles that have the same level of utility ((equally desirable to consumer)
∴ consumer is indifferent to bundles along this curve
(i.e indifference curve))*

look on slide 19

Question 13

what are the main propitiates of a well behaved indifference curve?(5)

Answer 13

1.) bundles further form the origin are prefered (monotonicity)

2.) There is an indifference curve through every possible bundle
(because of completeness of preferences)

3.) Indifference curves cannot cross
(because of transitivity of
preferences)

4.) Indifference curves slope downward
(because of strong
monotonicity)

5.) Indifference curves cannot be “thick” (because of local
non-satiation / monotonicity)

Question 14

every point on a indifference curve has the same ______ ______ because of ________ ∴ all indifference curves have a _____ ______ ∴ _____ _____

Answer 14

utility value, completeness (of preferences), unique value, cannot cross

Question 15

Marginal Rate of Substitution (MRS) is the…

∴we can write MRS as:
MRS (over 2 points) =
or MRS (at a single point) =

MRS is always a ________ value

is MRS different along the same indifferent curve?

diminishing rate of return is the reason the curve gets ______ the further along the x axis. this is because

Answer 15

The max amount of good A a consumer will sacrifice to obtain one unit of good B, while maintain the same overall utility level

MRS = Δy/Δx
MRS = dx/dy

negative

yes

flatter.
the more abundant a good is the less valued it is ∴ the more consumers are willing to give up

(think of it as the price a consumer is willing to pay at any given time for a unit of good A but insted of money the consumer is paying in units of another good B) ∴ MRS ,how many units of B they are willing to give up, would depend on the how abundent good B is and how scarce good A is)

Question 16

budget constant is given by the equation… where (state what each part means) …
or you can rearrange it to form the equation of the line,…

• p(x)/p(y) is the gradient of the budget constant line but what else can you call - p(x)/p(y)?

draw budget constraint graph

Answer 16

M = p(x)x + p(y)y
where p(x or y) is price and x or y is quantity of good and M is total income
rearrange to give:
y = - p(x)/p(y) * x + M/p(y)

the opportunity cost of x in terms of y

-graidiant straight line (slide 33)
y intercepct is M/p(y)
x intercept is M/p(x)

Question 17

budget constraint graphs:
draw graph for:
a decrease and increase in M and

decrease and increase in p(x) and p(y)

Answer 17

slides 36-41

Question 18

how do you calculate the optimal consumption bundle?

what does the right and left hand sides represent?

draw a rough graph that can represent the optimal consumption bundle

Answer 18

where
|MRS|=p(x)/p(y)
(at this point the gradient of the MRS and budget line are equal)

|MRS| represents the benefits of consuming x as compered to y
p(x)/p(y) represents the opportunity cost of x in terms of y

see slide 51

Question 19

when x and y are perfect substitutes (and convexity is not followed e.g U(x, y) = x + y what does MRS/indifferent curve graphs look like?

what will the consumer do in this situation?

does |MRS|=p(x)/p(y) hold as the optimal bundle in this case?

when
|MRS| > p(x)/p(y) the solution for the consumer is…
|MRS| < p(x)/p(y) the solution for the consumer is…

Answer 19

they are both negative straight linear lines (slide 57)
consume only the good which gives more utility per unit money spent (cheapest one)

no

only consume good x
only consume good y
(not sure why this last one happens need to look into this more)slide 57/58

Question 20

what is the typical utility function that creates a perfect substitution indifference curve?

Answer 20

U(x, y) = cx + dy (c&d +ve constents)

(not sure about this one need to look into this)

Question 21

when are 2 goods perfect complements?

draw a graph for when 2 goods are perfect complements (e.g left and right shoes)

what is the general utility function equation for this?

Answer 21

when they are consumed together in fixed proportions

see slide 59

U(x, y) = min{x, y}

Question 22

what is the substitution effect? (budget constraint lines)

Answer 22

the change in the consumption bundle purely on change in price alone

Question 23

what is the income effect? (budget constraint lines)

Answer 23

the change in the consumption bundle purely on the change in income alone