Week 1 - Consumer Theory Flashcards
1
Q
Indifference Curves
A
Used to represent our preferences over two goods
2
Q
Utility Function
A
- Mathematically represents preferences and over set of goods
- Only used to compare bundles. Values in and of themselves are useless.
3
Q
Assumptions for rationality and utility functions
A
- Transitivity. (if a>b & b>c, then a>c)
- Completeness - always have a preference between two bundles.
- Continuity
- Motonicity - more is better
- Convexity - averages are better than extremes
4
Q
(i) What do these indifference curves tell us about:
1. Monotonicity
2. Convexity
(ii) Why can’t indifference curves cross
A
- Monotonicity - Indifference curve through e would be preferred to c.
- Convexity - Prefer c to a and b
(ii) In figure, satisfaction from point A and from B on IC1 will be the same. Similarly, points A and C on IC2 also give the same level satisfaction. It means points B and C should also give the same level of satisfaction. However, this is not possible, as B and C lie on two different indifference curves, IC1 and IC2 respectively and represent different levels of satisfaction
5
Q
Monotonic Transformations
A
Transforms set of numbers into another while preserving the order of preferences
6
Q
Marginal rate of substitution (MRS)
A
- The ratio which consumer if willing to trade goods, as long as utility is constant
- represented by slope of the indifference curve
7
Q
Perfect Substitutes
A
- Good which consumer has identical preference for.
- MRS is constant. Willing to substitute 1 to 1, as derive same utility from each good.
- Indifference curve is linear
8
Q
Perfect Complements
A
- Two goods that must be consumed together
- MRS is 0 on horizontal axis. MRS is infinity on horizontal axis.
9
Q
Cobb Douglas
A
- alpha and not alpha always positive otherwise would violate motonicity axiom. that is more would actually be less.
10
Q
Budget contraints
A
- Bundle of good x and y that leaves consumer with no unspend income.
- Given by, p1x1 + p2x2 = Y
- Slope of budget line is p1/p2
