WEEK 1 + Week 2, Consumer theory Flashcards
What are the axioms of choice and what are there definitions
Completeness- either strictly prefer one to another or indifferent. there is no non answer
reflexivity- A bundle is at least as good as itself
transitivity- 3 bundles a,b,c
If A is better than or at least as good as b and b is better or at least as good as c. Than assume a is better or at least as good c
Marginal utility
additional utility you get from consuming one more good
how to work out marginal utility
first derivative of total utility
indifference curves
bundles of goods that give the same utility
what are the assumptions of well behaved preferences
continuity- for any bundle (a) their is another (b) that is slightly different so you’re indifferent between the two. tiny differences mean that you’re indifferent
monotonicity- more is preferred to less, if marginal utility is positive
convexity- average consumption bundles are preferred to extreme bundles (a lot of one good compared to another). Somwhere in the middle is at least as good utility if not more.
inferior good
a good that when income increase demand decreases- negative derivative.
normal good
a good that as income increase demand also increase- positive derivative
Economically feasible set
depends on the context e.g time constraint sleep 8 hours a day only have 16 hours to work with.
utility function
mathematical function mapping from an element of the consumption possibility set to the real number line (value of a consumption bundle)
What is the slope of an indifference curve
marginal rate of substitution (rate of which you’re wiling to sub one good for an additional unit of the other good while keeping utility constant.
Where can you find the Marginal rate of substitution and how can you work it out mathmatically
slope of inderference curve
dmarginal utility with respect to x/derivative marginal utility with respect to Y. (draw it)
Marshallian demand function
maths function which tells the quantity of x that you want to consume if you’re maxing your utility given the income you have and the prices you face
Marshalian demand function steps, just first lagragian steps
Lagragian- thing max on min first. Plus lambda in brackets is the constraint. Move everything to the left hand side of the constraint.
Law of demand
as prices rise demand decreases. inverse function and a downward sloping demand curve
substitution effect
change in demand away from one good to another
Income effect
as income decreases you can afford less stuff now so purchasing power decreases reducing demand.
overall change in demand
sub effect = income effect
Slutsky method
original consumption bundle A
Price of x rises,
new steeper budget constraint (straight line swings inwards as consumer can now afford less of good x),
new consumption point change is from a to b.
consumer given more income (Slutsky) to be able to afford good A. budget constraint pushed out to point A
new optimal consumption point is point C. as maximizes utility a consumes at the point of tangency between the indifference curve and the budget constraint
The effect from point A to C is the Sub effect as real income held constant and change in demand is due to relative prices changing
anything left is income effect
Hicks method
Consumer are given enough money to gain the same utility rather than the same original bundle- as slutsky method gives people higher utility as the indifference curve shifts out
Hicks method gives enough money to end on the same indifference curve, which therefore gives the same level of utility
again point a to c sub effect. relative prices have changed
rest income effect
when use slutsky when use hicks
- use Hicks when given utility function
-use slutsky when no utility function is given
slutsky calculation
calculate income that consumer needs to purchase og bundle
use new prices times orginal consumption bundles to calculate new income
go to demand function, substitute new income and new price into the demand function
sub effect is change. new consumption bundle- original consumption bundle
remainder is income effect.
inferior good
when you have less money you want to buy more of the good
ordinary good
a good that satisfies the law of demand. as prices rise demand goes up
example of ordinary good
normal good
maybe inferior- will be if the substitution effect is larger than the income effect
Why is a good a giffen good
if the income effect is larger than the sub effect it violates the law of demand and is therefore a giffen good. upward sloping demand curve
ex. some inferior goods
Price elasticity of demand
percentage change in quantity when price changes.
partial derivative of Marshallian demand for x
usually negative as price rises buy less
perfectly inelastic demand
0
perfectly elastic demand
infinity
consumer welfare
benefit derived from consumption of goods and services
compensating variation
method to measure the change in consumer welfare
if price of good increases how much receive to make them as well off as they were original at price of new good.
calculate cv mathmatically
lagragian
first order conditions
eliminate lambda solve for x and y
sub q into first order condition solve for x and y
write down expenditure function
sub hicksian demands into budget constraint
