WEEK 1 + Week 2, Consumer theory

Question 1

What are the axioms of choice and what are there definitions

Answer 1

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

Question 2

Marginal utility

Answer 2

additional utility you get from consuming one more good

Question 3

how to work out marginal utility

Answer 3

first derivative of total utility

Question 4

indifference curves

Answer 4

bundles of goods that give the same utility

Question 5

what are the assumptions of well behaved preferences

Answer 5

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.

Question 6

inferior good

Answer 6

a good that when income increase demand decreases- negative derivative.

Question 7

normal good

Answer 7

a good that as income increase demand also increase- positive derivative

Question 8

Economically feasible set

Answer 8

depends on the context e.g time constraint sleep 8 hours a day only have 16 hours to work with.

Question 9

utility function

Answer 9

mathematical function mapping from an element of the consumption possibility set to the real number line (value of a consumption bundle)

Question 10

What is the slope of an indifference curve

Answer 10

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.

Question 11

Where can you find the Marginal rate of substitution and how can you work it out mathmatically

Answer 11

slope of inderference curve

dmarginal utility with respect to x/derivative marginal utility with respect to Y. (draw it)

Question 12

Marshallian demand function

Answer 12

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

Question 13

Marshalian demand function steps, just first lagragian steps

Answer 13

Lagragian- thing max on min first. Plus lambda in brackets is the constraint. Move everything to the left hand side of the constraint.

Question 14

Law of demand

Answer 14

as prices rise demand decreases. inverse function and a downward sloping demand curve

Question 14

substitution effect

Answer 14

change in demand away from one good to another

Question 15

Income effect

Answer 15

as income decreases you can afford less stuff now so purchasing power decreases reducing demand.

Question 16

overall change in demand

Answer 16

sub effect = income effect

Question 17

Slutsky method

Answer 17

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

Question 18

Hicks method

Answer 18

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

Question 19

when use slutsky when use hicks

Answer 19

• use Hicks when given utility function

-use slutsky when no utility function is given

Question 20

slutsky calculation

Answer 20

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.

Question 21

inferior good

Answer 21

when you have less money you want to buy more of the good

Question 22

ordinary good

Answer 22

a good that satisfies the law of demand. as prices rise demand goes up

Question 23

example of ordinary good

Answer 23

normal good

maybe inferior- will be if the substitution effect is larger than the income effect

Question 24

Why is a good a giffen good

Answer 24

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

Question 25

Price elasticity of demand

Answer 25

percentage change in quantity when price changes.

partial derivative of Marshallian demand for x

usually negative as price rises buy less

Question 26

perfectly inelastic demand

Answer 26

0

Question 27

perfectly elastic demand

Answer 27

infinity

Question 28

consumer welfare

Answer 28

benefit derived from consumption of goods and services

Question 29

compensating variation

Answer 29

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.

Question 30

calculate cv mathmatically

Answer 30

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