Week 2

Question 1

What are the three elements in the study of human behaviour?

Answer 1

Consumer preferences
Budget constraints
Consumer choices

Question 2

What are the basic assumptions made when discussing consumer preferences?

Answer 2

Completeness
Non-satiation or monotonicity
Transitivity

Question 3

What’s completeness?

Answer 3

The assumption that consumers can compare consumption possibilities and rank them in terms of which of the options they prefer.

Question 4

What’s non-satiation / monotonicity?

Answer 4

The assumption that consumers would prefer to consume more than less (more is better).

Question 5

What’s transitivity?

Answer 5

A logical assumption that ensures consistency. (If I prefer X to Y, and I prefer Y to Z, then I must prefer X to Z).

Question 6

What’s a market basket / consumption bundle?

Answer 6

A combination of goods that a person considers purchasing.

Question 7

What are the types of utility functions?

Answer 7

A general functional form: U = F(X,Y)

A specific functional form: U = 10X + 5Y

Question 8

What are indifference curves?

Answer 8

Indifference curves can be used to represent all combinations of market baskets that a consumer is indifferent between.

Question 9

What are the characteristics of indifference curves?

Answer 9

They can be drawn.

ICs further from the origin represent higher utility.

ICs never intersect.

ICs are broadly convex to the origin.

Question 10

What’s an indifference map?

Answer 10

A collection of indifference curves.

Question 11

What’s the marginal rate of substitution?

Answer 11

How a person is willing to trade one good for another.

Question 12

What’s the formula for marginal rate of substitution?

Answer 12

MRS(XY) = - (Change in Y/Change in X)

Question 13

What’s marginal utility?

Answer 13

Marginal utility is the extra utility a consumer receives from consuming one extra unit of something.

Question 14

How does the shape of indifference curves reveal information about the relationship between goods?

Answer 14

Relatively straight ICs describe goods that are more readily substitutable.

More convex ICs describe goods that are more complementary.

Question 15

What are budget constraints?

Answer 15

Budget Constraints limit an individual’s ability to consumer, given the prices they must pay for particular goods and services.

Question 16

What are the things that can change in budget constraints?

Answer 16

The price of one of the goods

The level of income

The prices of both goods change (proportionally)

The prices of both goods change (disproportionally)

Question 17

What happens if the price of one good changes?

Answer 17

If the price of one good increases, the budget line pivots inward from the intercept on the other good’s axis.

If the price of one good decreases, the budget line pivots outward from the intercept on the other good’s axis.

Question 18

What happens if the level of income changes?

Answer 18

An increase in income causes a shift outward, parallel to the original line.

A decrease in income causes a shift inward, parallel to the original line

Question 19

What happens if the prices of both goods change proportionally?

Answer 19

If the goods increase in price, the line will shift inward.

If the goods decrease in price the line will shift outward.

Question 20

What happens if the prices of both goods change disproportionally?

Answer 20

If both goods increase disproportionately, the line will change its slope and shift somewhat inwards.

If both goods decrease disproportionally, the line will change its slope and shift somewhat outwards.

Question 21

What conditions must the utility maximising basket satisfy?

Answer 21

It must be located on the budget line

It must give the consumer their most preferred combination of the goods.

Question 22

What’s the point of tangency?

Answer 22

Occurs where the slops of the indifference curve is equal to the slope of the budget constraint (where they touch). Therefore, tangency occurs where the marginal rate of substitution is equal to the ratio of prices.

Question 23

What are the important properties of the demand curve?

Answer 23

The level of utility that the consumer obtains changes as we move along the curve.

The lower the price of the product, the higher the utility.

At every point on the demand curve, a consumer is maximising their utility.

Question 24

What happens when the price of a good changes relative to the price of another?

Answer 24

The purchasing power of a consumer’s income changes – because one good is cheaper, they can afford to buy more. This is called the income effect.

One good becomes relatively more expensive – they rationally buy more of the thing that is relatively cheaper. This is called the substitution effect.

The total effect is the net outcome of the income and substitution effect.