Week 2

Question 1

Does the level of utility throughout the indifference curve change?

Answer 1

No, only the allocation of the goods changes

Question 2

What is a utility function?

Answer 2

Summarizes a consumer’s preferences in terms of how much utility she gets from consuming an available good/bundle of goods

Question 3

What is the axiom of completeness?

Answer 3

Given any 2 choices, A and B, an individual can always make a comparison

Question 4

What is the axiom of transitivity?

Answer 4

If they prefer A to B and B to C, they must prefer A to C

Question 5

What is revealed preference?

Answer 5

If a consumer chooses bundle x from set A and another bundle y was also affordable in that set but not chosen, then x should be revealed preferred to y

Question 6

What is consistency of choices?

Answer 6

If the individual can afford a certain bundle in 2 different budget sets, and they choose it in one, they should not prefer a less preferred bundle in another situation

Question 7

What is the Independence of Irrelevant Alternatives (IIA)

Answer 7

A decision theory axiom that states that a choice between 2 options shouldn’t be affected by the presence of a third, unrelated option (If you’re choosing between chocolate and vanilla, your preference shouldn’t change if strawberry is added as a third option)

Question 8

What is the axiom of continuity?

Answer 8

Preferences are smooth and don’t exhibit extreme jumps

Question 9

What is Condorcet’s paradox?

Answer 9

• Refers to the inconsistency that arises in group decision-making processes
• If there are 2 candidates, the answer is clear - choose the one who would win the most votes in a head-to-head election
• But with 3 or more candidates, when each voter has ranked his or her candidate preferences, the answer is less obvious

Question 10

What is the Money Pump Argument

Answer 10

A pattern of intransitive/cyclical preferences causes a decision-maker to be willing to pay repeated amounts of money to have these preferences satisfied without gaining any benefit
- e.g., you prefer A to B, B to C, but then prefer C to A
- This cycle is irrational
- Someone sells you A because you have C and you prefer A to C so you pay $1 to trade C for A
- Someone then sells you B because you prefer B over A
- Someone then sells you C since you prefer C to B - then cycle repeats

Question 11

What is the learnings of the money pump argument?

Answer 11

• It emphasizes the importance of having consistent, transitive preferences to avoid being taken advantage of financially or in decision-making situations
• Utility maximisation might fail in systematic ways (paradoxes, biases)