Week 2 Flashcards
What are we building up to do in this week?
We are looking at individual demand which will eventually aggregrate to get market demand.
When ronny goes to the supermarket what does he have to think about?
A theory of optimal consumption
What is the theory of optimal consumption?
Consumption bundles
Preference/utility
Budget line
Lines of equal preferences
Rationality/optimal consumption
What do we mean by consumption bundles?
All the products you decided to buy on that day.
What do we mean by preference/Utility?
How you enjoy different bundles of consumption
What do we mean by Budget line?
Constraints that economic agents face, money-income
What do we mean by lines of equal preferences?
Indifference curves( points of consumption bundles that give ronny the same level of happiness or utlitiy.
What do we mean by Rationality/Optimal consumption?
Optimal or maxmise consumption bundle.
What is our theory about how ronny will make decisions in the supermarket?
It involves the theory of rationality, a rational agent will always consume a consumption bundle that optimises his preferences given his income and the prices of goods that are avaliable
Lets Ronny is hiking but there is a fence and he can’t go passed it but wants to get to the top of the mountain, there are contour lines on the map, describing the steepness of the hill, what can we say about the highest point that Ronny can go on which is on the fence?

At the highest point of the slope of the fence is equal to the slope of the altutide lines(or contour lines)
Lets change ronny instead of going north or east, lets change axis to Pink lady apples and Granny smith apples, that ronny can buy with a budget of £100. Lets think of the mountain as a line of preferences, the higher he is the more happy he is. Let the altutide lines or contour lines be the lines of equal preferences. What do we mean by this?

The line of equal preferences here means that as we travel along these contour lines or altitude lines, i.e changing consumption bundle, ronny has the same level of happiness, from all these points on the same line. (indifference curves)
Lets change ronny instead of going north or east, lets change axis to Pink lady apples and Granny smith apples, that ronny can buy with a budget of £100. Lets think of the mountain as a line of preferences, the higher he is the more happy he is. Let the altutide lines or contour lines be the lines of equal preferences. What is the fence?
It is the budget line.
How can we draw the budget line with kilos of pink lady apples on y axis and Kilos of granny smith apples on x axis and what is equation, with a budget of £100.
Where Ppink is the price of pink lady apples time Y is how many kilos and Pgranny is price times X is how many kilos of it.

If pink lady apples where 4 pounds and Granny smith was £5 and the equation is Ppink x Y + Pgranny x X = £100. What is the maxmium pink lady apples and maximum granny smith apples, ronny could get, draw the diagram.

If ronny was to choose a point below the line, can he afford it?

He would spend less than £100 meaning that he can afford it.
If Ronny was to choose a point above the line, would he be able to afford it?

No as he is going to need to spend more than £100 and he doesn’t have that so he cannot afford it.
If ronny was to choose a point on the budget line, can he afford it?

Yes he can because he is spending exactly £100.
What 3 assumptions here do we make about Ronny and the pink lady apples assumption?
Apples are goods
Non-satiation
No saving
What do we mean by apples are goods and non-satiation ?
Apples are goods: Ronny always enjoys Pink lady apples and Granny smith apples
Non-satiation: Ronny would always strictly prefer to get an extra pink lady or an extra granny smith apple( wants to maxmise utlitiy)
What do we mean by no saving?
Ronny has no use for extra money left over from his shopping in the supermarket.
With these 3 assumptions draw the indifferences curves on the budget line diagram?

Why are indifference curves always decreasing?
This is because as the consumer increases the consumption of a particular commodity (X), he or she must sacrifice units of the other commodity (Y) to maintain the same level of satisfaction.
(in other words the only way of keeping ulitity constant when consuming more of one good, is to consume less of another. )
What does a higher indifference curve line mean?

This corresponds to a higher level of utilitiy, same with the map a higher line corresponds to being higher on the mountain
So to calculate the optimal consumption bundle, what would we have to do?

Draw indifference curve on budget line and this corresponds to the optimal consumption bundle.









































