week 4 Flashcards
what is a consumption bundle
a complete list of quantities for all available goods
notation of typical consumption bundle X=(Xb, Xc, Xf)
what are the preferences, consumption bundle by any individual
if bundle A is strictly preferred to bundle B, A>B
if bundle A is weakly preferred to bundle B, A≥B
if the individual is indifferent between A and B then A ~ B
what are the assumptions about individual preferences
completeness - for any pair of available consumption bundles X and Y, the individual can say X≥Y, Y≥X or both
transitivity - for any three consumption bundles X, Y and Z, X≥Y and Y≥Z imply X≥Z
reflexivity - for identical consumption bundles, there is no strong preference for either of them: X~X
non-satiation - more is better than less
what is the utility function
assigns to each consumption bundle an index number of happiness = total utility
two consumption bundles X and Y, the utility function can be used to extract the individuals preferences as follows: U(X) > U(Y) then the individual strictly prefers bundle X to Y
if U(X) = U(Y) then the individual is indifferent between consumption bundles X and Y
what is ordinal utility
means that only the ranking of utility levels has a meaning - the difference between utility levels is meaningless
what is an indifference curve
you are indifferent between X and Y
U(X) = U(Y)
all bundles that lead to the same utility lie on the same indifference curve
what do different utility curves represent
there is one indifference curve for each utility level
indifference curves for higher utility levels lie further outwards to the origin
indifference curves are always downward sloping
indifference curves cannot cross
what is marginal utility
the additional utility generated by an additional unit of the good, holding the quantities of all other goods constant
what is diminishing marginal utility
it tends to be the case that as an individual consumes more and more of some good, the additional utility gained from an additional unit of consumption decreases
what are trade-offs
holding the utility constant, how much of one good a consumer will give up to get a little bit more of another good
what is the marginal rate of substitution
measures how many units of good 2 the individual is willing to give up for 1 additional unit of good 1, such that utility remains constant
MRSp,c = MUp / MUc
what is diminishing MRS
MRS is typically decreasing
what are budget constraints
individuals have money, income or a budget to finance consumption
how do you denote a budget set
expenditure for a consumption bundle X=(Xp Xc)
E(X) = Pp x Xp + Pc x Xc
what is a budget set
consists of all feasible consumption plans
what is the budget line
consists of all bundles that exhaust the consumers income
m = Pp x Xp + Pc x Xc
how do changes in income and prices effect the budget line
what is an optimal consumption bundle
the feasible consumption bundle that maximises the consumers utility
what is the rational spending rule
MRS1,2 = p1/p2 MU1/p1 = MU2/p2
MRS1,2 = MU1/MU2
what does it mean if MRS is greater than p1/p2`
buy more of good 1 and less of good 2
what does it mean if MRS is less than p1/p2
buy more of good 2 and less of good 1
how does increase in income effect consumption
if both goods A and B are normal goods, increase in income leads to an increase in consumption of both goods
what is income elasticity of demand
the percentage change in quantity demanded associated with a 1% change in consumer income
describes how repsonsive demand is to income changes
positive for normal goods
negative for inferior goods
what is income elasticity of demand
the percentage change in quantity demanded associated with a 1% change in consumer income
describes how responsive demand is to income changes
positive for normal goods
negative for inferior goods
how does price increase effect normal goods
reduces substitution effect and income effect so decreases total effect
how does decrease in price effect normal goods
increases substitution effect and income effect, so increases total effect
how does increase in price effect inferior goods
reduces substitution effect and increases income effect
how does decrease in price effect inferior goods
increases substitution effect and decreases income effect
