week 4

Question 1

what is a consumption bundle

Answer 1

a complete list of quantities for all available goods
notation of typical consumption bundle X=(Xb, Xc, Xf)

Question 2

what are the preferences, consumption bundle by any individual

Answer 2

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

Question 3

what are the assumptions about individual preferences

Answer 3

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

Question 4

what is the utility function

Answer 4

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

Question 5

what is ordinal utility

Answer 5

means that only the ranking of utility levels has a meaning - the difference between utility levels is meaningless

Question 6

what is an indifference curve

Answer 6

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

Question 7

what do different utility curves represent

Answer 7

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

Question 8

what is marginal utility

Answer 8

the additional utility generated by an additional unit of the good, holding the quantities of all other goods constant

Question 9

what is diminishing marginal utility

Answer 9

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

Question 10

what are trade-offs

Answer 10

holding the utility constant, how much of one good a consumer will give up to get a little bit more of another good

Question 11

what is the marginal rate of substitution

Answer 11

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

Question 12

what is diminishing MRS

Answer 12

MRS is typically decreasing

Question 13

what are budget constraints

Answer 13

individuals have money, income or a budget to finance consumption

Question 14

how do you denote a budget set

Answer 14

expenditure for a consumption bundle X=(Xp Xc)
E(X) = Pp x Xp + Pc x Xc

Question 15

what is a budget set

Answer 15

consists of all feasible consumption plans

Question 16

what is the budget line

Answer 16

consists of all bundles that exhaust the consumers income
m = Pp x Xp + Pc x Xc

Question 17

how do changes in income and prices effect the budget line

Answer 17

Question 18

what is an optimal consumption bundle

Answer 18

the feasible consumption bundle that maximises the consumers utility

Question 19

what is the rational spending rule

Answer 19

MRS1,2 = p1/p2 MU1/p1 = MU2/p2
MRS1,2 = MU1/MU2

Question 20

what does it mean if MRS is greater than p1/p2`

Answer 20

buy more of good 1 and less of good 2

Question 21

what does it mean if MRS is less than p1/p2

Answer 21

buy more of good 2 and less of good 1

Question 22

how does increase in income effect consumption

Answer 22

if both goods A and B are normal goods, increase in income leads to an increase in consumption of both goods

Question 23

what is income elasticity of demand

Answer 23

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

Question 24

what is income elasticity of demand

Answer 24

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

Question 25

how does price increase effect normal goods

Answer 25

reduces substitution effect and income effect so decreases total effect

Question 26

how does decrease in price effect normal goods

Answer 26

increases substitution effect and income effect, so increases total effect

Question 27

how does increase in price effect inferior goods

Answer 27

reduces substitution effect and increases income effect

Question 28

how does decrease in price effect inferior goods

Answer 28

increases substitution effect and decreases income effect