Week 6 - Consumer theory I: Utility and indifference analysis Flashcards
What is a Budget line
A graphical representation of all possible combinations of 2 goods which can be purchased given income and prices
Describe the effect of a change in Income or Prices on the Budget line (x2)
An increase in income will shift the budget line right/outwards, a decrease in income will shift the budget line left/inwards
A price change will cause the budget line to pivot, moving on the axis of the good that experienced the price change
What General formula represents the budget line, and how is it re-written to be graphically drawn
PxX + PyY = M
Y = M/Py - (Px/Py)X
What expression in the budget line formula determines the Slope of the budget line
-Px/Py
What does the Slope of the budget line show
The slope measures the rate at which the consumer can trade one good for another subject to the budget constraint
When making the optimal choice, define the consumer’s objective
The rational consumer chooses the feasible bundle that provides the highest utility
What does the Indifference curve and Budget line define (x2)
The indifference curve defines the sets of preferred and dominated bundles
The budget line defines the sets of affordable and unaffordable bundles
Considering a consumer’s indifference curve and budget line, at what point is maximum utility achieved (x2)
When the indifference curve is tangent to the budget line
When the slope of the indifference curve is exactly equal to the slope of the budget line (MRS)
For two goods X and Y, the Rational consumer will choose such that (x2):
(slope of indifference curve) MUx/Px = (slope of budget line) MUy/Py
or
(MRS) MUx/MUy = (price ratio) Px/Py
What General formula represents the indifference curve
U(X, Y) = U1
What are the endogenous and exogenous variables in the indifference-budget model
2 endogenous variables:
- quantity of X
- quantity of Y
3 exogenous variables:
- price of X, Px
- price of Y, Py
- income, M
What is an Income expansion path
A graph that compares the consumption rate of 2 products when consumer income increases
What are 2 different income expansion paths
If X and Y are both normal goods, the income expansion path is upwards sloping
If one of X and Y are inferior goods, the income expansion path bends backwards
What is an Engel curve
A graph that illustrates the relationship between a consumer’s income level and the quantity of a specific good they demand
What are 2 different Engel curves
Normal goods will have upwards sloping Engel curves
Inferior goods will have downwards sloping, or backwards bending Engel curves
