1-2: Preferences, Constraints and Choice

Question 1

bundle

Answer 1

collection of goods

Question 2

fundamental concept of choice theory

Answer 2

people have preferences over bundles, not goods

Question 3

preference

Answer 3

ordering

Question 4

utility function

Answer 4

function that takes a bundle as an input and returns a single number

Question 5

two assumptions of consumer preference

Answer 5

completeness
- consumer can successfully compare all bundles without not knowing how they feel
- implies reflexivity where every bundle is at least as good at itself

transitivity for triples
- if they prefer x to y to z, then they must prefer x to z

Question 6

characteristics of utility functions

Answer 6

ordinal not cardinal
- only relative magnitudes matter, but not the size of the utility number

Question 7

two assumptions of well-behaved preferences

Answer 7

monotonicity
- more of a good is better than less
- formally, there is one good such that the consumer prefers a bundle with a higher amount of that good all else equal

convexity
- average consumption bundles are preferred to extremes
- formally, strictly convex indifference curves imply that for any two bundles, the weighted average is strictly preferred by the consumer over either

Question 8

marginal rate of substitution

Answer 8

rate at which the consumer is willing to trade one good for another

slope of the indifference curve
- varies depending on where on the IC you’re at

Question 9

slope of the budget line

Answer 9

market rate of exchange between the two goods

relative price of good 1
- how much of good 2 must you give up to be able to afford a little more of good 1

Question 10

optimal choices for well-behaved preferences are characterised by?

Answer 10

tangency

market rate of exchange is equal to private erate of exchange

Question 11

tangency method

Answer 11

find MRS

apply tangency (only when preferences are well-behaved)
- slope of MRS = slope of budget line

equation of budget line

Question 12

solution to cobb-douglas utility maximisation problem

u = clnx1 + dlnx2

Answer 12

x1* = (c/c+d)m/p1

x2* = (d/c+d)m/p2

Question 13

order-preserving/monotonic transformations

Answer 13

whenever the first function gives a higher utility number to bundle A over B, the second utility function will do so as well

shows the ordinal and not cardinal nature of utility functions

Question 14

u=min(a,b)

Answer 14

perfect complements

Question 15

u=a+b

Answer 15

perfect substitutes

Question 16

if MRS > p1/p2, then?

Answer 16

wants to consume more of good 1

values good 1 over good 2 at this point

Question 17

if MRS < p1/p2, then?

Answer 17

wants to consume more of good 2

values good 2 over good 1 at this point