Chapter 4 - Consumer behaviour

Question 1

What are the 4 assumptions about preferences ?

Answer 1

1. Complete
2. More > Less
3. Transitive
4. The more a consumer has of a good then the less they are willing to give up to get more of it

Question 2

What is marginal utility?

Answer 2

The utility received from a one unit increase in consumption

Question 3

How do you caluculate marginal utility of x?

Answer 3

MUx = Change in overall utility divided by the change in x

Question 4

What do indifference curves show?

Answer 4

All the possible combinations of goods which provide the consumer with the same level of utility

Question 5

What are the key facts about indifference curves?

Answer 5

1. They slope downwards
2. They never cross
3. They are convex to the origin due to MRS

Question 6

What is the marginal rate of substitution?

Answer 6

It is how much of one good a consumer is willing to give up to get an additional unit of another.
It also shows a consumer’s marginal utility which is how much utility they gain/lose from this substituion.

Question 7

How do you calculate MRS?

Answer 7

By finding the negative of the slope of the indifference curve at any given point or MRSxy = - change in Y/change in X which also = Mux/MUy.

Question 8

What does the steepness of the indifference curve indicate?

Answer 8

The consumers MRS, If it is steep the consumer is willing to give up a large quantity of good Y for one more unit of good X and vice versa.

Question 9

What does the curvature of the indifference curve indicate?

Answer 9

It indicates how substitutable the 2 goods are. If it is relatively straight then they are quite good substitutes whereas a more extreme curve means they are not.

Question 10

What does a perfectly straight indifference curve show?

Answer 10

That the goods are perfect substitutes and MRS is constant.

Question 11

What does a right-angled indifference curve show?

Answer 11

That the goods are perfect complements and thus the consumer would be indifferent to an increase in just one of the goods.

Question 12

What does the indifference curve look like when one good is a bad?

Answer 12

It will be upwards sloping as in order to outweigh the negatives the consumer will require more of the alternative good.

Question 13

What does the budget constraint illustrate?

Answer 13

Every set of bundles a consumer can buy when using their maximum income.

Question 14

What is the formula for the budget constraint?

Answer 14

Income = PxQx + PyQy.

Question 15

Where is the utility maximising bundle?

Answer 15

It is at the point where the indifference curve is tangent to the budget constraint and thus their slopes are equal or where the marginal utility and price ratios are equal.

Question 16

What is the equation for finding the utility maximising bundle?

Answer 16

• MRSxy = - MUx/MUy = -Px/Py

or MRSxy = MUx/MUy = Px/Py

Question 17

Why will 2 consumers with the same income and relative prices have the same ratio of marginal utilities?

Answer 17

This will occur as consumers will naturally consume more of the good they prefer and thus this will drive down marginal utility until the relative value of the goods becomes entirely dependant on their prices.

Question 18

What is a corner solution?

Answer 18

This is a special case where the consumer will maximise utility by only consuming one of the goods on offer. It may occur when the price of the preferred good is significantly higher than that of the other one.

Question 19

How can a consumer minimize expenditure while still achieving a given level of utility?

Answer 19

By finding the lowest budget constraint which is tangent to a given indifference curve. Basically, you start by graphing the indifference curve and use this info to draw a budget constraint with one point of tangency.