CHAPTER 6: DOING THE BEST WE CAN

Question 1

Economic circumstances:

Tastes:

Answer 1

Choice set

Indifference curves

Question 2

Economic circumstances + tastes =

Answer 2

Choice of the best bundle possible

Question 3

Constrained optimisation problem

Answer 3

Max u(1,x2) subject to p1x1 + p2x2 = I
X1,x1

Question 4

MRS = -p1/p2 is only true at

Answer 4

The best bundle

Question 5

MRS definition

Answer 5

In terms of x2, how much we are willing to pay for 1 more x1

Question 6

Slope of budget line definition

Answer 6

In terms of x2 how much we have to pay fro 1 more x1

Question 7

MRS = -p1/p2 implies

Answer 7

At the “best” affordable bundle, the amount we are willing to pay for x1 is on margin (equal) to what we have to pay.

Question 8

Different tastes but at the same margin

Answer 8

Consumers like different bundles overall, but when it comes to making trade off’s between goods, they are willing to substitute in the same way.

Question 9

Gains from trade

Answer 9

Consumers gain from trading with one another if they can agree on a trade that makes both of them better off.

Question 10

Mutual beneficial trade is always possible if

Answer 10

Tastes differ at the margin (MRS differ)

Question 11

When all consumers face the same prices, their tastes

Answer 11

Align at the margin, so all gains from trade are exhausted and no further trade is needed.

Question 12

Corner solutions

Answer 12

Purchasing only one good,
Normally w perfect subs when one good is cheeper
Only possible with no essential goods

Question 14

Corner solutions + gains from trade

Answer 14

No, because the corner solution person have no x2 to trade

Question 15

Non - congestive is =

Answer 15

Multiple optima

Question 16

Method 1

Answer 16

Solve for x2,
Sub into f(x1)
Dy/dx1
Gives x1
Plug into x2, to Give x2

Question 17

Method 2: Lagrange method

Answer 17

L(x1,x2,l) = u(x1,x2) + alpha(I - x1,x2)
First order conditions
Divide x1 and x2 one by each other.
Combine (x2,x1 = ) with 3rd order condition

Question 18

Method 3: economic intuition

Answer 18

MRS = -p1/p2
Plug into with prices.

Question 19

All 1, 2,3 methods only work for

Answer 19

Interior solutions

Question 20

Interior solution v corner solution

Answer 20

X1 > 0 x2 > 0 = interior solution

If not then corner

Question 21

First order conditions are sufficient if

Answer 21

1) there are no flat spots on indiff curves
2) all goods are essential
3) no nonconvexities in choice sets or tastes.

Question 22

Dealing w kinked budgets

Answer 22

Still use methods, just treat as separate problems.
If neither lie on the kinked line then the kink point is optimal