Consumer Preferences

Question 1

What are consumer preferences assumed to be?

Answer 1

Complete (either will prefer one to other, or will be indifferent); Transitive (will prefer an ultimate alternative after options in between); More is better than less

Question 2

What does an indifference curve show?

Answer 2

Combinations of bundles of goods that give the same degree of utility; different bundles ranked according to what is preferable

Question 3

What does a higher indifference curve show?

Answer 3

Higher utility (along the assumption that consumers will always prefer more rather than less)

Question 4

What do our assumptions imply about indifference curves on a graph?

Answer 4

They cannot intersect

Question 5

What is the marginal rate of substitution?

Answer 5

The amount of one good that a consumer is willing to give up in order to obtain one additional unit of another good

Question 6

The more of one unit we have, the less highly you value the additional units - what happens to the marginal rate of substitution?

Answer 6

It declines

Question 7

What does the slope of an indifference curve measure?

Answer 7

The marginal rate of substitution (MRS) between two goods

Question 8

What happens to the indifference curve when the MRS diminishes?

Answer 8

The curve becomes convex (because the more of one good the consumer has, the less willing he or she is to give up the other good and vice versa)

Question 9

What do indifference curves typically look like?

Answer 9

They are negatively sloped and convex to origin

Question 10

What does a budget line show?

Answer 10

The combinations of goods that can be purchased given the consumer’s income and the prices of the good

Question 11

What changes the slope of a budget line?

Answer 11

Changing incomes and prices

Question 12

How can the slope of the budget line be worked out?

Answer 12

X axis / Y axis

Question 13

What happens to the budget line when income increases?

Answer 13

The budget line shifts to the right (outwards - customer can afford more on every level)

Question 14

What happens to the budget line when income falls?

Answer 14

The budget line shifts to the left (inwards - customer can’t afford as much on every level)

Question 15

How does a change in the price of a good affect the budget line?

Answer 15

It causes the budget line to rotate

Question 16

When the price of one of the goods falls, what happens to the budget line?

Answer 16

The line rotates outwards (can afford more units of that good because its price has fallen, whereas the other good’s prices remain constant)

Question 17

When the price of an item increases, what happens to the budget line?

Answer 17

The line rotates inwards (can afford fewer units of that good because its price has gone up, and the customer can’t afford to buy as many given the units of the other item that he/she needs)

Question 18

How can a customer achieve utility maximisation?

Answer 18

To achieve maximum satisfaction from consumption, the choice must be located on the budget line and give the consumer the most preferred combination of goods and services

Question 19

How is utility maximisation reflected on a graph?

Answer 19

It is the point at which the budget line is tangential to the indifference curve (no higher level can be attained because of income restraints, and lower levels will provide a lower level of satisfaction). Reflects how the marginal rate of substitution (MRS) is equal to the ratio of the two prices.

Question 20

For normal goods, how does an increase in the price of goods affect the utility maximisation point?

Answer 20

There is a new maximisation point when purchase power increases - line rotates outwards and point is lower on the budget line. Reflects the inverse nature of the demand curve (that people want more of what costs less). Income effect shifts to the right, and is positive.

Question 21

How do we realign a budget line to reach original levels of consumption before incomes rose?

Answer 21

Reduce income until it reaches the original consumption point that enabled them to buy the original combination of goods

Question 22

What happens to the budget line for an inferior good, if the price of the item falls?

Answer 22

Consumption (demand will increase) but the utility maximisation point will be higher on the budget line (because a decrease in the price of food leads to an increase in the quantity demanded) and the income effect shifts to the left - it is negative.

Question 23

How is a market demand curve obtained?

Answer 23

By summing horizontally individual consumer demand curves (shape and position reflects the preferences of individual curves)

Question 24

How is a consumer’s preferred position expressed as an equation?

Answer 24

MRS (Marginal Rate of Substitution) = P of item one / P of item two (satisfaction is maximised when the marginal benefit is equal to the cost of obtaining that unit)

Question 25

What does the vertical height of the demand curve show?

Answer 25

The max prices consumers would pay to obtain additional units of output (price valuations reflect perceived marginal benefits)

Question 26

Why is the demand curve downward sloping?

Answer 26

Increased consumption of the product implies that additional units are valued less highly (diminishing MRS - as the consumer has more of this product, additional units are valued less highly and the consumer will only buy them if the price is lower)

Question 27

In money terms, how is marginal benefit from every additional unit expressed?

Answer 27

The vertical height below the demand curve reflects the maximum prices that people will pay; the demand curve shows the maximum valuation of the product; the horizontal length below the demand curve shows how much one is willing to buy

Question 28

What is a consumer surplus?

Answer 28

Difference between what a consumer is willing to pay for a good, and the amount actually paid

Question 29

How to calculate the consumer surplus?

Answer 29

Total benefit from the consumption of a product - the total cost of purchasing it (value - price paid); on a graph, it is reflected by the sum of vertical distances from the price of an item

Question 30

How to calculate the total valuation of an item?

Answer 30

Calculate the area of the triangle underneath the budget line, and the rectangle beneath the market price (which ends and goes vertical at the point at which the market price and demand curve intersect)

Question 31

How do we measure how much customers gain from a price fall?

Answer 31

Examine how consumer surplus changes (price falls generate increases in consumer surplus). The consumer surplus gained is the trapezoid beneath the first triangle where price/quantity 1 was established, after a larger triangle encompassed that