Consumer Theory Flashcards
(41 cards)
What assumptions are made to give rationality to define a utility function?
Non-satiation Transivity Completeness Continuity Convexity
What does non-satiation mean?
More is preferred to less
What does transivity mean?
if X>Y and Y>Z then X>Z
What does completeness mean?
Consumers will always be able to rank goods -> they will always know what good they prefer
What does continuity mean?
Small changes to a consumer’s bundle will not change their preferences relating to it
What does convexity mean?
An bundle where an average of 2 goods is included is preferred to an extreme bundle (having a lot more of one good than the other)
What shape is the IC for a perfect substitute good and why?
The IC will have a constant gradient -> the IC will be linear. This is because the MRS is constant at all points on the IC
What does this mean about the utility attributed with consuming perfect substitute goods?
Utility comes from the sum of both goods in the bundle in whatever ratio that may be
What is the shape of the IC for a perfect complement good and why?
The IC is L-shaped because utility is conditioned by the quantity of the lowest consumed good in the bundle
What does the Cobb Douglas function show?
It shows the preferences between 2 goods that lie in between the 2 extremes mentioned above
What is the formula for the Cobb Douglas function?
U(x1,x2) = x1^a.x2^(1-a)
What does the Cobb Douglas formula show?
That the substitutability of the 2 goods adds up to 1
How will the size of (a) in the Cobb Douglas determine the shape of the IC?
The higher is a the quicker the IC converges to the x-axis, the lower is a the quicker the IC converges to the y-axis
What is a monotonic transformation and why is it different?
It means that a transformation can be made to a utility function that may create an entirely new utility function, but the preferences of the consumer will remain constant after the transformation
Lagrange method
Check notes -> can’t be put on flash cards
How do revealed preferences help economists?
They reveal the preferences of the consumer, meaning that no assumptions about those preferences have to be made
Diagram of these preferences
Check notes
What is the difference between WARP and SARP?
WARP allows you to make direct comparisons between bundles, stating which one you prefer
SARP allows you to make indirect comparisons between bundles -> leads to transivity (assumptions)
What are homothetic tastes?
This is where consumer preferences depend on the ratio of one good in the bundle to another
What do homothetic tastes mean the IC looks like at all levels of consumption?
It will have the same MRS -> when M increases, the proportional increase in X and Y will be the same
What are quasilinear tastes?
Means that at all levels of consumption and income, the quantity consumed of a good will be constant
What does that mean that IC shifts will look like for Quasilinear tastes?
The IC will only shift vertically -> it can shift out and right but the consumer has no increase in utility by consuming more units of that good than the desired constant amount
What does the Engel curve show?
It shows the relationship between income and the quantity of a good that is consumed. For a normal good it will have a positive gradient, for an inferior good it will be negatively sloped and for a quasilinear good it will be vertical
What is expenditure minimisation?
It is finding the cheapest expenditure, given a new price ratio, where utility will be the same as for the original bundle
