Consumer theory, utility maximisation

Question 1

Bundle of goods

Answer 1

collection of goods and services that a consumer might consume

Question 2

An axiom

Answer 2

a statement that is taken to be true

Question 3

Utility function

Answer 3

Gives us the utility of a consumer from the goods consumed (bundle yielding a higher utility level is preferred to another one)

Question 4

Marginal utility of a given goods

Answer 4

the rate at which total utility changes as the level of consumption of that good rises

Question 5

Indifference curve

Answer 5

set of all consumption bundles that provide the consumer w the same level of utility

Question 6

Budget set

Answer 6

bundles of goods that a consumer can buy given the prices and the income

Question 7

The economists’ concept of rationality

Answer 7

• preferences are complete
  > E > B
  > E ∼ B
  > E < B
• preferences are transitive
  > G > E
  > E > B
  > G > B
• preferences are continuous

Question 8

Theorem

Answer 8

consumer preferences are representable by a continuous utility function if they satisfy the previous three axioms

Question 9

Monotone transformation

Answer 9

• any positive monotone transformation of a UF represents the same preference ranking

Question 10

Marginal utility of a given good

Answer 10

• depends on the level of consumption of all goods
• monotonicity (MU is positive)
• MU is diminishing in x

Question 11

Properties of indifference curves

Answer 11

• indifference curves do not intersect (each bundle has a unique utility level which corresponds to a unique indifference curve)
• indifference curve is downward sloping (the more is better)

Question 12

Marginal rate of substitution (def)

Answer 12

To increase X by one marginal unit, how many marginal units of Y can you sacrifice to maintain the same utility

Question 13

Marginal rate of substitution

Answer 13

equals the ratio of marginal utilities of these goods

Question 14

Convexity of preferences

Answer 14

• diminishing MRS decreases when the consumer increases her consumption of X, and decreases her consumption of Y, along the same indifference curve
• implies that indifference curves are convex

Question 15

Convex preferences (mean)

Answer 15

consumer prefers a mix to any two equally valuable extremes
- if consumer likes both food and clothing, then he prefers some of each to only food or clothing

Question 16

MRS decreasing in XY

Answer 16

• preferences satisfy diminishing MRS
• preferences are convex
• indifference curves face away from the origin

Question 17

Optimal choice

Answer 17

consumer chooses the bundle of goods such that
- maximises his utility
- remains within his budget set

Question 18

Tangency condition

Answer 18

MRS = Px / Py

Question 19

Balanced budget condition

Answer 19

pxX + pyY = M

Question 20

Changes in optimal consumption: consumer chooses bundle of goods such that:

Answer 20

• utility is maximised
• remains within his budget set

Question 21

Changes in optimal consumption: an increase of price changes

Answer 21

• the budget constraint
• the purchasing power of the consumer

Question 22

Changes in optimal consumption: the change in D can be decomposed in 2 components

Answer 22

the substitution effet
the income effect

Question 23

The substitution effect

Answer 23

the change in D when the prices are changed but the purchasing power remains constant

Question 24

The income effect

Answer 24

the change in demand when prices rain constant and purchasing power is changed