Indifference curves / Budget lines

Question 1

What does the indifference curve show?

Answer 1

Preferences, based on utility

Question 2

What does the budget line show?

Answer 2

The highest bundle a consumer can afford

• represents all the possible combinations of two goods a consumer can afford given their income and the prices of those goods

Question 3

What is a composite good?

Answer 3

All other goods or services

Question 4

What is utility?

Answer 4

Satisfaction

Question 5

When is a consumer indifferent?

Answer 5

Where two bundles of goods provide the same level of utility (satisfaction) for a consumer, the consumer is indifferent between the two bundles.
(They don’t care which one they have)

Question 6

What is the marginal rate of substitution?

Answer 6

Willingness to give up good Y (y axis) for an additional unit of good X (x axis)
- What you give up / what you gain
whilst remaining at the same level of utility / satisfaction

Question 7

As a good becomes more scarce…

Answer 7

The utility for the good increases (your willingness to give up the good gets less and less)

(vice versa - as a good becomes less scarce, utility decreases)

Question 8

What shape is the indifference curve?

Answer 8

Convex
Marginal rate of substitution decreases as we move along the curve

Question 9

What happens if you get a good for free?

Answer 9

• You have more utility, you have gained but haven’t had to give up
• You will need to shift to a new (higher) indifference curve (more preferred)

Question 10

Does an indifference curve shift?

Answer 10

No, you move to a higher indifference curve

Question 11

What is / How is a perfect substitute seen on an indifference curve?

Answer 11

The consumer doesn’t care about the difference / cares equally about each good
- Straight line because utility lost is equal to utility gained
- Price of exchange / ratio doesn’t change 1:1

Question 12

What is / How is a perfect compliment seen on an indifference curve?

Answer 12

No matter how many of one more someone gives you, you don’t gain more utility

• You have to consume the goods in pairs / together
• Therefore curves are L shaped, each curve moving further upward / outward
• Perfect compliments must be consumed in the same ratio. (1:1 - 1left and 1 right shoe, has the same utility as 1 left and 2 right shoes)

Question 13

What are the two indifference curve rules?

Answer 13

1. Indifference curves don’t cross (can’t intersect)
   - It doesn’t make sense that one combination of goods can be on two different curves with different levels of utility
   2. Indifference curves can’t be too curvy
      
      • With a horizontal or vertical line it should only intersect the indifference curve at one point

Question 14

What do budget lines tell us?

Answer 14

the highest bundle a consumer can afford

Question 15

Issues with points inside or outside the budget line

Answer 15

Any point inside the budget line = not all income is spent
Any point outside the budget line = unaffordable

Question 16

Which bundle will a utility maximizing consumer consume?

Answer 16

A utility maximizing consumer will consume a bundle on the highest possible indifference curve, where all income is spent (point on the budget line)
- Where the indifference curve is tangent (one intersect) to the budget line

Question 17

How is the slope of the budget line expressed?

Answer 17

• (price of good x) / (price of good y)

(generally ignore the negative)

Question 18

Where is the point of consumption?

Answer 18

Where the indifference curve is tangent to the budget line

Question 19

Which good would we want to buy?

Answer 19

We want to buy the good that gives us the most utility per dollar spent

Question 20

How does utility fall for a good? What occurs when this happens?

Answer 20

As a consumers buys more of one good, their utility will start to fall
(start to get sick of the good)

This will continue until the utility per dollar spent on Good A = the utility per dollar spent on Good B
- The consumer is indifferent between the goods at this point

Question 21

What is the tangency condition?

Answer 21

optimal bundle is where the marginal utility per dollar spent is the same for both goods

Question 22

What happens to BL / I with an increase in income?

Answer 22

budget line shifts outward (higher budget), shift to a higher indifference curve

- Points that were once outside the budget line are now attainable 
	○ Budget lines are parallel, as prices have not changed 

(We are assuming both goods are normal goods, so the Qd increases as income increases)

Question 23

What happens to BL / I with a decrease in income?

Answer 23

budget line would shift inward, consumer would move to a lower indifference curve

Question 24

What happens to BL / I with INFERIOR goods and a decrease in income?

Answer 24

Budget line decreases
The indifference curve is lower but shifts upward towards the inferior good section of the line
- buy more inferior goods when we have lower income
- Indifference curve contains more of the inferior good

(opposite for an increase in income)

Question 25

On the indifference / Budget line what are the axis??

Answer 25

Both axis are quantity

Question 26

How do you calculate points on the axis of BL/I?

Answer 26

income / price of good (x or y)

Question 27

What happens when the price changes of one good?

Answer 27

- As P of Y increases, the consumer can only afford a smaller quantity of good Y - The X axis is unaffected - The consumer moves to a lower indifference curve tangent to the new budget line - The bundles of goods on the original indifference curve are now unaffordable ○ They now have less utility - are worse off (If the price decreased the y axis intercept would be higher, the consumer would move to a higher indifference curve / budget line)

Question 28

What do community service cards do?

Answer 28

makes the price of medical services decrease (composite good) - Consumers can afford to buy more - an increase in the quantity of medical services and a small increase in the quantity of the composite good - The y axis intercept has increased, x axis hasn't changed Consumer can now consume bundle on a higher indifference curve tangent to the new budget line - people may go to the doctor when they don't need to - govt must pay more subsidies

Question 28

What do we mean by composite goods?

Answer 28

All other goods and services

Question 29

What do govt cash beneficiaries do?

Answer 29

BL shifts outward for both y and x axis - Both policies make the consumer equally as well off (same utility) - Both are government - use of tax payers funds The consumer who doesn't need lots of medical services will prefer this option - can get higher indifference curves towards good x - could be spent innapropriatley

Question 30

When the indifference curve is tangent to the budget constraint...

Answer 30

a consumer cannot be made better off without increasing their income or lowering at least one of the prices.