Midterm 1 Flashcards
(25 cards)
What is a bundle?
Combination of good and services.
Bundle A : (good1, good2) = (x, y)
Basic assumptions about preferences:
1: Completeness - people can always make a choice between any two options presented to them
2: Transitivity - logically consistent e.g. a>b, b>c, so a must be greater than c, a>c.
3: Non-satiation - the more the better
What is indifference?
2 options provided to the consumer provide the same benefit, i.e. perfect complements
What is Utility?
The amount of happiness a good/service provides, measured in Utils
Traits of Indifference Curves (IC):
- Infinite IC in any given family
- Infinite bundles on any individual IC
- ICs are always downward sloping
- ICs in a family never cross
What does the slope of an Indifference Curve (IC) mean?
The slope is how much a person is willing to trade off one good for one more unit of another good.
- Convex Indifference Curves for most* goods.
- The slope changes along the curve
What does the IC of perfect substitutes look like?
Linear
What do the IC of perfect complements look like?
L shaped
What is the formula for the Utility Function?
U = f(x, y)
What does the Linear Utility Function represent?
Always represents perfect substitutes.
What is the formula for the Cobb-Douglas Utility function?
U = ax^by^c
- x and y cannot equal 0
What is marginal utility (MU)
Measures the added utility derived from a one-unit increase in consumption of a commodity, holding the consumption of other commodities constant.
What is the Marginal Utility for a perfect complements?
The marginal utility for perfect complements is always 0.
Marginal Rate of Substitution (MRS):
- Negative of the slope of the IC (MRS>0), positive.
i.e. MRS = (-) change in y/change in x - Trade-Off Rate: How much of one good a person is willing to give up in order to obtain one more unit of the other good
True/False: The Marginal Utility (MU) of a Cobb-Douglas function has diminishing returns.
True.
if x increases then MUx decreases
if y increases then MUy decreases
What do Px, Py and I stand for?
Px = price of x
Py = price of y
I = Income
What is the difference between budget constraint and indifference curves?
Budget Constraints: shows how much of one good you must give up to get 1 more unit of another good.
Indifference Curves: Shows the willingness to give up one good for another.
Traits of Budget Constraints (BC)
- BC is always linear
- Bundles above the BC are unaffordable
- Bundles below the BC are affordable, but inefficient.
How do changes in Px (price of x), Py (price of y), and I (income), affect the Budget Constraint (BC)?
- if Px increases, BC steeper and rotates inward
- if Px decreases, BC flatter and rotates outward
- if Py increases, BC flatter and rotates inward
- if Py decreases, BC steeper and rotates outward
- if I increases, BC shifts outward
- If I decreases, BC shifts inward
Consumer Choice for perfect substitutes:
Always only consume 1 good, unless MRS = slope of BC, then any bundle will provide the same utility.
Consumer Choice for perfect complements:
Find price of a set, then divide Income by price of a set to get # of sets. After, multiply # of sets by the price of each good to get the optimal bundle.
The Impact of Income Change on Consumer Choice:
- if Income increases, consumption of x increases if x is a Normal Good
- if income increases, consumption of x decreases if x is an Inferior Good.
- it is not possible for both x and y to be inferior goods.
What is the substitution effect?
The decrease in consumption for a commodity when the price rises, due to consumers switching to cheaper alternatives.
What is the income effect?
The change in demand for a commodity caused by an increase in income. x increases if normal good, decreases if inferior good.
