Topic 1: Budget Constraints & Preferences Flashcards
(16 cards)
What is the focus of microeconomics?
Microeconomics studies the allocation of scarce resources, focusing on individual and firm-level decisions, and how they interact in markets
How do economists model decision-making in microeconomics?
By assuming agents have stable preferences and solve optimization problems subject to constraints (e.g., income, prices).
What is the standard two-good budget constraint formula?
PxX+PyYβ€M
Px = price of X
Py = price of Y
and M = income
How do you represent the budget constraint graphically?
A straight line with slope ππ/ππ and intercepts π/ππ and π/ππ on the X and Y axes respectively.
What does the slope βππ/ππ represent?
The opportunity cost of good X in terms of good Y
What happens to the budget line if income increases?
The budget line shifts outwards in a parallel fashion.
What happens if the price of X increases?
The budget line rotates inward, pivoting on the Y-axis
What is the βnumeraireβ in consumer theory?
A good whose price is normalized to 1 to simplify analysis; all other prices are expressed relative to it
What properties must preferences satisfy to be considered rational?
Completeness (any two bundles can be compared) and Transitivity (consistent ranking)
What does monotonicity mean in consumer preferences?
More of a good is always preferred to less
What does convexity of preferences imply?
Consumers prefer averages (i.e., combinations of goods) over extremes. Graphically, indifference curves are bowed toward the origin
What is an indifference curve?
A curve that connects all consumption bundles providing the same level of utility
What are three key properties of indifference curves (under rational, monotonic, and convex preferences)?
Downward sloping
Do not cross
Convex to the origin
What is the Marginal Rate of Substitution (MRS)?
The rate at which a consumer is willing to substitute one good for another while maintaining the same level of utility; equals the slope of the indifference curve at a point
What do indifference curves look like for perfect substitutes?
Straight lines
What do indifference curves look like for perfect complements?
Right-angled (L-shaped)
