We make four assumptions about preferences: completeness and rankability, “more is better,” transitivity, and consumers want variety. Briefly describe each assumption.
Completeness and rankability mean that consumers can make comparisons across all consumption bundles. “More is better” describes the assumption that for most goods, consuming more of the good benefits the consumer. Transitivity implies that if a consumer prefers good A to good B and good B to good C, then the consumer also prefers good A to good C. Finally, consumers prefer variety, meaning that the more a consumer has of a particular good, the less she is willing to give up something else to get more of that good.
What does the term “utility” mean? How does utility relate to a utility function?
Utility provides a measure of how satisfied a consumer is with a consumption bundle. The utility function describes the relationship between a consumer’s satisfaction level, or utility, and what the consumer actually consumes.
Define “indifference curve.” What does an indifference curve tell us about the consumer?
An indifference curve shows the combination of all the different consumption bundles at a given utility level. In other words, given a utility level, it shows all the consumption bundles among which a consumer is indifferent.
We learned that the slope of the indifference curve is called the marginal rate of substitution of X for Y. What does the MRSXY tell us about a consumer’s preferences between two goods?
The marginal rate of substitution of X for Y reveals the willingness of a consumer to give up good X for good Y while still being left equally well off.
Why does the slope of the indifference curve vary along the curve? What does this variability tell us about consumers’ preferences?
The negative of the slope of the indifference curve is equal to the consumer’s MRSXY, or how much of good X he is willing to give up to receive more of good Y. As you move along a consumer’s indifference curve in the standard case, the curvature of the indifference curve reflects the change in the consumer’s relative preferences for the two goods. In particular, as the consumer gains more of good X, he is willing to give up less of good Y—a characteristic of the indifference curve that stems from our assumption that consumers prefer variety.
What does a steep indifference curve indicate about a consumer’s preferences? What does a flat indifference curve say?
Indifference curves that are relatively steep indicate that the consumer is willing to give up a large quantity of good Y to get another unit of good X. Relatively flat indifference curves imply that the consumer would require a large increase in good X to be willing to give up a unit of good Y.
When are two goods perfect substitutes? What does the indifference curve look like, or what is its curvature?
Perfect substitutes are goods that a consumer can trade for another good, in fixed units, and receive identical levels of utility. Indifference curves for perfect substitutes are straight lines.
When are two goods perfect complements? What does the indifference curve look like?
Perfect complements are goods whose utility levels depend on being used in fixed proportion with one another. Indifference curves for perfect complements are L-
In addition to utility, what other factors determine how much of a good to buy?
Consumers make utility-
Describe the three assumptions we make when incorporating income into our model of consumer behavior.
We make three assumptions before defining the economic model that incorporates a consumer’s budget constraint: (a) Each good has a fixed price and unlimited quantity, (b) the consumer’s income is fixed, and (c) the consumer cannot save or borrow.
What is a budget constraint?
A consumer’s budget constraint is the curve that describes the entire set of consumption bundles a consumer can purchase when spending his entire income.
What determines the slope of a budget constraint? What situation would change the slope of a budget constraint?
The slope of the budget constraint is equal to the negative of the ratio of the two prices, –Px/Py. Any nonproportional change in the goods’ prices would affect the slope.
What do we call the bundle represented by the point of tangency between the consumer’s indifference curve and her budget constraint?
The consumer’s optimal, or utility-
At the point of tangency, what is true about the ratio of the goods’ marginal utilities and the ratio of their prices?
At the point of tangency between the consumer’s budget constraint and her indifference curve, the ratio of the goods’ marginal utilities equals the ratio of the goods’ prices.
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