consumer theory

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Last updated 4:52 PM on 5/28/26
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22 Terms

1
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properties of a utility function

  • completeness

  • non satiation

  • diminishing marginal rate of substitution

  • transitivity

<ul><li><p>completeness </p></li><li><p>non satiation </p></li><li><p>diminishing marginal rate of substitution </p></li><li><p>transitivity </p></li></ul><p></p>
2
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completeness in utility function

needs to be expressed for all bundles

either a is preferred or b, or equally valued

3
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non satiation in utility function

more is better

4
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diminishing marginal rate of substitution in utility function

willingness to give up a lot of a good in abundance for an increase in a scarce good, maintaining the utility

5
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transitivity in utility function

if a is preferred to b and b is preferred to c then a must be preferred to c

6
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perfect substitutes

  • marginal rate of substitution is constant → no diminishing returns, fixed exchange rate

  • consumer is indifferent to which good they consume

  • linear utility function = •U=αx+βy

<ul><li><p>marginal rate of substitution is constant → no diminishing returns, fixed exchange rate </p></li><li><p>consumer is indifferent to which good they consume </p></li><li><p>linear utility function = <span>•</span><span style="font-family: &quot;Cambria Math&quot;;">U=αx+βy</span></p></li></ul><p></p>
7
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perfect compliments

  • goods are consumed together in a set ratio

  • having an extra unit of on means that the utility will still stay the same as the ratio you have 2:2 is the same as 2:3

<ul><li><p>goods are consumed together in a set ratio </p></li><li><p>having an extra unit of on means that the utility will still stay the same as the ratio you have 2:2 is the same as 2:3</p></li></ul><p></p>
8
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budget constraints

  • individuals do not have unlimited money, stick to a fixed budget

  • how much of the goods can they consume depends on the rice of the good and available budget

  • PXX + PYY = M

<ul><li><p>individuals do not have unlimited money, stick to a fixed budget </p></li><li><p>how much of the goods can they consume depends on the rice of the good and available budget </p></li><li><p>P<sub>X</sub>X + P<sub>Y</sub>Y = M</p></li></ul><p></p>
9
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income change with budget constraints

  • BC shift inwards or outwards

  • increase → afford more

  • decrease → afford less

<ul><li><p>BC shift inwards or outwards </p></li><li><p>increase → afford more</p></li><li><p>decrease → afford less </p></li></ul><p></p>
10
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price change with budget constraints

  • pivot inwards or outwards around intercept

  • increase → afford less inwards

  • decrease → afford more outwards

<ul><li><p>pivot inwards or outwards around intercept </p></li><li><p>increase → afford less inwards </p></li><li><p>decrease → afford more outwards </p></li></ul><p></p>
11
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utility maximisation

homo econmicus → utility maximiser

so they will choose the consumption bundle that maximises their budget constrains

tangency point between BC and IC

<p>homo econmicus → utility maximiser </p><p>so they will choose the consumption bundle that maximises their budget constrains </p><p>tangency point between BC and IC</p>
12
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finding utility maximisation

  • tangency condition → MRS = PX/PY

  • MRS = MUX/MUY

  • MUX = DU/DX

  • effectively (MU_x)/MUy=p_x/p_y

13
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perfect substitutes and utility

knowt flashcard image
14
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price changes on the budget curve

  • pivots inwards or outwards

  • increase → inwards

  • decrease → outwards

  • re optimise based on new prices

15
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demand changes with the budgets constraint

  • substitution effect → the change in the relative price of the goods

  • income effect → change in real income

  • slutsky, hicksian (substitution effects)

16
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slutsky

i give enough money to afford original at the new price

  • substitution effect → difference between reoptimisation and initial

  • income effect → difference between the reoptimisation bundle and final

<p>i give enough money to afford original at the new price </p><ul><li><p>substitution effect → difference between reoptimisation and initial</p></li><li><p>income effect → difference between the reoptimisation bundle and final </p></li></ul><p></p>
17
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hicksian

i give enough to avoid original utility at the new price

  • substitution effect → difference between the new bundle and initial

  • income effect → difference between new bundle and final bundle

<p>i give enough to avoid original <strong>utility </strong>at the new price </p><ul><li><p>substitution effect → difference between the new bundle and initial</p></li><li><p>income effect → difference between new bundle and final bundle </p></li></ul><p></p>
18
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change in CB and normal goods

  • demand increase with income

  • substitution and income effects reenforce each other

<ul><li><p>demand increase with income </p></li><li><p>substitution and income effects reenforce each other </p></li></ul><p></p>
19
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change in CB and inferior goods

  • demand decreases with income

  • both effects more in opposite ways

<ul><li><p>demand decreases with income </p></li><li><p>both effects more in opposite ways </p></li></ul><p></p>
20
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change in CB and giffen goods

  • extreme inferior

  • both move in opposite ways but income is greater

  • violation in law of demand

<ul><li><p>extreme inferior </p></li><li><p>both move in opposite ways but income is greater </p></li><li><p>violation in law of demand </p></li></ul><p></p>
21
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pure substitution effect

demand only shifts when the other good is the price of utility is cheaper for the other good

<p>demand only shifts when the other good is the price of utility is cheaper for the other good </p>
22
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percept compliment in BC

  • good combination never changes → just quantity ever ratio

  • no substitution effect

<ul><li><p>good combination never changes → just quantity ever ratio</p></li><li><p>no substitution effect</p></li></ul><p></p>