Economics Quiz 3 Part 2

What are the two considerations on the consumer choice model when choosing bundles?

individual preferences and possible combinations within a given price

What are two constraints in the 2 good setting?

the individual has a per-period income and there is a set price of good J

What must happen in this consumer choice model?

The individual cannot save or borrow. They must spend all their income

What are all the points on the line of the budget constraint graph?

all possible bundles within the constraints

What bundle will consumers choose?

the one that yields the most utility

What is the consumer’s utility function?

u = f (x, y)

What does a consumer’s utility function identify?

the utility that is attained/realized from every bundle

Marginal Utility

change in utility/change in x

Law of diminishing marginal utility

as consumption of a good rises (all else constant) beyond a point, the utility will increase but at a decreasing rate

What is slope on a utility graph?

Slope is positive at any point.

What is slope at any point on a utiltiy graph?

the marginal (change in utility/change in x)

What do inviduals prefer?

more over less

What can we derive from a utility function?

a set of functions that will be critical for solving the consumer’s optimization problem. These are called indifference functions

What does an indifference function identify?

all bundles that yield the same amount of utility

What are the three relationships between economic goods?

• perfect substitutes

• imperfect substitutes

• complements

Perfect Substitutes

goods that a consumer can replace with one another at a constnat rate while maintaining the same level of satisfaction

Linear

Imperfect Substitutes

Goods/services that are substitutes but not the same. As a consumer uses more of one good and less of another, the rate at which they are willing to trade one for the other changes

Convex (bowed inward toward origin). Slope changes at every point

How do you find the slope at any given point on a graph for imperfect substitutes?

ratio of marginal utilities of x and y (x/y)

Complements

Goods that consumers must use together in a fixed, unvarying proportion

L shaped graph, the corner represents the required proportion.

What does the slope on the flat/vertical parts of a complement graph mean?

infinite or zero willingness to trade

What does the indifference curve look like when both are economic bads?

downward sloping because one of them rises as the other increases

If utility remains constant and you have to experience one bad, the exposure to the other must decrease

What does the indifference curve look like when one is an economic bad and the other is a good?

the indifference curves are positive sloping

If utility is constant and the bad increases, then the good must also increase

Higher indifference curves are associated with…

greater levels of utility

What does a budget constraint show?

what consumers can do

What does the consumer choice model/indifference curve model show?

what consumers would like to do

What does an optimization graph show/

what the consumer will do

Where does the best bundle occur?

at the tangent point between the indifference curve and budget constraint

If you identify the optimal x and y bundle what else have you identified?

a point on the demand curve for good x and good y

What happens if price of one good goes up on an optimization graph?

your budget constraint shifts inward so you’re forced to consume along a lower indifference curve, which has lower utility

Marginal Rate of Substitution

slope at a given point of an indifference curve

MU_x/MU_y

What is the slope at the tangency point on a consumer optimization graph?

Slope of the budget constraint = to the slope of the tangential indifference curve

Where is utility maximized?

where marginal utility per dollar is equal over goods on the final units purchased

What does marginal utility being equal over goods mean?

you don’t only take into account the satisfaction you get from goods or just the prices of goods. You take both into account