ECON 300 Exam 1: Chapter 4

assumptions on consumer preferences

1. Completeness and rankability

- means that, given any two bundles, a consumer can decide which she prefers (or whether she is indifferent, meaning she likes them the same)

2. More is better than less

- means that, given any two bundles, a consumer can decide which she prefers (or whether she is indifferent, meaning she likes them the same)

3. Transitivity

- For any three bundles of goods (call them A, B, and C), if a consumer prefers A to B and also prefers B to C, then she prefers A to C

4. The more a consumer has of a particular good, the less she is willing to give up of something else to get even more of that good

- The idea behind this assumption is that consumers like variety. If you like powdered donuts and haven't had any lately, you might be willing to give up a lot to get some. You might be willing to pay a high price for a donut, wait in a long line for a donut, or trade away your last carton of milk for a good donut. On the other hand, if you've just polished off eight donuts in a row, you wouldn't pay as much for the ninth donut as you did for that first one.

Marginal Utility

the extra utility a consumer receives from a 1-unit increase in consumption

Marginal utility formula

Mu = (%change Total Utility) / (%change Quantity)

Indifference curve assumptions

1. We can always draw indifference curves

- The first assumption, completeness and rankability, means that we can always draw indifference curves: All bundles have a utility level, and we can rank them.

2. We can figure out which indifference curves have higher utility levels and why they slope downward.

- The "more is better" assumption implies that we can look at a set of indifference curves and figure out which ones represent higher utility levels. This can be done by holding the quantity of one good fixed and seeing which curves have larger quantities of the other good.

3. Indifference curves never cross

- The transitivity property implies that indifference curves for a given consumer can never cross.

4. Indifference curves are convex to the origin

- The fourth assumption of utility — the more you have of a particular good, the less you are willing to give up of something else to get even more of that good — implies something about the way indifference curves are curved. Specifically, it implies they will be convex to the origin; that is, the middle will bend in toward the origin as if the origin is tugging on the indifference curve, trying to pull it in.

special cases for indifference curves

perfect substitutions and complements

Budget Constraint

a curve that describes the entire set of consumption bundles a consumer can purchase by spending all income.

Budget Constraint Formula

Income = PxQx + PyQy

feasible bundle

a bundle that the consumer has the ability to purchase; lies on or below the consumer's budget constraint

infeasible bundle

a bundle that the consumer cannot afford to purchase; lies to the right and above a consumer's budget constraint

Utility Maximization

The proposal that people make decisions by selecting the option that has the greatest utility.