Econ 2Z03: 2 - Consumer Choice

What is the market demand function?

It represents the total quantity demanded in the market for a particular good and its per-unit cost over a given period.

How does individual demand contribute to market demand?

Market demand is the aggregation of the quantities demanded by each individual consumer.

What assumption do consumers make about prices in a competitive market?

Each consumer takes the price as given, as their individual actions have negligible impact on the market.

What is opportunity cost in consumer decision-making?

It is the foregone alternative of spending money on another good instead of the one being purchased.

What does the budget constraint represent?

It states that a consumer can only afford bundles of goods whose total cost does not exceed their income.

How is the consumer's total expenditure calculated?

It is calculated as e(x1, x2) = p1x1 + p2x2, where p1 and p2 are the per-unit prices of the goods.

What is the budget set S?

The budget set S includes all affordable bundles (x1, x2) that satisfy the condition p1x1 + p2x2 ≤ m.

What happens if a bundle exceeds the budget constraint?

If p1x1 + p2x2 > m, the bundle does not belong to the budget set S.

What is the significance of the variable m in consumer theory?

It denotes the consumer's income, which is a finite amount available for spending on goods.

What is the role of income in consumer choice?

Income is used to purchase goods that yield satisfaction, and consumers typically spend their entire income on these goods.

How do preferences influence consumer choices?

Consumer choices are driven by individual preferences, which determine how they allocate their income among various goods.

What is the utility function in consumer theory?

It is a real-valued function u(x1, x2) that represents the level of satisfaction derived from consuming two goods.

What does maximizing utility involve for a consumer?

It involves choosing quantities of goods x1 and x2 that provide the highest satisfaction without exceeding income m.

What is the implication of assuming money has no direct value to the consumer?

It implies that consumers derive satisfaction only from the goods they can purchase with money, not from the money itself.

What choices do consumers face regarding their income?

Consumers must decide how to allocate their income among various expenditures and savings for future needs.

What is an example of a simple consumer choice problem?

Deciding how much of two goods, like apples and bananas, to buy with a given income.

How can changes in income affect consumer choices?

An increase or decrease in income can alter the budget constraint and the set of affordable bundles.

What is the relationship between individual choices and broader social choices?

Individual choices, such as spending on goods, reflect broader social choices encountered throughout life.

What is the significance of consumer preferences in economic theory?

They are central to understanding how consumers make decisions about spending and consumption.

How does the concept of scarcity relate to consumer choices?

Scarcity forces consumers to make choices about how to allocate limited resources among competing needs.

What does it mean when a consumer defers a choice?

Deferring a choice is itself a decision, reflecting the complexity of consumer behavior.

What does the budget line represent in consumer choice?

The budget line includes all consumption bundles that cost exactly as much as the consumer's income.

What is the formula for the budget line in terms of two goods?

m = p1x1 + p2x2, where m is income, p1 and p2 are prices of goods 1 and 2, and x1 and x2 are quantities of goods 1 and 2.

How can the budget line be expressed in terms of one good?

x2 = m/p2 - (p1/p2)x1, showing the relationship between the quantities of the two goods.

What does a change in the price of good 1 do to the budget line?

It rotates the budget line, affecting the quantity of good 1 that can be purchased while keeping the vertical intercept unchanged.

What happens to the budget line if the consumer's income increases?

The budget line shifts outward, increasing the intercepts without changing the slope.

What is the significance of the slope of the budget line?

The slope, -p1/p2, indicates the rate at which the consumer can trade off one good for another.

How do consumer preferences affect choices within the budget set?

Consumers may choose different bundles from identical budget sets based on their subjective preferences.

What are the three possible rankings a consumer can make between two bundles?

1) Strictly prefers A to B (A ≻ B), 2) Indifferent between A and B (A ∼ B), 3) Strictly prefers B to A (B ≻ A).

What is a utility function in the context of consumer choice?

A utility function ranks consumption bundles by assigning a numerical value that represents the consumer's happiness from each bundle.

How is consumer preference represented using utility values?

A is (weakly) preferred to B if u(A) ≥ u(B), strictly preferred if u(A) > u(B), and indifferent if u(A) = u(B).

What does it mean for a consumer to have subjective preferences?

Subjective preferences mean that different consumers may value the same goods differently based on personal tastes.

What is the impact of a price change on the budget line's intercepts?

A price change affects the slope of the budget line but does not change the vertical intercept if the price of good 2 remains constant.

What is the relationship between the budget line and purchasing power?

The budget line reflects the real purchasing power of the consumer's income, determined by the price-income ratio.

What happens to the budget line if the price of good 2 changes?

The vertical intercept changes while the horizontal intercept remains the same, resulting in a new slope.

What is the role of economists in analyzing consumer choices?

Economists aim to analyze a wide variety of consumer preferences without imposing subjective judgments on what choices are 'right' or 'wrong.'

How does the concept of indifference relate to consumer choice?

Indifference indicates that a consumer derives the same level of utility from two different bundles, allowing for flexibility in choice.

What is the significance of the intercepts on the budget line?

The intercepts represent the maximum quantity of one good that can be purchased when the other good's quantity is zero.

How do changes in relative prices affect consumer choices?

Changes in relative prices alter the slope of the budget line, influencing the trade-offs between goods.

What does it mean for a consumer to strictly prefer one bundle over another?

It means the consumer derives more utility from the preferred bundle compared to the other.

What is the importance of the budget constraint in consumer choice theory?

The budget constraint defines the limits of what a consumer can afford, shaping their consumption decisions.

How do economists model consumer preferences?

Economists assume consumers can rank bundles and often use utility functions to simplify the representation of preferences.

What does the term 'budget set' refer to?

The budget set includes all bundles that a consumer can afford given their income and the prices of goods.

What is the effect of a price decrease on the budget line?

A price decrease for one good makes the budget line flatter, indicating a better trade-off for that good.

Why is it difficult to measure utility objectively?

Utility is subjective and varies between individuals, making it challenging to establish a universal measure of happiness.

What does a consumer's utility function describe?

It describes the consumer's preferences and how they rank different bundles of goods.

What happens when a utility function is linearly transformed?

The consumer's preferences remain unchanged; the ranking of bundles is the same.

What is marginal utility?

Marginal utility is the additional utility gained from consuming one more unit of a good.

How is marginal utility calculated for a good i?

It is calculated as the partial derivative of the utility function with respect to good i: MUi = ∂u/∂xi.

What does it mean when marginal utility is decreasing?

It means that as a consumer has more units of a good, the additional satisfaction from consuming more of it diminishes.

What is the marginal rate of substitution (MRS)?

MRS is the rate at which a consumer can substitute one good for another while maintaining the same level of utility.

What is the formula for calculating MRS?

MRS = -MU1/MU2, where MU1 and MU2 are the marginal utilities of goods 1 and 2, respectively.

What is an indifference curve?

An indifference curve represents all bundles of goods that provide the same level of utility to the consumer.

What shape do indifference curves typically take?

The shape depends on the utility function; they can be convex, linear, or other forms based on preferences.

What is the utility function for perfect substitutes?

The utility function is u(x1, x2) = ax1 + bx2, where a and b are positive constants.

What is the marginal utility for perfect substitutes?

For perfect substitutes, the marginal utilities are constant: MU1 = a and MU2 = b.

How does the MRS for perfect substitutes behave?

The MRS is constant and equals -a/b, indicating a fixed rate of substitution between the two goods.

What is the significance of the negative sign in MRS?

The negative sign indicates that to keep utility constant, a decrease in one good must be compensated by an increase in another.

What does it mean if a consumer prefers bundle A over bundle B?

It means that the utility derived from bundle A is greater than that from bundle B.

What is the relationship between utility functions u and v if they represent the same preferences?

u(A) > u(B) if and only if v(A) > v(B), indicating they rank bundles identically.

How does the number of units of a good affect its marginal utility?

Marginal utility typically decreases as the quantity of the good increases due to diminishing returns.

What happens to the utility of a consumer when they receive additional units of a good?

The utility increases by the product of the number of additional units and the marginal utility of that good.

What is the implication of having no food in the fridge for the value of potatoes?

The first kg of potatoes is extremely valuable to prevent starvation, but additional kg may have negligible value.

What does the equation x = MU1/MU2 represent?

It represents the number of additional units of good 2 needed to compensate for the loss of one unit of good 1.

What is the utility function example given for perfect substitutes?

The example is u(x1, x2) = 2x1 + x2.

What is the MRS for the utility function u(x1, x2) = 2x1 + x2?

The MRS is -2, indicating the consumer's rate of substitution between the two goods.

What happens when the consumption of good 1 decreases by one unit and good 2 increases by two units?

The consumer maintains the same level of utility.

What is an example of perfect substitutes in consumer goods?

A brand-name pharmaceutical pill (500mg) can be substituted with a generic pill (1000mg) under certain conditions.

What is the utility function for perfect complements?

u(x1, x2) = min{ax1, bx2}, where a and b are positive constants.

Give an example of perfect complements.

Owning left and right shoes; one shoe alone provides no utility.

What shape do the indifference curves take for perfect complements?

L-shape, indicating that utility is derived from pairs of goods.

How does the marginal utility of good 1 change when the consumer has more of it?

The marginal utility of good 1 decreases as the quantity of good 1 increases.

What is the marginal utility of good 1 when ax1 ≥ bx2?

The marginal utility of good 1 equals 0.

What is the Cobb-Douglas utility function?

u(x1, x2) = x^α1 * x^β2, where α and β are between 0 and 1.

What is the marginal rate of substitution (MRS) in the context of Cobb-Douglas utility?

MRS(x1, x2) = -MU1(x1, x2) / MU2(x1, x2) = -α/β * (x2/x1).

What does a convex preference indicate about a consumer's choices?

The consumer prefers a balanced consumption of both goods rather than extreme quantities of one.

What is the effect of increasing the quantity of good 2 when the consumer has more of good 1?

It increases the marginal utility of good 2, as it helps achieve the desired proportion of goods.

What does it mean if a consumer has perfect substitutes for two goods?

The consumer is indifferent between the two goods at a specific ratio.

What happens to utility if a consumer has an extra left shoe when they already have three left and four right shoes?

The extra left shoe increases utility by completing an additional pair.

What is the implication of having a utility function of u(x1, x2) = min{ax1, bx2}?

The consumer's utility is limited by the lesser quantity of the two goods.

How do consumers typically react to additional units of a good in Cobb-Douglas preferences?

They derive less satisfaction from each additional unit due to diminishing marginal utility.

What is the relationship between the quantities of goods in Cobb-Douglas utility?

The consumer's utility depends on the product of the quantities raised to their respective powers (α and β).

What does the term 'indifference curve' refer to?

A curve that represents all combinations of goods that provide the same level of utility to the consumer.

What does the term 'marginal utility' refer to?

The additional satisfaction gained from consuming one more unit of a good.

What is the significance of the constants a and b in the perfect complements utility function?

They represent the fixed proportions in which the goods are consumed to maximize utility.

What is an example of a situation where goods are not perfect substitutes?

Consumers may prefer Coke over Pepsi or vice versa, indicating individual preferences.

What does the slope of the indifference curve represent in Cobb-Douglas preferences?

The rate at which a consumer is willing to substitute one good for another while maintaining the same utility.

How do consumers with convex preferences behave?

They prefer a mix of goods rather than consuming one good in excess.

What is the consumer's problem?

Finding the bundle that gives the most utility among all affordable bundles.

What does marginal utility (MU) indicate?

The additional happiness a consumer derives from purchasing an additional unit of a good.

What must a consumer consider when spending their budget?

The per-dollar marginal utility of each good, which is influenced by the prices of the goods.

What happens if MU1/p1 > MU2/p2?

The consumer will spend their dollar on good 1.

What happens if MU1/p1 < MU2/p2?

The consumer will spend their dollar on good 2.

What does it mean if MU1/p1 = MU2/p2?

Spending the dollar on either good is optimal for the consumer.

How does a consumer maximize utility with a budget?

By spending each dollar on the good that provides the highest per-dollar marginal utility.

What is the budget constraint in utility maximization?

p1x1 + p2x2 = m, where m is the consumer's total budget.

What happens when a consumer has perfect substitutes and a > b?

The consumer will buy only good 1 until their budget is exhausted.

What does it mean if ax1 < bx2 in perfect complements?

The consumer has fewer units of good 1 than needed to match good 2, so they need more of good 1.

What is the implication of having ax1 > bx2?

The consumer needs more of good 2 to achieve the desired proportion.

What is the optimal bundle for perfect complements?

A bundle where ax1 = bx2, meaning the goods are in the desired proportion.