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ECON 410: TEST 1 REVIEW
Preference Assumptions |
-Completeness: Every pair can be ranked in some way.
-Transitivity: Rankings are rational. (A>B and B>C A>C) -Nonsatiation: More is better -Strict Covexity: If you are indifferent to A and B then you prefer the average.
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Bundle Assumptions |
-Non-negativity: Quantity of bundle is always greater or equal to 0 (not negative quantity)
-Divisibility: Parts of the bundle can take any non-negative value
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Marginal Rate of Substitution (MRS) |
-Slope of the indifference curve
-Rate of giving up one good for one more of another -Is negative (you move down an indifference curve typically)
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Indifference Curves Rules |
- ICs cannot cross
-slope downward for "good" goods -the farther from the origin the better -are not thick -there is one for every possible bundle
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Perfect Substitutes |
-No balance between goods needed
-There is a constant MRS -IC's have a constant slope (are straight lines)
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Perfect Complements |
-Goods are used in fixed proportion
-MRS is sensitive to this proportion -IC's are kinked at a rate angle
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Bad Good |
-negative value to the consumer
-consumption lowers utility -IC is curved up and out..."decreasingly increasing"
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Utility for Perfect Substitutes |
-Utility function is U= aX + bY
-Straight downward sloping IC
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Marginal Utility |
-The change in utility from increasing the quantity of one good.
-MU from X is the partial derv of U with respect to X. Examples: U=X+Y MUx = 1 U=2XY MUx = 2Y
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Utility, MU, and Indiff Curves |
- MRSxy = MUx / MUy
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Budgets |
Budget Constraint- Total Spending must be no greater than income
Budget Set- The Collection of all affordable or buyable bundles Budget Line- The collection of bundles which exhaust a consumers income
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Optimal Bundle |
1. MRS = Px/Py (Slope of IC = slope of budget)
2.PxX + PyY = I (All income is spent)
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MRS and Prices |
MRS=Px / Py
MUx / MUy = Px / Py so MUx / Px = MUy / Py 1/Px = Amount of X you can buy for $1 MUx = Extra happiness from one more X MUx/Px = Extra happiness per dollar
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Usual Price Change |
When Price falls Demand increases.
-Budget line will shift out. New further out indifference curve. Point will be out and down. When Price rises Demand decreases. -Budget line shifts in. New closer in indifference curve. Point will be up and left.
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Unusual Price Changes |
When Price changes Demand moves with price. Demand curve is shaped up.
Budget line shifts out but point moves up and left. Budget line shifts in but point moves down and right. This is very rare and has been proven to not be completely accurate in real market situations.
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Income Changes |
For normal goods you desire more of them as your income rises.
Graphically-New IC will most likely shift directly out (proportionately) For inferior goods you desire less as your income rises (the trade in effect). Graphically- New IC will shift away from the inferior good.
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Cross-Price Effects |
-Demand of good rises when price of a substitute rises
-Demand falls when a complementary good's price rises.
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Consumer Surplus |
When consumers pay less than they are willing to.
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Compensating Variation |
The amount of money one would have to give a consumer to offset a price increase. This uses the new prices but the old utility.
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Equivalent Variation |
Amount of money needed to take away from the consumer to harm as much as a price increase. Uses old prices and the new utility.
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