Microeconomics Test #1: The Theory of Consumer Behavior

question

Theory of Consumer Behavior

answer

given a budget constraint and preferences, which bundle will the consumer chose to maximize utility?

question

We use the TCB to...

answer

derive a Demand Curve

question

Endogenous

answer

independent variables

question

Exogenous

answer

dependent variables

question

Comparative Statics

answer

shocking an exo variable, ceteris paribus, and observing the effects.

question

analytical method

answer

pen and paper way to find optimal solution

question

numerical method

answer

using excel's solver to find optimal solution

question

Consumption Possibilities Frontier (CPF)

answer

the budget constraint; a fence where things on/under the curve are attainable while things over the curve are not

question

How to derive a demand curve

answer

change price, ceteris paribus

question

What pivots the budget line?

answer

change in price

question

What shifts the budget line?

answer

change in income

question

Funky Budget Lines

answer

taxes, subsidies, rationing and food stamps

question

Increase in Price of x1 (p1)

answer

rotate left (from x1 to x1')

question

Decrease in Price of x1 (p1)

answer

rotate right (from x1 to x1')

question

Increase in price of x2 (p2)

answer

rotate left (from x2 to x2')

question

Decrease in price of x2 (p2)

answer

rotate right (from x2 to x2')

question

Increase in Income (m)

answer

shift BC right

question

Decrease in income (m)

answer

shift BC left

question

Preferences

answer

a set of the consumer's likes, desire, and tastes

question

Comparing Preferences (3 ways)

answer

Strictly preferred, indifferent, weakly preferred

question

Indifference Curve

answer

Set of combinations that give equal satisfaction

question

Marginal Rate of Substitution (MRS)

answer

slope of the indifference curve; "how much is someone willing to give up x2 to get x1"

question

Funky Preferences and Indifference Curves

answer

Perfect Substitutes, perfect complements, bads, neutral goods

question

Perfect Substitutes

answer

constant slope. EX: 1 five dollar bill; 5 one dollar bills

question

Perfect Complements (L-Shaped)

answer

Things that can only be used in fixed proportions. EX: 1 car, 4 tires. 2 cars, 8 tires

question

Income Consumption Curve

answer

given a change in income, ceteris paribus, this is the line through the optimal solutions

question

Price Consumption Curve

answer

given a change in income, ceteris paribus, this is the line through the optimal solutions

question

Theory of Revealed Preference

answer

in every consumer's head there is the ability to compare and decide about items

question

Cardinal

answer

1,2,3,4 (can add, subtract, multiply, and divide)

question

Ordinal

answer

1st, 2nd, 3rd, 4th (cannot add, subtract, multiply, divide)

question

Monotonic Transformation

answer

squared rankings mean the same as their non squared counterparts. MRS remains the same under any transformation

question

Computing the MRS for a Utility Function (2 options)

answer

from a point and @ a point

question

MRS from a point

answer

change in x2 over change in x1

question

MRS @ a point

answer

(negative) partial derivative of x1 over partial derivative of x2. x-axis is numerator. y-axis is denominator.

question

If MRS=12

answer

Im willing to give up 12 x2 in order to get one more x1.

question

Canonical Graph

answer

graph of budget constraint, and indifference map. y-axis is x2, x-axis is x1

question

Indifference Map

answer

shows consumer's preferences; convex, downward sloping, and insatiable

question

Initial Solution

answer

finding max Utility through analytical or numerical methods

question

Steps to find optimal solution

answer

1) rewrite constraint
2) Write the Legrangean
3) Take Partial Derivatives with respect to endogenous variables
4) Set equations=0 (first order condition)
5) divide equation one by equation 2 (cancel lambdas
6) Sub value into the budget constraint (third order condition)

question

How to find lambda*

answer

use sensitivity report in solver

question

Quasilinear Utility function

answer

"sorta-linear", cannot get a giffen good

question

Miserable Result

answer

when solver tries to put a negative # in the function

question

Disastrous Result

answer

when solver found a wrong answer, but the graph did not move; you cant tell the answer is wrong

question

Corner Solution

answer

food stamps, MRS does not = price ratio but it is still the optimal solution given the possible bundles.

question

Distorted Consumers

answer

willing to give up very little x2 to get x1. prefers x2.

question

Carte Blanche Principle

answer

cash is always as good or better than in-kind

question

If MRS > p1/p2

answer

need to move up budget line. until MRS < price ratio

question

Own Unit Elasticity

answer

change in endo divided by change in exo

question

Elasticity

answer

responsiveness of the agent to a shock

question

Engel Curve

answer

graph of endogenous variable as a function of exogenous variable. (Income is the shock variable)

question

Unit Elastic

answer

=1; percent change is same for both variables. move at the same rate

question

Inelastic

answer

between 0 and 1. the shock did not cause the endogenous variable to change as much

question

Perfectly Inelastic

answer

A shock will have no change in the endogenous variable

question

Demand Curve Axis

answer

Y-endogenous variable
X-price

question

Inverse Demand Curve Axis

answer

Y-Price
X-Endogenous Variable

question

Giffen Goods

answer

violates the law of demand. If price were to increase we would consumer more of these products. Demand Curve is upward sloping

question

Price Elasticity of demand

answer

% change in x1 over % change in income

question

Total Effect

answer

Substitution Effect+Income Effect. B+C

question

Substitution Effect

answer

From A to B. When price changes, what bundle will we prefer

question

Income Effect

answer

From B to C. Amount I want to buy given the 'perceived' change in income

question

When IE & SE work together

answer

Normal good, downward sloping demand curve

question

When IE & SE work against each other

answer

Inferior good, downward sloping demand curve

question

When IE swamps SE

answer

Giffen good, upward sloping demand curve.

question

SE is always negative because....

answer

relationship between price and quantity is always negative

question

Endowment Model

answer

consumer has a specific allotted amount for x1 and x2. The consumer starts at a point on the graph. Can move to anywhere on the budget constraint.

question

Move northwest of the initial endowment means....

answer

sell x1 for more x2.

question

Move southeast of the initial endowment means...

answer

selling x2 for more x1

question

Increase in p1 (EM)

answer

bundles of x2 become more desirable. Budget line shifts right while still going through IE

question

Decrease in p1 (EM)

answer

bundles of x1 become more desirable. Budget line shifts left while still going through IE

question

Increase in p2

answer

bundles of x1 become more desirable. Budget line shifts right while still going through IE.

question

Decrease in p2

answer

bundles of x2 become more desirable. Budget line shifts left while still going through IE

1 of 71

question

Theory of Consumer Behavior

answer

given a budget constraint and preferences, which bundle will the consumer chose to maximize utility?

question

We use the TCB to...

answer

derive a Demand Curve

question

Endogenous

answer

independent variables

question

Exogenous

answer

dependent variables

question

Comparative Statics

answer

shocking an exo variable, ceteris paribus, and observing the effects.

question

analytical method

answer

pen and paper way to find optimal solution

question

numerical method

answer

using excel's solver to find optimal solution

question

Consumption Possibilities Frontier (CPF)

answer

the budget constraint; a fence where things on/under the curve are attainable while things over the curve are not

question

How to derive a demand curve

answer

change price, ceteris paribus

question

What pivots the budget line?

answer

change in price

question

What shifts the budget line?

answer

change in income

question

Funky Budget Lines

answer

taxes, subsidies, rationing and food stamps

question

Increase in Price of x1 (p1)

answer

rotate left (from x1 to x1')

question

Decrease in Price of x1 (p1)

answer

rotate right (from x1 to x1')

question

Increase in price of x2 (p2)

answer

rotate left (from x2 to x2')

question

Decrease in price of x2 (p2)

answer

rotate right (from x2 to x2')

question

Increase in Income (m)

answer

shift BC right

question

Decrease in income (m)

answer

shift BC left

question

Preferences

answer

a set of the consumer's likes, desire, and tastes

question

Comparing Preferences (3 ways)

answer

Strictly preferred, indifferent, weakly preferred

question

Indifference Curve

answer

Set of combinations that give equal satisfaction

question

Marginal Rate of Substitution (MRS)

answer

slope of the indifference curve; "how much is someone willing to give up x2 to get x1"

question

Funky Preferences and Indifference Curves

answer

Perfect Substitutes, perfect complements, bads, neutral goods

question

Perfect Substitutes

answer

constant slope. EX: 1 five dollar bill; 5 one dollar bills

question

Perfect Complements (L-Shaped)

answer

Things that can only be used in fixed proportions. EX: 1 car, 4 tires. 2 cars, 8 tires

question

Income Consumption Curve

answer

given a change in income, ceteris paribus, this is the line through the optimal solutions

question

Price Consumption Curve

answer

given a change in income, ceteris paribus, this is the line through the optimal solutions

question

Theory of Revealed Preference

answer

in every consumer's head there is the ability to compare and decide about items

question

Cardinal

answer

1,2,3,4 (can add, subtract, multiply, and divide)

question

Ordinal

answer

1st, 2nd, 3rd, 4th (cannot add, subtract, multiply, divide)

question

Monotonic Transformation

answer

squared rankings mean the same as their non squared counterparts. MRS remains the same under any transformation

question

Computing the MRS for a Utility Function (2 options)

answer

from a point and @ a point

question

MRS from a point

answer

change in x2 over change in x1

question

MRS @ a point

answer

(negative) partial derivative of x1 over partial derivative of x2. x-axis is numerator. y-axis is denominator.

question

If MRS=12

answer

Im willing to give up 12 x2 in order to get one more x1.

question

Canonical Graph

answer

graph of budget constraint, and indifference map. y-axis is x2, x-axis is x1

question

Indifference Map

answer

shows consumer's preferences; convex, downward sloping, and insatiable

question

Initial Solution

answer

finding max Utility through analytical or numerical methods

question

Steps to find optimal solution

answer

question

How to find lambda*

answer

use sensitivity report in solver

question

Quasilinear Utility function

answer

"sorta-linear", cannot get a giffen good

question

Miserable Result

answer

when solver tries to put a negative # in the function

question

Disastrous Result

answer

when solver found a wrong answer, but the graph did not move; you cant tell the answer is wrong

question

Corner Solution

answer

food stamps, MRS does not = price ratio but it is still the optimal solution given the possible bundles.

question

Distorted Consumers

answer

willing to give up very little x2 to get x1. prefers x2.

question

Carte Blanche Principle

answer

cash is always as good or better than in-kind

question

If MRS > p1/p2

answer

need to move up budget line. until MRS < price ratio

question

Own Unit Elasticity

answer

change in endo divided by change in exo

question

Elasticity

answer

responsiveness of the agent to a shock

question

Engel Curve

answer

graph of endogenous variable as a function of exogenous variable. (Income is the shock variable)

question

Unit Elastic

answer

=1; percent change is same for both variables. move at the same rate

question

Inelastic

answer

between 0 and 1. the shock did not cause the endogenous variable to change as much

question

Perfectly Inelastic

answer

A shock will have no change in the endogenous variable

question

Demand Curve Axis

answer

Y-endogenous variable
X-price

question

Inverse Demand Curve Axis

answer

Y-Price
X-Endogenous Variable

question

Giffen Goods

answer

violates the law of demand. If price were to increase we would consumer more of these products. Demand Curve is upward sloping

question

Price Elasticity of demand

answer

% change in x1 over % change in income

question

Total Effect

answer

Substitution Effect+Income Effect. B+C

question

Substitution Effect

answer

From A to B. When price changes, what bundle will we prefer

question

Income Effect

answer

From B to C. Amount I want to buy given the 'perceived' change in income

question

When IE & SE work together

answer

Normal good, downward sloping demand curve

question

When IE & SE work against each other

answer

Inferior good, downward sloping demand curve

question

When IE swamps SE

answer

Giffen good, upward sloping demand curve.

question

SE is always negative because....

answer

relationship between price and quantity is always negative

question

Endowment Model

answer

consumer has a specific allotted amount for x1 and x2. The consumer starts at a point on the graph. Can move to anywhere on the budget constraint.

question

Move northwest of the initial endowment means....

answer

sell x1 for more x2.

question

Move southeast of the initial endowment means...

answer

selling x2 for more x1

question

Increase in p1 (EM)

answer

bundles of x2 become more desirable. Budget line shifts right while still going through IE

question

Decrease in p1 (EM)

answer

bundles of x1 become more desirable. Budget line shifts left while still going through IE

question

Increase in p2

answer

bundles of x1 become more desirable. Budget line shifts right while still going through IE.

question

Decrease in p2

answer

bundles of x2 become more desirable. Budget line shifts left while still going through IE

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