Chapter 4 Summary

Restrictions on ICs...

...come from the set of properties imposed on utility functions.

Utility function...

...describes the relationship between a consumer's satisfaction level, and what the consumer actually consumes.

Consumer's decision...

...is a constrained-optimization problem: to maximize utility while staying within their budget constraint.

Consumer preferences...

...lead to differences in steepness and curvature of ICs.

Utility...

...provides a measure of how satisfied a consumer is with a consumption bundle.

The MRS of X for Y...

...reveals the willingness of a consumer to give up good X for good Y while still being equally well off.

Indifference Curves...

...show all the combinations of goods over which a consumer receives equal utility.

Satiation point

A point at which more of a good thing stops being better.

Properties of Utility Functions

Completeness, rankability, transitivity of utility bundles, that having more of a good is better than having less, and that the more a consumer has of a particular good, the less willing she is to give up something else to get more of that good.

...Indifference Curves

Consumers' preferences are reflected in their...

Implications of transitivity

If a consumer prefers good A to good B and good B to good C, then the consumer also prefers good A to good C.

...right angles

If a consumer views two goods as perfect complements, their ICs will be shaped like...

...straight lines

If a consumer views two goods as perfect substitutes, their ICs will be shaped like...

...give a person utility.

In consumer behavior, the inputs to a utility function are the different things that can...

Assumptions when analyzing role of income in consumption decisions

Each good has a fixed price, and an consumer can buy as much of a good as she wants at that price if the consumer has sufficient income to pay for it; the consumer has some fixed amount of income to spend; consumer cannot save or borrow

Features of ICs

Slope downward, never cross for a given individual, and are convex to the origin. DOWNWARD, NO CROSS, CONVEX.

...more curvature

In this graph, if our consumer has many shirts and few pants, he will be willing to trade many shirts to get a pair of pants. If they have many pants and few shirts, they will be less willing to trade a shirt for pants. Good that are complementary will generally have ICs with...

...relatively straight

In this graph, our consumer is willing to trade about the same amount of the first good (black socks) to get the same amount of the second good (blue socks). Goods that are highly substitutable are likely to produce ICs that are...

Utility-maximizing solution

To consume the bundle of goods located where an IC is tangent to the budget constraint. The consumer's MRS equals the goods' relative price ratio.

rich

Utility is NOT a measure of how ________ a consumer is.

Emily likes hip-hop downloads and doesn't care about heavy metal downloads. Hip-hop is good, heavy metal is neutral.

What are Emily's preferences based on the graph? Bundles on U2 are preferred to bundles on U1.

Michael only likes dress shirts and cufflinks in 1 to 2 proportions. Dress shirts and cufflinks are perfect complements.

What are Michael's preferences based on the graph? Bundles on U2 are preferred to bundles on U1.

Paul likes pencils and pens. Both are goods for Paul.

What are Paul's preferences based on the graph? Bundles on U2 are preferred to bundles on U1.

Rhonda likes carrots and dislikes broccoli. Carrots are a good, broccoli is a bad.

What are Rhonda's preferences based on the graph? Bundles on U2 are preferred to bundles on U1.

Marginal utility

What is this an example of? J was for Junior Mints, M for Milk Duds.

Marginal rate of substitution of X for Y

What is this?

horizontal, vertical

When ICs are flat, consumers are willing to give up a lot of the good on the ______________ axis to get a small additional amount of the good on the ________________ axis. In this case, concert tickets and MP3s. They would give up many MP3s to get a small additional amount of concert tickets.

vertical, horizontal

When ICs are steep, consumers are willing to give up a lot of the good on the ______________ axis to get a small additional amount of the good on the ________________ axis. In this case, concert tickets and MP3s. They would give up many concert tickets to get a small additional amount of MP3s.

Corner solution

Where the optimal quantity consumed of one good is zero. Can occur when a consumer's marginal utility of a good is so low compared that good's relative price that she is better off not consuming any of that good at all. MRS does not equal the price ratio even though the consumer is at the utility-maximizing consumption bundle.

John will choose bundle C over bundle A.

Suppose John is indifferent between consuming bundle A, 4 apples & 1 peach, and bundle B, 4 peaches & 1 apple. If John were given the choice between bundle A and bundle C, 3 peaches and 2 apples, which should he pick? See graph for help!

Budget constraint

Captures both a consumer's income and the relative prices of goods. Shows which consumption bundles are feasible or infeasible.

Utility

The economic concept of consumers' happiness or wellbeing

Slope of budget constraint

(-Px/Py)

Perfect complements

ICs are L-shaped. Having more of one shoe without the other shoe provides no extra utility. Utility only rises when customer has more of both goods. What kind of goods is this graph showing?

...indifferent!

ICs show the combination of all the different consumption bundles at a given utility level. In other words, given a utility level, it shows all the consumption bundles among which a consumer is...

Utility Function

The construct that relates the amount of goods consumed to the consumer's utility level. Inputs vs Outputs

...income and pricing

The consumer's decision about how much of each good to consume depends not only on utility, but also on...

Expenditure-minimization problem

The consumer's problem of what and how much to consume can be recast as an ________________, rather than thinking of consumers as trying to maximize utility subject to a budget constraint, we could think of them as trying to minimize the expenditure necessary for them to reach a given level of utility.

Slope of budget constraint

The negative ratio of the prices of the two goods.

MRSxy

The negative slope of the IC. The ratio of marginal utilities of the goods in the utility function.

The MRS should equal their price ratio

The optimal choices for both consumer problems result in the same thing:

...the consumer's utility level.

The output of the utility function is...

Perfect substitutes

This graph has ICs that are straight lines. The consumer is willing to trade one 12oz bag for four 3oz bags no matter how much they have of each. Consumer's preference for chips does not change along the IC. The MRS is constant. What kind of goods is this graph showing?