ECON 3140 Ch.4

Consumption Bundle

A set of goods and services a consumer considers purchasing

Four assumptions about consumer preferences

1. completeness and rankability 2. for most goods more is better than less 3. transitivity 4. the more a consumer has of a particular good, the less they are willing to give up something else to get more of that good (variety)

assumptions about budget constraint

1. each good has a fixed price 2. the consumer has a fixed amount of income to spend 3. for now the consumer cannot save or borrow

Corner vs Interior Solution

A corner solution is a utility maximum bundle located at the "corner" of the budget constraint where the consumer purchases only one of the two goods. An interior solution contains positive quantities of both goods

Budget Constraint

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

Feasible vs infeasible bundle

A feasible bundle is a bundle that the consumer has the ability to purchase; lies on or below the consumer's budget constraint while an infeasible bundle is the bundle that a consumer cannot afford to purchase; lies to the right and above a consumer's budget constraint.

Normal Good

A good for which consumption increases when income rises

Economic Bad

A good or service that provides a consumer with negative utility

Perfect Substitutes

A good that a consumer can trade for another good, in fixed units, and receive the same level of utility. Ex: 1 12 oz bag of chips or 3 4oz bags of chips':

Inferior Good

A good which consumption decreases when income rises

Perfect Complements

A good which the consumer receives utility dependent on its being used in a fixed proportion with another good. Ex: A left and right shoes

Utility Function Definition

A mathematical function that describes the relationship between what consumers actually consume and their level of well-being

Indifference Curve

A mathematical representation of the combination of all the different consumption bundles that provide a consumer with the same utility

Utility

A measure of how satisfied a consumer is

Consumer Choice

How consumers decide to spend their money based on their preferences and budget constraint and the effect on the demand optimization curve

Marginal utility equation

MUx = ΔU(X,Y) / ΔX marginal utility of x is the change in utility from one unit change in X

what is optimal consumption bundle? Where is it?

MUx/MUy = Px/Py at the point of tangency - where the slope of the indifference curve equals the slope of budget constraint

Marginal Utility vs Total Utility

Marginal utility is the additional utility earned when a consumer receives one additional unit while total utility is the sum of all a consumers marginal utilities for a particular good

mathematical formula for budget constraint (regular and slope intercept)

Income = PxX +PyY or Qy = income/Py -(Px/Py)Qx

Marginal Rate of Substitution of X for Y (MRSxy)

The rate at which a consumer is willing to trade off one good (the good on the horizontal axis X) for another (the good on the vertical axis Y) and still be left equally well-off MRSxy = -ΔQY/ΔQX =MUx/MUy

substitutes

if a consumer is willing to trade about the same amount of X good to get the same amount of Y good Py decreases consumption of X decreases

welfare economics

the area of economics concerned with the economic well being of society as a whole

what dos a steep curve mean for indifference curve

willing to give up a lot of good Y to get a little more of good x

characteristics of indifference curves

1. we can draw indifference curves 2. indifference curves of individuals never cross 3. indifference curves are convex (bend toward) the origin

complements

Py decreases consumption of X increases

Expenditure Minimization

Start with a level of utility and find the cheapest bundle that achieves that utility level

utility function equation

U=U(X,Y)