- In the diagram below, a consumer maximizes utility by choosing point A, given BL1.
Suppose that both good x is normal and good y is inferior, and the budget line shifts to BL2. Which of the following could be the new optimal consumption choice?
a) B.
b) C.
c) D.
d) Either B or C or D.
- Which of the following diagrams could represent the change in a consumer’s budget line if (i) the price of good y increases AND (ii) the consumer’s income decreases.
6.2 The Indifference Curve
- If a consumer (who buys two goods) has strictly convex preferences, then:
a) Her indifference curves are relatively steep at low levels of x and relatively flat at high levels of x.
b) Her preference is to have some of each of the two goods, rather than all of one and none of the other.
c) Her marginal rate of substitution diminishes.
d) All of the above are true. - The diagram below illustrates the indifference curve of a consumer of goods x and y.
Assuming the current consumption bundle is the point labelled A, which of the following statements is TRUE?
a) This consumer is just willing to give up 2 units of y for an additional x.
b) This consumer is just willing to give up 1 unit of y for an additional 2 units of x.
c) This consumer is just willing to give up 1/2 a unit of x for an additional y.
d) Both a) and c) are true.
- A consumer has $20 per week to spend on coffee and muffins. The price of a cup of coffee and the price of a muffin both equal $1 each. If the consumer always likes to consume one muffin for every cup of coffee he drinks, what consumption bundle will maximize his utility?
a) 20 muffins and no coffee.
b) 20 coffees and no muffins.
c) 10 coffees and 10 muffins.
d) All of the above consumption bundles maximize his utility – he is indifferent among all those options listed.
6.3 Understanding Consumer Theory
- In the diagram below, a consumer maximizes utility by choosing point A, given BL1.
Suppose that both goods x and y are normal and the budget line shifts to BL2. Which of the following could be the new optimal consumption choice?
a) B.
b) C.
c) D.
d) Either B or C or D.
- Suppose that, given the consumption bundle x = 10 and y = 10, a consumer’s MRS is equal (in absolute value) to 4. The price of x is $1 and the price of good y is $0.25, and the bundle x = 10 and y = 10 uses up all the consumers income. The consumer’s preferences are strictly convex. Which of the following is TRUE?
a) To maximize utility the consumer should but more x and less y.
b) To maximize utility the consumer should buy less x and more y.
c) The bundle x = 10 and and y = 10 maximizes the consumer’s utility.
d) To maximize utility the consumer should buy more of both x and y. - The diagram below illustrates the effect of a decrease in the price of good y, for a given consumer.
Which of the following statements is TRUE?
a) Goods x and y are substitutes.
b) Goods x and y are complements.
c) Goods x and y are neither substitutes or complements.
d) None of the above statements are true.
- The diagram below illustrates the effect of a decrease in the price of good y, for a given consumer. Which of the following statements is TRUE?
a) Goods x and y are substitutes.
b) Goods x and y are complements.
c) Goods x and y are neither substitutes or complements.
d) None of the above statements are true.
- Refer to the indifference curve/budget line diagram below.
Suppose that a consumer initially faces budget line BL1, and thus, by choosing consumption point c, is able to achieve the utility level associated with IC1. If px decreases, then the substitution effect is the movement from and the income effect is the movement from .
a) a to b; b to c.
b) b to a; a to d.
c) c to d; d to a.
d) d to c; c to b.
- Refer to the indifference curve/budget line diagram below.
This consumer has $300 in income and initially faces prices of px = $1 and py = $3. Given this, she maximized her utility at point a.
If the price of good x rises to $3, how much additional income would the consumer need, in order to be able to attain her original level of utility given the new prices?
a) There is insufficient information to determine the additional income needed.
b) $450.
c) $300.
d) $150.
- Refer to the indifference curve/budget line diagram below.
Suppose that a consumer initially faces budget line BL1, and thus is able to achieve the utility level associated with IC1. If py increases, then the substitution effect is the movement from and the income effect is the movement from .
a) e to d; d to c.
b) e to c; e to d. c ) e to c; c to d.
d) e to f; f to d.
- Suppose that, given the consumption bundle x = 10 and y = 10, a consumer’s MRS is equal (in absolute value) to 0.4. The price of x is $0.50 and the price of good y is $0.75, and the bundle x = 10 and y = 10 uses up all the consumers income. The consumer’s preferences are strictly convex. Which of the following is TRUE?
a) To maximize utility the consumer should buy more x and less y.
b) To maximize utility the consumer should buy less x and more y.
c) The bundle x = 10 and and y = 10 maximizes the consumer’s utility.
d) There is insufficient information to determine what the consumer should do to maximize utility.
Revision
Budget Constraint
The different combinations of goods a consumer can afford with a limited budget, at given price
Budget line
The graphical representation of a budget constraint, showing the maximum affordable quantity of one good for given amounts of another good
Relative Price
The price of one good relative to the price of another
An increase in income will shift the budget line
Upward and rightward
A decrease in income will shift the budget line
Downward and leftward
Changes in income
Do NOT affect the budget lines slope
(shifts are parallel)
When the price of a good changes
The budget line rotates: both its slope and one of its intercepts will change
Rational Preferences
Preferences that satisfy two conditions
1) Any two alternatives can be compared, and one is preferred or else the two are valued equally
2) The comparisons are logically consistent or transitive
(Rational preferences)
Rationality is:
A matter of how you make your choices, NOT what choices you make
Consumer will always choose
A point ON the budget line, not below
-MORE IS BETTER
Theories of consumer decision making
1) assume that preferences are rational
2) assume that the consumer would be better off with more of any good we’re considering
-always choose a combination of goods ON the budget line
Utility
A quantitative measure of pleasure or satisfaction obtained from consuming goods and services
Anything that makes consumer better off
will raise his utility
Anything that makes consumer worse off
will decrease the utility
Marginal utility
The change in total utility an individual obtains from consuming an additional unit of a good or service
-how much more happiness/utility would you have with more unit of a good
In making decision about spending must face two facts of economic life:
1) we have to pay for the goods and services we buy
2) we have limited funds to spend
Any point below or to the left of the budget line is
affordable
Px/Py
-Relative price of good X
-opportunity cost of one more unit of good X
-the absolute value of the slope of the consumer’s budget line
-Px is on the horizontal axis
Bundle
Amount of (x,y)
If you are indifferent
you are exactly equally happy between two things
