Microeconomic Theory 1: Ordinal Utility Approach

Monotonic Preference

It means that to maintain the same level of utility, the consumer must compensate for a decrease in one good by increasing the other good.

The budget constraint defines the outer limit of the opportunity set. The opportunity set includes all bundles a consumer can afford.

<p>It represents the total expenditure on burgers and pizzas, which must equal the consumer's total budget.</p> Signup and view all the answers

<p>It solves for the quantity of burgers (B) that the consumer can buy, given their income (Y), the price of pizzas (PZ), the quantity of pizzas (Z), and the price of burgers (PB).</p> Signup and view all the answers

<p>It shows the relationship between the quantity of burgers (B) and the quantity of pizzas (Z) that Lisa can buy, given her budget and the prices of the two goods.</p> Signup and view all the answers

<p>Monotonic Preferences</p> Signup and view all the answers

<p>As the price of pizza increases, the slope of the budget line becomes steeper (more negative).</p> Signup and view all the answers

<p>When the price of pizza doubles, the consumer can afford fewer pizza and burger combinations. The budget line shifts inward, reducing the feasible set.</p> Signup and view all the answers

<p>A budget line</p> Signup and view all the answers

<p>The shaded area represents the bundles of pizza and burgers the consumer could afford before the price change but can no longer afford after the price increase.</p> Signup and view all the answers

<p>The opportunity cost of consuming pizza increases, as the consumer has to give up more burgers to consume one more pizza.</p> Signup and view all the answers

<p>The consumer will likely consume less pizza and more burgers, as the price change makes pizza relatively more expensive.</p> Signup and view all the answers

<p>The budget constraint is given by: Y = PzZ + PbB, where Y is income, Pz is the price of pizza, Z is the quantity of pizza, Pb is the price of burgers, and B is the quantity of burgers.</p> Signup and view all the answers

<p>The slope of the budget line before the price change is -$2/$2 = -1.</p> Signup and view all the answers

<p>The budget constraint shifts inward, pivoting around the vertical intercept (representing the maximum quantity of burgers the consumer can purchase). This is because the consumer can now purchase fewer combinations of pizza and burgers with the same income.</p> Signup and view all the answers

<p>A quantity tax increases the price of the taxed good, leading to a steeper budget constraint. The slope of the budget constraint becomes steeper, indicating a higher relative price for the taxed good. The consumer's budget constraint shifts inward, reducing the feasible consumption bundles.</p> Signup and view all the answers

<p>Both ad valorem and quantity taxes reduce a consumer's purchasing power and shift the budget constraint inward. However, a quantity tax causes a parallel shift, while an ad valorem tax results in a rotation of the budget constraint. The rotation occurs because the tax's effect is proportionate to the price of the good, making the price increase more pronounced at higher initial prices.</p> Signup and view all the answers

<p>A specific subsidy reduces the price of a good, making it more affordable. This results in a flatter budget constraint, indicating a lower relative price for the subsidized good and increased purchasing power. In contrast, a lump sum subsidy increases the consumer's income without affecting prices, leading to a parallel outward shift of the budget constraint.</p> Signup and view all the answers

<p>Rationing is a limitation on the quantity a consumer can purchase, regardless of their willingness to pay. It's a direct constraint on consumption, limiting the feasible set of consumption bundles. Unlike a tax, rationing does not generate revenue for the government. It directly restricts the consumer's ability to choose freely, regardless of price, unlike taxes.</p> Signup and view all the answers

<p>An ad valorem tax is a tax levied as a percentage of the value of a good or service. For instance, sales tax is an ad valorem tax, where a fixed percentage of the purchase price is added as tax. This means the more expensive an item is, the higher the tax amount.</p> Signup and view all the answers

<p>A specific subsidy is like a discount on a specific item. Imagine the government wants to encourage people to buy more fruits and vegetables. They could provide a subsidy on fruits and vegetables, making them cheaper for everyone, encouraging people to buy more of these healthy foods.</p> Signup and view all the answers

<p>This is a complex question with no single right answer. Some might argue that a lump sum tax is the fairest because it's a fixed amount everyone pays, regardless of income. Others might argue that a progressive tax system based on income is fairer, because it takes a larger proportion from those who can afford it. The 'fairness' of different taxes depends on your values and beliefs about social justice.</p> Signup and view all the answers

<p>The slope of the budget line becomes -(1+t)Px/Py. The tax increases the price of good X, leading to a steeper slope (more negative) and a rotation inwards.</p> Signup and view all the answers

<p>Rationing helps to distribute scarce resources more evenly, preventing the wealthiest from consuming everything. However, it can also lead to frustration and inefficiency, if people can't get the goods and services they need. It can also create black markets, where goods are traded illegally at higher prices.</p> Signup and view all the answers

<p>An ad valorem tax increases the price of good X by a factor of (1+t). This changes the slope of the budget line to -(1+t)Px/Py. The slope becomes steeper, indicating a greater price difference between goods X and Y.</p> Signup and view all the answers

<p>A lump sum tax does not alter the slope of the budget line. It shifts the entire budget line inwards, reducing the consumer's purchasing power without changing the relative prices of goods.</p> Signup and view all the answers

<p>Consumer equilibrium occurs when the marginal utility per dollar spent on good X equals the marginal utility per dollar spent on good Y. This can be expressed as MUx/Px = MUy/Py. At this point, the consumer maximizes their utility given their budget constraint.</p> Signup and view all the answers

<p>The rationing quota restricts the consumer's opportunity set, effectively creating a new, smaller budget constraint. The consumer is now limited to a maximum of 10 thousand gallons, even though they could afford to buy more. This reduces the consumer's purchasing power and potential consumption choices.</p> Signup and view all the answers

<p>At the consumer's optimal consumption point, the slope of the budget line and the slope of the indifference curve are equal. This implies that the marginal rate of substitution (MRS) is equal to the price ratio of the two goods (Px/Py).</p> Signup and view all the answers

<p>An increase in the price of good X rotates the budget line inwards, making it steeper. The slope becomes more negative, reflecting the higher relative price of good X compared to good Y. The consumer can now purchase less of good X with the same income.</p> Signup and view all the answers

<p>A subsidy on good Y will make good Y relatively cheaper compared to good X. This will cause the budget line to rotate outwards, becoming flatter, giving the consumer more purchasing power for good Y.</p> Signup and view all the answers

<p>At the optimal consumption point (e), the MRS (the consumer's willingness to trade one good for another) equals the MRT (the rate at which the market allows the consumer to trade one good for another).</p> Signup and view all the answers

<p>A corner solution arises when the budget constraint intersects the indifference curve at a point where only one good is consumed. This occurs when the consumer's preferences are such that they are willing to consume only one good at the given prices, regardless of their budget.</p> Signup and view all the answers

<p>Perfect substitutes are goods that provide the consumer with the same level of utility, regardless of the ratio in which they are consumed. In such a scenario, the optimal consumption point often ends up at a corner solution, where the consumer only consumes the good with the lower price.</p> Signup and view all the answers

<p>Strictly concave preferences imply that the indifference curves exhibit a diminishing marginal rate of substitution (MRS). This means that the consumer is willing to give up less of one good for a unit of another good as they consume more of the second good. Consequently, the optimal consumption point will not lie at a corner solution, as the consumer will always choose a combination of both goods.</p> Signup and view all the answers

<p>The optimal consumption point occurs where the indifference curve and the budget line are tangent. This happens when the slope of the indifference curve (the MRS) is equal to the slope of the budget line (the MRT) at that point.</p> Signup and view all the answers

<p>Satiation occurs when a consumer reaches a point where consuming more of a good does not provide additional utility, or even leads to diminishing utility. In the context of indifference curves, satiation causes the curves to have a positive slope when there is &quot;too much&quot; of one or both goods. This indicates that the consumer would be better off by consuming less of these goods to move closer to their &quot;bliss point.&quot;</p> Signup and view all the answers

<p>A 'bad' is a good that the consumer dislikes, and consuming more of it makes them worse off. On the other hand, a 'neutral' is a good that the consumer neither likes nor dislikes – it has no impact on their utility. Examples of bads include noise pollution and pollution. Examples of neutrals include the color of a wall or a specific type of music.</p> Signup and view all the answers

<p>Monotonic preferences assume that consumers always prefer more of a good to less of it, up to a point. This assumption is central to basic consumer theory and allows economists to make predictions about consumer behavior. Satiated preferences, on the other hand, acknowledge that there is a point where consuming more of a good will actually lead to decreasing utility. Monotonic preferences are assumed before this point of satiation is reached.</p> Signup and view all the answers

<p>The key assumption behind &quot;more is better&quot; is that consumers have <strong>non-satiated preferences</strong>. This means that they always prefer more of a good to less of it, at least within a reasonable range. This assumption is crucial because it allows economists to build models of consumer behavior that predict how consumers will react to changes in prices or income. If consumers did not generally prefer more to less, then their decision-making would be much more erratic and difficult to understand.</p> Signup and view all the answers

<p>The budget constraint represents the limit on the consumption bundles a consumer can afford given their income and the prices of the goods. It is a line that shows all the possible combinations of two goods that a consumer can buy with their income. The budget constraint slopes downwards because to consume more of one good, the consumer must consume less of the other. Any consumption bundle that lies above the budget constraint is unaffordable since it requires more income than the consumer has.</p> Signup and view all the answers

<p>Consumer equilibrium occurs at the point where the budget constraint is tangent to the highest attainable indifference curve. This means that the consumer is maximizing their utility given their budget constraint. At this point, the slope of the indifference curve (marginal rate of substitution) is equal to the slope of the budget constraint (relative price ratio). This implies that the consumer is getting the most satisfaction they can from their limited budget, and they would not be better off consuming more of one good and less of another.</p> Signup and view all the answers

<p>The marginal rate of substitution (MRS) measures the rate at which a consumer is willing to trade one good for another while remaining at the same level of utility. It represents the absolute value of the slope of the indifference curve at a given point. In other words, the MRS tells us how many units of one good the consumer is willing to give up to get one more unit of the other good while keeping their overall satisfaction unchanged.</p> Signup and view all the answers