Intermediate Microtheory. Chapter 2

Front 1

How does a consumer with limited income decide which goods to buy? This is the theory behind the demand function

Back 1

(3) steps:
1) What can a consumer afford - Budget constraint
2) What does the consumer like? Preferences
3) Given income and prefernces, what does the consumer choose? The model of consumer behavior assumes that individuals take actions to make themselves as well off as possible. specifically, each consumer chooses the best affordable bundle

Front 2

What do we do with the theory?

Back 2

1) Test it - see if it is adequate to describe consumer behavior

2) Use it to predict how behavior would change as the economic environment changes (policy impacts, cost-benfit analysis)

Front 3

Consumption Bundle (or basket)

Back 3

List the specific quantities on one or more goods

Front 4

Preferences are relationships between bundles. Prefernces have to do with the entire bundle of goods, not the individual...

Back 4

goods

Front 5

Preferences
Notation...

(Xa, Ya) > (Xb, Yb) means..

Back 5

the consumer stricly prefers bundle A over bundle b

Front 6

Notation:

(Xa, Ya) ~(Xb, Yb) means..

Back 6

that the consumer is indiffernt between bundle a and bundle b

Front 7

Notation:

(Xa, Ya) ≥ (Xb, Yb) means that...

Back 7

bundle A is a least as good as (preferred to or indifferent to bundle b)

Front 8

Assumptions about the prefernces of the rational consumer:

Completeness (Def)

Back 8

Any two bundles can be compared that is either (Xa, Ya) > (Xb, Yb), (Xb, Yb) > (Xa, Ya) or (Xa, Ya)~ (Xb, Yb) for all x & Y

Front 9

Transitivity

Back 9

Consider three bumdles, A, B, C. If A ≥ B and B ≥ C, then A ≥ C

Front 10

Assumptions about prefernences of the rational consumer

Balance; Def

Back 10

Averages are preferred to extremes. Take two bundles over which the consumer prefers a mix of A and B (say the average, C = .5A +.5B) over either A or B

Front 11

Indiffernce Curves (Def)

Back 11

Is the locus of points representing bundles among which the consumer is indifferent

Front 12

Indiffernce Curves. Assume prefernces satisy completeness and transitivity.

Back 12

Then is is possible to represent prefernces with indiffernce curves. Nonsatiation and balance are not necessary, but they are technical assumptions that make the IC's nicely shaped

Front 13

IC's through all bundles and but one IC through each bundle

Back 13

a) By completeness
B) Each bundle correspnds to one and only one of satisfaction, so there is one and only one IC that passes through it.

Front 14

For a given individual consumer, IC's never cross

Back 14

A) By transitivity
B) Proof

i) Assume other wise they do cross
ii) Draw 3 bundles, A, B and C, A and B on different IC's but C on both
iii) A and B lie in differnt IC's so either A is preferrred to B or B is preferrred to A. But A~C and C~B, and by transitivity, A~B. But this contradicts that A is preferred to B or B is preferred to A

Front 15

Nonsatiation

Back 15

More is better