Term
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Definition
| The ratio of the demand for one good to the demand for another, represents general equilibrium in a two-good economy, where relative price adjusts to equate relative supply and relative demand |
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Term
| What are homothetic preferences? |
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Definition
When individuals consume the same RATIO of two goods at ALL levels of income.
Someone making $10k a year will spend the same ratio on goods as someone making $100k a year. |
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Term
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Definition
| An economy that is self-sufficient and does not engage in international trade. |
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Term
| What is the intuitive definition of MRS? |
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Definition
| Marginal rate of substitution is a consumers willingness to give up one good for more of another good while maintaining the same level of satisfaction. |
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Term
| What is an endowment economy? |
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Definition
Where people are given an endowment of perishable consumption each period, and where money has no value.
Money has no value because stuff is perishable. |
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Term
Given a budget constraint:
I = PcDc + PfDf
What is the slope? |
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Definition
Slope = MRS = Pc/Pf
Because we can rewrite it:
Df = I/Pf - (Pc/Pf)Dc |
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Term
| If a budget constraint has a slope of Pc/Pf where C = clothing and F = food, Pc/Pf is the relative price of ___ measured in units of ___. |
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Definition
| Pc/Pf is the relative price of CLOTHING measured units of FOOD. |
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Term
| What is the budget line for an endowment of clothes and food? |
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Definition
| PcDc + PfDf = PcEc + PfEf |
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Term
Given the following budget line for an endowment economy find the relative prices for food and clothes:
PcDc + PfDf = PcEc + PfEf |
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Definition
| (Pc/Pf)Dc + Df = (Pc/Pf)Ec + Ef |
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Term
| What are RELATIVE PRICES and why do they matter in an endowment economy? |
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Definition
| Relative prices are the ONLY prices that matter in an endowment economy because there is no money. |
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Term
| What is marginal utility of a good? |
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Definition
| The rate at which total utility changes as consumption of that good rises. |
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Term
| What is the mathematical definition monotonicity? |
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Definition
When marginal utility is non-decreasing in both goods.
MUx > 0
MUy > 0 |
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Term
| What is the intuition behind monotonicity? |
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Definition
Monotonicity is when a consumer likes both goods (they both have positive marginal utility to him).
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Term
| What does monotonicity imply about the slope / shape of the indifference curves? |
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Definition
| Indifference curves will have a negative slope and will be bowed inward from the origin |
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Term
| T/F: MRS is the slope of the indifference curves and is different at different points. |
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Definition
True, consumers will have different desire to trade one good for another at one end of the IC than at the other end of the IC. MRS therefore changes along the curve.
NOTE: Not true for perfect substitutes. |
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Term
| What is the formula for MRS? |
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Definition
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Term
| What is the intuition behind a diminishing marginal rate of substitution of x for y? |
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Definition
| MRS will diminish as the amount of x increases along the indifference curve. Further along the x axis, consumer is LESS willing to give up y-axis goods to get more of x-axis goods. So, MRS or his willingness to substitute, gets lower. |
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Term
| What does diminishing MRS imply about indifference curves? |
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Definition
| They're bowed inwards to the origin. |
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Term
| What is the intuition behind increasing MRS? |
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Definition
| Indifference curves are bowed outwards from the origin, means consumer will be more willing to substitute more of y for more of x the further he moves along the x axis. |
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Term
| What are the 3 assumptions we make for utility functions? |
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Definition
1) Monotonicity
2) Units of U not relevant, just order
3) MRS decreasing in absolute value |
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Term
| What is the intuition behind decreasing MRS? |
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Definition
If a person has a lot of Y, they're willing to give up a lot of it to get more of X.
If a person has less of Y, they're willing ot give up less of it to get more of X. |
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Term
| When is the MRS constant? |
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Definition
| When X and Y are perfect substitutes. |
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Term
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Definition
| When there X and Y are perfect complements (no substitutability). |
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Term
| Using MUx,Px and MUy,Py what is the mathematical intuition behind maximizing utility? |
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Definition
At MUx/Px = MUy/Py utility is maximized.
If either greater than or less than, utility can be increased and we are not yet at a maxima. |
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Term
| T/F: Utility is maximized when the slope of the budget constraint is equal to the price ratio. |
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Definition
True.
MUx/Px = MUy/Py
MUx/MUy = Px/Py |
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Term
Can it happen that
MUc/MUf > Pc/Pf
OR
MUc/MUf < PC/Pf
always? |
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Definition
| No, not if we assume MRS is strictly decreasing. |
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