Lesson 3

Question 1

What are the three fundamental Assumptions on Preferences?

Answer 1

Complete, Reflexive, and Transitive.

Question 2

What does the Completeness assumption mean?

Answer 2

Consumers are able to choose a bundle they prefer; for any two bundles, one must be weakly preferred to the other.

Question 3

What does the Reflexivity assumption state?

Answer 3

Any bundle is as good as itself.

Question 4

What does the Transitivity assumption require?

Answer 4

Consumers are logical and the order of preferences must be preserved (if A≿B and B≿C, then A≿C).

Question 5

What is the principle of Monotonicity?

Answer 5

The assumption that “more is better,” but not to extremes (i.e., no satiation and every commodity is a good).

Question 6

What does Monotonicity imply about the slope of an indifference curve?

Answer 6

It implies a negative slope.

Question 7

What is the direction of increasing preference for most goods?

Answer 7

Northeast (having more of both goods).

Question 8

What does Convexity of preferences imply?

Answer 8

That indifference curves are convex; averages of bundles are preferred to the extremes.

Question 9

What does Strictly Convex mean?

Answer 9

A weighted average of two bundles is strictly preferred to the original bundles themselves.

Question 10

What does Weakly Convex mean?

Answer 10

The average bundle is at least as good as the extreme bundles.

Question 11

What is Non-convex preference?

Answer 11

The average bundle is less preferred than the extreme bundles (x and y).

Question 12

What is the Marginal Rate of Substitution (MRS)?

Answer 12

The slope of the indifference curve; it tells the marginal willingness to pay or trade one good for another.

Question 13

How is MRS typically expressed?

Answer 13

As a negative number, representing the rate at which a consumer is willing to give up good Y for good X.

Question 14

What is the economic insight behind MRS?

Answer 14

The more you have of a good, the more willing you are to trade it away (diminishing MRS).

Question 15

When will a consumer agree to trade?

Answer 15

When the exchange rate is lower or higher than their MRS.

Question 16

When will a consumer not trade?

Answer 16

When the exchange rate is equal to their MRS; they stay on their original indifference curve.

Question 17

What is the key difference between willingness to pay and the actual price paid?

Answer 17

Willingness to pay is based on MRS (personal valuation), while the actual price is set by the market.

Question 18

What are the characteristics of Perfect Substitutes?

Answer 18

Indifference curves are straight lines with a constant negative slope; the MRS is constant.

Question 19

What are the characteristics of Perfect Complements?

Answer 19

Indifference curves are L-shaped (right angles); the MRS is zero or infinite at the kink. Consumers consume the goods together in a fixed ratio.

Question 20

What is the direction of increasing preference for perfect complements?

Answer 20

Towards a higher number of complete pairs obtained.

Question 21

How is an indifference curve for a “Neutral” good represented?

Answer 21

As a vertical line; the slope (MRS) is infinity. The consumer doesn’t care about the neutral good.

Question 22

How is an indifference curve for a “Bad” good represented?

Answer 22

It has a positive slope. The direction of increasing preference is away from the bad good.

Question 23

What is the relationship if a consumer finds a bundle Strictly Preferred (≻)?

Answer 23

The consumer always chooses that bundle over the other.

Question 24

What is the relationship if a consumer is Indifferent (∼) between two bundles?

Answer 24

The consumer chooses either bundle, as they provide equal satisfaction.

Question 25

What is the relationship if a consumer Weakly Prefers (≿) a bundle?

Answer 25

The consumer either strictly prefers it or is indifferent.

Question 26

If a consumer weakly prefers A to B and weakly prefers B to A, what is the relationship?

Answer 26

The consumer is indifferent between A and B (A ∼ B).

Question 27

If one bundle is indifferent and the other is weakly preferred, what is the relationship?

Answer 27

The weakly preferred bundle is strictly preferred.

Question 28

What does the area beyond (above) an indifference curve represent?

Answer 28

Bundles that are strictly preferred to those on the curve.

Question 29

What does the area below an indifference curve represent?

Answer 29

Bundles that are weakly preferred to those on the curve (including the curve itself).

Question 30

Why is it logically impossible for indifference curves to intersect?

Answer 30

Because it violates the assumptions of transitivity and/or monotonicity.

Question 31

What is a Saturation Point or "Bliss Point"?

Answer 31

A point where utility is maximized; preference decreases in any direction away from it.

Question 32

How are preferences represented when a good is only available in integer units?

Answer 32

Consumption bundles are a set of distinct points, not a continuous curve.

Question 33

What does it mean for a good to be redefined as a continuous good?

Answer 33

It is an approximation that allows us to draw smooth indifference curves and calculate MRS, even if the good is naturally discrete.