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Exam 1 ReviewQ 1 2 3

# Exam 1 ReviewQ 1 2 3 - Review Questions 1 1 Public...

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Review Questions 1 1. Public Finance/Public Sector Economics - Study of how government expenditures, taxation, and regulation affects an economy’s allocation of resources and distribution of income. 2. Indifference Curve (IC) – Locus of various commodity bundles that yield to a given individual a fixed level of satisfaction (or utility) IC’s requires the person’s tastes, preferences, likes and dislikes for the items in the commodity bundle to figure out the slope of their indifference curves. IC curves cannot intersect because this would imply that that a single combination of two goods would render two different levels of satisfaction, which is impossible. 3. Marginal Rate of Substitution (MRS) – (-) change in consumption of one good per change in consumption of another good that will make a given individual indifferent. MRS = X / Y Utility held constant MRS = (-) slope of the IC “Diminishing MRS” implies that goods are more highly valued when they are scarce 5. They can both “like” parks and libraries, but one can like them more than the other which would make them want different combinations of the two. 6. Budget Line – Locus of (x, y) combinations that satisfy P x * X + P y * Y = M (income) Slope of the budget line is determined by the Price of X (P x ) over the Price of Y (P y ) P x /P y Factors causing the B.L. to shift 1) M – More income will increase amount consumer is able to spend on goods 2) P x – Increase will cause BL to shrink while decrease will cause BL to grow 3) P y – See #2 7. Rational Choice Hypothesis = individuals behave as if they maximize their utility subject to relative constraints. Climb onto highest possible indifference curve while on the BL. At consumer’s optimum: (-) slope of IC = (-) slope of BL MRS = P x /P y Intuition: If the amount of good y that the consumer is “willing” to give up to attain one more unit of x so as to remain equally happy, is greater than the amount of y that the consumer “must” give up to obtain one extra unit of x, then the consumer can move up to a new utility curve until the slope of the BL is equal to the slope of the indifference curve 8. Normal Goods – Increases in income causes increase in the quantity demanded. Inferior Goods – Increases in income causes decreases in the quantity demanded. All goods cannot be inferior, but at least one good must be normal. 9. An edgeworth box is a diagram of the endowment constraints in the given market and any point in the box is an example of a combination of a possible allocation of goods in that market.

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10. A distribution of income point Β is said to be Pareto Superior to point α if: 1. No person is worse off at β than at α 2. At least one person is better off at β than at α 11. A distribution of income is said to be Pareto Optimal if it is impossible to make one person better off without making another person worse off.
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