PART II - PART II PRODUCERS, CONSUMERS, AND COMPETITIVE...

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PART II PRODUCERS, CONSUMERS, AND COMPETITIVE MARKETS CHAPTER 3 CONSUMER BEHAVIOR REVIEW QUESTIONS 1. What does transitivity of preferences mean? Transitivity of preferences implies that if someone prefers A to B and prefers B to C , then he or she prefers A to C . 2. Suppose that a set of indifference curves was not negatively sloped. What could you say about the desirability of the two goods? One major assumption of preference theory is that more is preferred to less. Thus, we can expect that consumers will experience a lower level of satisfaction if we take some of a good away from them. From this, we necessarily derive negatively sloped indifference curves. However, if one good is undesirable, then less of the undesirable good leaves the consumer better off, e.g., less toxic waste is preferred to more toxic waste. When one good is undesirable, the indifference curves showing the trade-off between that good and a desired good have positive slopes. In Figure 3.2 below, the indifference curve U 2 is preferred to the indifference curve U 1 . Figure 3.2 3. Explain why two indifference curves cannot intersect. The explanation is most easily achieved with the aid of a graph such as Figure 3.3, which shows two indifference curves intersecting at point A. We know from the definition of an indifference curve that a consumer has the same level of utility along any given curve. In this case, the consumer is indifferent between bundles A and B because they both lie on indifference curve U 1 . Similarly, the consumer is indifferent between bundles A and C because they both lie on indifference curve U 2 . By the transitivity of preferences this consumer should also be indifferent between C and B . However, we see from the graph that C lies above B, so C must be preferred to B . Thus, the fact that indifference curves cannot intersect is proven.
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Figure 3.3 4. Draw a set of indifference curves for which the marginal rate of substitution is constant. Draw two budget lines with different slopes; show what the satisfaction-maximizing choice will be in each case. What conclusions can you draw? In Figure 3.4, Good X and Good Y are perfect substitutes and, thus, the indifference curves are straight lines, U 1 and U 2 , each with a slope of -1. For goods that are perfect substitutes, the consumer will always prefer to purchase the cheaper of the two goods to obtain maximum utility. For example, if Good Y is cheaper than Good X , the consumer would face the budget constraint L 2 and would maximize utility at point A . On the other hand, if Good X were cheaper than Good Y , the consumer would face the budget constraint L 1 and would maximize utility at point B . If Good X and Good Y have the same price, the budget constraint would coincide with the indifference curve, and the consumer would be indifferent between any point on the curve. To see this, recall that the slope of the budget line is More generallly, the slope of a linear indifference curve is the constant rate at which the consumer is willing to trade the two goods. If
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PART II - PART II PRODUCERS, CONSUMERS, AND COMPETITIVE...

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