Consumer Demand Theory

The Budget Constraint, Indifference Curves and Consumer Optimisation
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Consumer Problem
Consumers have infinite demands but there are finite resources, how can consumer welfare be maximised subject to constraints
Budget Constraint Curve
Shows how much a consumer can consume subject to their constraints of income and price
Shifts and Pivots in the Budget Constraint
Changes in price and income (wages or non labour) result in changes in the budget constraint
Non-Satiation Assumption
Consumers will choose any point on the budget constraint, but have preferred points
Endowment Point
A fixed point on a curve, when this is present any changes in income or price result in the budget line pivoting around this point
Budget Equation
Px(X)+Py(Y) < M
Two-part Tariff
Where the good/service has a fixed charge and a unit charge
Rationality
Completeness where the individual has preference, and Transitivity where the preference of one affects the preference of another
Indifference Curve
A way of representing people's preferences, the further out the indifference curve the higher the utility
Indifference Curve Slope
The slope shows the rate at which the consumer is prepared to swap one good for another, the MRS
Indifference Curve Conditions
Where preferences are rational the curves do not cross, monotonicity and convexity
Monotonicity
More is better, resulting in a downward sloping utilitycurve
Convexity
Averages are preferred, an additional unit of x means one of Y is given up and vise versa
Perfect Compliments
Movements along the indifference curve do not increase or decrease a person utility, no substitution effect
Perfect Substitutes
Two parallel curves
Optimal Combination
Where the indifference curve is tangent to the budget constraint, the ideal point. Any point above is of higher utility but is unattainable given the current budget
Tangency Condition
The additional utility from the last penny spent on Y has to equal the additional utility from the last penny spent on X, Px/Py, used to help identify quantities
Mathematical Interpretation
Find Convexity, Interior Solution, Tangency Condition, Find Quantities
Unit Taxes and Ad Valorem Taxes
Unit taxes cause the budget constraint curve to shift inwards whilst ad valorem or specific taxes cause a pivot in the budget constraint
Substitution Effect
When there is a pivot in the budget constraint, how much consumption consumers shifts, always negative
Income Effect
When there is a shift or pivot in the budget constraint, shows the actual change
Hicksian Demand Curve
Following a change in price, shows how much nominal income needs to be increased by in order for the consumer to reach their original utility
Slutsky Demand Curve
Following a change in price, shows how much nominal incomes needs to be increased by in order for the consumer to afford their initial bundle. A new indifference curve forms
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