Answer to Question #243268 in Microeconomics for Laisiana.Lavo

Question

Define the following with examples
Optimisation Principle
Lump Sum Principle
Homogeneity of expenditure functions
Homothetic Preferences
Utility and marginal rate of substitution
Convexity of indifference curves

Answer 1

optimisation principle

Refers to the maximization of something subject to particular constraints. For instance, for producers, their aim is to maximize profit subject to the constraint which is technology. For consumers, their aim is to maximize utility subject to the constraint imposed household income and market prices.

Lump sum principle

States that a tax on a person's general purchasing power is more efficient than a tax on specific goods.

Homogeneity of expenditure functions

This is used to explain the dual relationship between expenditure function and utility function. Homogeneity implies that prices are once homogeneous and utility is monotomically increasing . In this case the expenditure function is usually non negative and a concave function. For instance, using Cobb Douglas function to generate demand function.

Homothetic preferences

A preference is said to be homothetic if the slope of indifference curves remain constant along any ray from the origin.

For example, utility functions having constant elasticity of substitution are homothetic.

Utility and marginal rate of substitution

Utility refers to the total satisfaction received from the consumption of a good or a service.

Marginal Rate of substitution refers to the amount of good that a consumer is willing to consume compared to another good. For example, a consumer must choose between hotdogs and hamburgers. To determine Marginal rate of substitution, the consumer has to tell what combination of hotdogs and hamburgers provide the same level of satisfaction.

Convexity if indifference curves

This implies that the marginal rate of substitution of good X for good Y falls as more of good X is substituted for good Y.