Question

For all of the following pairs of terms, define the two phrases/terms and then explain the relationship between them.

1. Comparative Statics, Equilibrium Analysis, and Constrained Optimization.

2. Perfect substitutes and Perfect Complements.

3. Diminishing Marginal rate of substitution and the Diminishing Marginal Utility.

4. Transitivity and Convexity.

5. Indifference curves and Utility functions.

6. Essential and Inessential Goods

Answer 1

1. Comparative Statics is simply the comparison of the before and after economic outcomes due to changes in one or more of the factors. The (general) equilibrium analysis is concerned with the overall changes in the demand and supply due to changes in one of more of the factors. Constraint optimization is the process of maximizing/minimizing an objective function (maximizing utility or minimizing cost) subject to a constraint (budget constraint or utility constraint). The comparative static and equilibrium analysis are linked in that the comparative static analysis is comparing the two different (before and after) equilibrium scenarios.

2. Perfect substitutes are goods that are similar to each other and substitutable for each other. The best example of substitutes is coke and Pepsi. Perfect complements are goods that are consumed along with another good. Example of complements is jam and bread. Perfect substitutes and perfect complements are two opposite kinds of goods.The two are related in that both tell us how the quantity demanded of the interest good changes with the change in the price of another good.

3. The diminishing marginal rate of substitution tells us that the marginal rate of substitution decreases as the consumption of good x increases. The marginal rate of substitution tells us the rate at which an individual is willing to trade goods x and y. The diminishing marginal utility tells us that as the consumer consumes more of any good, then the total added utility decreases. The two concepts are different. While the diminshing marginal utility is linked to the consumer side, diminishing the marginal rate of substitution is linked to the production side.  

4. Transitivity tells us that if A is preferred to B and B is preferred to C, then A is also preferred to C. Convexity often implies that "averages of two goods are better than the extremes." In other words, taking a weighted average of two goods on the same indifference curve is at least as preferred as the extremes of the two goods. Both Transitivity and convexity are preferences required to describe a well-behaved indifference curve

5. An indifference cure connects points/different bundles in the X-Y plane that yield the same utility to the consumer i.e. the consumer is indifferent to consuming any of these bundles that lie on the same indifference curve. A utility function, on the other hand, ranks/measures preferences for different sets or combinations of goods. Higher indifference curves represent a higher ranking of utility.