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21 Cards in this Set
- Front
- Back
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The basic theory of consumer choice helps us learn more about 3 things
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do all demand curves slope down?
how do wages affect labor supply? how do interest rates affect household saving? |
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Budget Constraint
(one piece of the analysis) |
The limit on the consumption bundles that a consumer can afford
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We can represent a consumer's preferences graphically by using
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indifference curves
A cure that shows consumption bundles that give the consumer the same level of satisfaction (indifferent to either choic) |
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The slope at any point on an indifference curve equals the rate at which the consumer is willing to substitute one good for another
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True
This rate is called the (MRS) Marginal rate of substitution |
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Marginal Rate of Substitution
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MRS
The rate at which a consumer is willing to trade one good for another The rate at which a consumer is willing to trade one good for the other depends on the amounts of the goods he is already consuming. |
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The consumer is equally happy at all points on any given indifference curve, but he prefers some indifference curves to others
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True
Because he prefers more consumption to less, higher indifference curves are preferred to lower ones. see pg 460 |
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Four properties of Indifference Curves
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1. Higher indifference curves are preferred to lower ones
2. Indifference curves are downward sloping 3. Indifference curves DO NOT cross 4. Indifference curves are bowed INWARD |
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Why are higher indifference curves superior to lower ones?
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Higher indifference curves = more/greater amount of consumption. People always want more not less
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Why are indifference curves downward sloping?
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The slope of an indifference curve reflects the rate at which the consumer is willing to substitute one good for the other. In most cases the consumer likes BOTH goods. Therefore, if the quantity of one good is reduced, the quantity of the other good must increase for the consumer to be equally happy. --Think about it
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Why can indifference curves never cross?
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Because a point on a superior higher indifference curve would then be just as satisfactory as a point on a lower indifference curves which contradicts the assumption that consumers want more. pg 461
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Why do indifference curves bow inward?
(review figure 4 pg. 462 now) |
The MRS usually depends on the amount of each good the consumer is currently consuming.
In particular, because people are more willing to rade away goods that they have in abundance and less willing to trade away goods of which they have little, the indifference curves are bowed inward. |
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An indifference curve will be perfectly straight if what?
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the 2 goods are <b>perfect substitutes</b> and therefore have a fixed or constant MRS-Marginal rate of substitutions
Like nickels for dimes--there will always be a fixed MRS 2:1 |
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Explain perfect complements and the associated indifference curves
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when two goods are strongly complementary, such as left shoes and right shoes, the indifference curves are right angles
see page 463 |
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The consumer's optimal choice lies at what point?
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Where the highest available indifference curve is tangent to the budget constraint.
At this point (optimum) the marginal utility per dollar spent on good X equals the marginal utility per dollar spent on good Y <b>at this point the slope of the indifference curve equals the slope of the budget constraint</b> The consumer picks this point because the marginal rate of substitution = the relative price |
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The slope of the indifference curve = what?
The slope of the budget constraint = what? |
the Marginal Rate of substitution (MRS)
the relative price of the two goods |
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*****IN making his consumption choices, the consumer takes as given the relative price of the two goods and then chooses an optimum at which his marginal rate of substitution equals this relative price
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the realtive price is the rate at which the market is willing to trade one good for the other, whereas the marginal rate of substitution is the rate at which the consumer is willing to trade one good for the other
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Normal Good & Inferior Goods
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Normal Good for which an increase in income raises the quantity demanded
Inferior Good for which an increase in income reduces the quantity demanded |
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Income Effect
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The change in consumption that results when a price change moves teh consumer to a higher or lower indifference curve
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Substitution Effect
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The change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution
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The effect of a change in price can be broken down into an income effect and a substitution effect
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true see page 470
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Giffen Goods
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a good for which an increase in the price raises the quantity demanded
inferior goods for which the income effect dominates teh substitution effect. Therefore, they have demand curves that slope upward |
