2. Chapter 21

Question 1

What is the budget constraint?

Answer 1

Shows the consumption bundles that the consumer can afford
The line on a quantity of Pepsi vs quantity of pizza graph that shows all possible combos of each affordable
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Question 2

What does it mean if a customer is indifferent between two bundles?

Answer 2

If the two options suit his taste equally well
This results in the indifference curve
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Question 3

What is an indifference curve?

What is the slope on it?

Answer 3

A curve that shows consumption bundles that give the consumer the same level of satisfaction
Shows the different combinations of pizza and Pepsi that make the consumer equally happy
The slope at any point equals the rate at which the consumer is willing to substitute one good for another

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Question 4

What is the marginal rate of substitution?

Answer 4

The rate at which a consumer is willing to trade one good for another
The slope on an indifference graph
It is not the same at all points on an indifference graph

Question 5

Can consumers prefer one indifference curve over another?

Answer 5

Yes

Question 6

What are the four properties of in difference curves?

Answer 6

1. Higher indifference curves are preferred to lower ones
2. Indifference curves are downward sloping- as long as both goods are wanted
3. Indifference curves do not cross
4. Indifference curves are bowed inwards

Question 7

What affects how bowed in an indifference curve is?

Answer 7

The customers willingness to trade one good for another
When the good are easy to substitute for eachother, the indifference curves are less bowed
When the good are hard to substitute, the indifference curves are very bowed in

Question 8

What are perfect substitutes?

Answer 8

Two good with straight line indifference curves
The marginal rate of substitution is constant

Example comparing nickles to dimes
You’ll always trade 2 nickels for one dime and visa versa

Question 9

What are perfect complements?

Answer 9

Two goods with right angle indifference curves

Example a bundle of left and right shows containing 5 each is the same as a bundle containing 5 right shoes and 7 left shoes since you’ll only still get 5 full pairs

Question 10

What are the two pieces necessary for understanding how a consumer makes choices?

Answer 10

1. The consumers budget restraint

2. The consumers preferences

Question 11

What is the optimum?

Answer 11

The point at which the highest indifference curve and the budget constraint touch

At the optimum, the slope of the indifference curve equals the slope of the budget constraint

Question 12

What is utility?

Answer 12

An abstract measure of the satisfaction or happiness that a consumer receives from a bundle of goods
Customer prefers one bundle over the other of it provides more utility, customer also maximizes utility

How economists describe preferences

Question 13

What is the marginal utility and diminishing marginal utility?

Answer 13

Marginal utility- the increase in utility that the consumer gets from an additional unit of that good
Diminishing marginal utility- the more of a good the consumer already has, the lower the marginal utility provided by an extra unit of that good

Question 14

What is the equation for calculations the marginal rate of substitution with prices of X and Y? How can this be transformed using marginal utilities instead of marginal rate of substitution?

Answer 14

MRS= Px/Py
MUx/MUy=Px/Py
MUx/Px=MUy/Py this is the equilibrium condition!

Question 15

How does the consumer pick consumption?

Answer 15

The consumer chooses the consumption of the two goods so that the marginal rate of substitution equals the relative price

Question 16

What is relative price?

Answer 16

The rate at which the the market is willing to trade one good for another
The marginal rate of substitution is the rate at which the CONSUMER is willing to trade one good for another

Question 17

What is normal good and inferior good?

Answer 17

Normal good- a good for which, other things equal, an increase in income leads to an increase in demand (pizza and Pepsi)
Inferior good- as good for which, other things equal, an increase in income leads to a decrease in demand (bus rides, as income increases, people move to cars)

Question 18

What is the income effect and substitution effect?

Answer 18

Income effect- the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve
Substitution effect- 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
Examples on top of page 444

Question 19

What is a giffen good?

Answer 19

A good for which an increase in the price raises the quantity demanded
Violates the law of demand

Question 20

Can there be demand curves that slope upward?

Answer 20

Yes giffen goods slope upward since the income effect dominates the substitution effect
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Question 21

What is the slope of the labour supply curve?

Answer 21

It slopes backwards like this /

Hours of labour supplied goes up with the wage

Question 22

What is reification?

Answer 22

Making concrete (money) something that is abstract (happiness)

Question 23

What is the equation for the consumption function?

Answer 23

U=f(x,y)
U= utility derived from consuming combinations of x and y
f= unique taste function of a consumer

Question 24

What is the budget constraint equation?

Answer 24

I=PxX + PyY
I= income
P= prices
X+Y= quantity of goods

Question 25

What is stable equilibrium compared to unstable equilibrium?

Answer 25

Stable- once achieved continued indefinitely unless there is a change in some underlying conditions
Unstable- once achieved will continue indefinitely unless one of the variables changes but the system will not return to the original equilibrium