Chap 22 - Consumer Choice Flashcards
What is a budget constraint?
The limit on the consumption bundles a consumer can afford.
Budget constraints reflect the trade-offs consumers face due to limited income.
What happens when a consumer buys more of one good?
They must buy less of another good due to limited income.
This highlights the trade-off in consumer choices.
What does the slope of the budget constraint represent?
The relative price of the two goods.
The slope indicates how many units of one good must be given up to obtain more of the other.
What do indifference curves show?
Bundles of goods that give the consumer the same level of satisfaction.
Indifference curves help visualize consumer preferences.
What are the four properties of indifference curves?
- Higher curves are preferred (more is better)
- They slope downward (trade-offs exist)
- They do not cross (preferences are consistent)
- They are bowed inward (willingness to trade changes)
These properties help understand consumer behavior.
What is the marginal rate of substitution (MRS)?
The rate at which a consumer is willing to trade one good for another (slope of the indifference curve).
MRS reflects consumer preferences between two goods.
How does a consumer choose the best bundle of goods?
By selecting the highest indifference curve that touches the budget constraint.
This reflects the optimal consumption point for a consumer.
What condition is met at the consumer’s optimal choice?
MRS = Relative Price of the two goods.
This equality indicates the consumer’s optimal allocation of resources.
What is the income effect?
A price drop increases purchasing power, leading to more consumption.
The income effect influences consumer behavior when prices change.
What is the substitution effect?
A price drop makes a good cheaper relative to others, causing consumers to buy more of it.
The substitution effect explains changes in consumption patterns with price changes.
How do normal and inferior goods respond to income changes?
- Normal goods → Buy more when income rises.
- Inferior goods → Buy less when income rises.
Understanding these responses helps predict consumer behavior in various economic scenarios.
What do perfect substitutes look like on an indifference curve?
A straight line (constant trade-off between goods).
Perfect substitutes indicate that consumers are willing to replace one good for another at a constant rate.
What do perfect complements look like on an indifference curve?
A right angle (goods must be consumed in fixed proportions).
Perfect complements illustrate consumption that requires specific ratios.
How does an increase in wages affect labor supply?
- Substitution effect: Higher wages make leisure more expensive → work more.
- Income effect: Higher wages increase wealth → work less.
These effects can lead to varying labor supply responses based on individual preferences.
How do interest rates affect saving behavior?
Higher interest rates can lead to more or less saving, depending on whether the substitution or income effect dominates.
This relationship is crucial for understanding consumer finance decisions.
What is a Giffen good?
A rare good where higher prices lead to more consumption, violating the law of demand.
Giffen goods are exceptions that challenge traditional economic theories.
How do consumers maximize happiness?
By choosing the best bundle of goods that fits their budget constraint and preferences.
This principle is fundamental in consumer choice theory.
What explains consumer responses to price changes?
The income and substitution effects.
Understanding these effects is essential for analyzing market behavior.
How does consumer theory apply to real life?
It explains labor supply, saving decisions, and exceptions like Giffen goods.
Consumer theory provides insights into everyday economic decisions.
