Chap. 5 - Consumer Theory Flashcards
What is Utility?
Measure of satisfaction, joy, or happiness
What is the Law of Diminishing Marginal Utility?
As more of the good is consumed, the additional satisfaction from another bite will eventually decline. The marginal utility is the satisfaction gained from each additional bite.
What is Utility based on and has also has nothing to do with?
Utility is based solely on the preferences of the individual and has nothing to do with the price of the good.
Can marginal utility be negative?
Yes. At a holiday dinner, you may overeat and suffer from indigestion afterwards to a point where you regret having eaten too much, but at the time of the dinner, you expected greater utility from eating the last of the meal.
How do consumers maximize their utility?
Consumers try to spend the limited money they have on what will give them the greatest amount of satisfaction. The decision rule for utility maximization is to purchase those items that give the greatest marginal utility per dollar and are affordable or within the budget.
What is Marginal Utility per Dollar?
Marginal Utility/Price
If Chino has an Income of $11 and can either buy pizza for $2/per slice or buy a shake for $1/per shake, how many slices of pizza and shakes will he buy given his constraint?
Info: Quant of 1 90 MU for pizza and decreases by 10 for each additional slice.
Quant of 1 50 MU for shakes and decreases by 10 for each additional shake up to quant of 5 which is 15 and quant of 6 is 10
1) Find Marginal Utility per Dollar, MU/Price.
2) We then compare the marginal utility per dollar for pizzas verses shakes.
3) For the first unit the marginal utility per dollar of a shake is 50 compared to only 45 for the pizza, so we would purchase the first shake. We then compare the marginal utility per dollar of the first pizza (45) to the marginal utility per dollar of the second shake (40) and purchase the first slice of pizza. If the marginal utility per dollar is the same for the two goods and we have income to purchase both then we would do so.
4) We would purchase four slices of pizza and three milkshakes and spend our entire budget of $11
What is an Indifference Curve?
Shows the different combinations of the two goods that yield the same level of utility, independent of the price of the goods.
What is Marginal Rate of Substitution?
The slope of the curve and measures the rate at which the consumer would be willing to give up one good for the other while maintaining the same level of utility.
What is a Budget Constraint?
Indicates the combinations of the two goods that can be purchased given the consumer’s income and prices of the two goods.
How do you find the intercepts of the budget constraint?
The intercept points of the budget constraint are computing by dividing the income by the price of the good. For example, if the consumer had $8 to spend and the price of pizza was $2 and shakes were $1, then the consumer could buy four pizzas ($8/$2) or eight shakes ($8/$1). Any combination of the two goods that are on or beneath the budget constraint are affordable, while those to the outside (farther from the origin) are unaffordable.
What is the slope of the Budget Constraint?
The negative ratio of the prices (-Px/Py). For example, given the price of pizza (on the x-axis) is $2 and the price of shakes (on the y-axis) is $1, then the slope of the budget constraint would be -2.
Given a Budget Constraint and Indifference Curves what is ideal for Utility Maximization?
Given the goal of consumers is to maximize utility given their budget constraints, they seek that combination of goods that allows them to reach the highest indifference curve given their budget constraint. This occurs where the indifference curve is tangent to the budget constraint.
What is the slope for an Indifference Curve?
The ratio of marginal utilities (-MUx/Muy)
When the Budget Constraint is tangent to the Indifference Curve what happens to their ratios?
They equal each other, (-MUx/Muy) = (-Px/Py), also can be rewritten (MUx/Px) = (MUy/Py).
