Chapter 21 - The Theory of Consumer Choice

Question 1

Budget Constraint

Answer 1

The limit on the consumption bundles that a consumer can afford.

Question 2

The slope of a budget constraint curve measures?

Answer 2

The rate consumer can trade one good for another.

Question 3

The slope of a budget constraint curve is also equal to?

Answer 3

The “relative price” of the 2 goods (price of one good compared to the other).

Question 4

Indifference Curve

Answer 4

Shows consumption bundles that give the consumer the same level of satisfaction

Question 5

Marginal Rate of Substitution

Answer 5

The rate at which a consumer is willing to trade one good for another (the slope at any point of the indifference curve).

Question 6

________ indifference curves are preferred to ______ indifference curves (more consumption).

Answer 6

Higher, lower

Question 7

4 Properties of indifference curves:

Answer 7

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 (because people are more willing to trade goods they have an abundance of, but less willing to trade their scarce goods).

Question 8

Extreme Cases of Indifference Curves

Answer 8

1. ) Perfect substitutes

2. ) Perfect complements

Question 9

What type of indifference curve do perfect substitutes make?

Answer 9

Straight, diagonal lines

Question 10

What type of indifference curve do perfect complements make?

Answer 10

Straight lines with a right angle

Question 11

Optimum

Answer 11

Point where budget constraint & indifference curve barely touch (Indifference curve is tangent to budget constraint).

Question 12

Consumer chooses consumption of the 2 goods so that the ________ equals the _________.

Answer 12

Marginal rate of substitution, relative price

Question 13

An increase in income leads to a ______ shift of the budget constraint.

Answer 13

Parallel

Question 14

Normal Good

Answer 14

A good for which an increase in income raises the quantity demanded.

Question 15

Inferior Good

Answer 15

A good for which an increase in income reduces the quantity demanded.

Question 16

Income Effect

Answer 16

The change in consumption that results when a price change moves the consumer to a higher or lower indifference curve.

Question 17

Substitution Effect

Answer 17

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.

Question 18

Giffen Good

Answer 18

A good for which an increase in the price raises the quantity demanded (violates law of demand).