Chapter 3: Consumer Behavior Flashcards
Define market basket
It is a list with specific quantities of one or more goods (for example, units of food against units of clothing)
The theory of consumer behavior begins with which three basic assumptions
- Completeness - preferences are assumed to be complete, in other words consumers can compare and rank all possible baskets
- Transitivity - preferences are transitive, this means that if a consumer prefers basket A to basket B and basket B to basket C, then the consumer also prefer A to C
- More is better than less - consumers always prefer more of any good to less
What is an indifference curve
It is a curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction
Why does the indifference curve slope downwards
If it did not, it would violate the assumption that more is better than less
What is an indifference map
Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent
Indifferent curves cannot intersect, why?
It violates the assumption of transitivity as well as more is better than less
If the price of one good increases the quantity of the other ___
Decreases
What does the magnitude of the slope of an indifference curve measure
It measures the consumers marginal rate of substitution (MRS) between two goods
Define what the marginal rate of substitution is
Maximum amount of a good that a consumer is willing to give up in order to obtain an additional unit of another good
True or False
The slope of the curve becomes less negative as we move down (difference becomes smaller)
True
*What are perfect complements
Two goods for which the MRS is zero or infinite, the indifferent curves are shaped as the right angles
What are perfect substitutes
Two goods for which the marginal rate of substitution of one for the other is a constant (straight downward sloping)
What is utility
Numerical score representing the satisfaction that a consumer gets from a given market basket
What is the first consumer theory assumption
That consumers rely on relative rankings of market baskets
What’s the difference between ordinal utility function and cardinal utility function
- ordinal utility function generates a ranking of market baskets in order of most to least preferred.
- cardinal utility function describes how much one market basket is preferred to another
What is the second consumer theory assumptionI
Budget constraints consumers, based on limited income
What is a budget line
Show all combinations of goods for which the total amount of money spent is equal to income
Income changes alters the intercepts of the
Budget line but not the slope. If income increases budget line shifts outward and if income decreases budget line shifts to the left
If price changes of one good ___
The intercept of that good will change.
If the price of a good increases, the intercept moves inward and if the price of a good decreases, the intercept moves outward. This is based on the effect of purchasing power of the consumer
What two conditions need to be met under consumer choices
- It must be located on the budget line - any market basket to the left or right leaves portion of the income and spent
- It must give the consumer the most preferred combination of goods and services
A market basket that maximises satisfaction will always lie on
On the highest indifference curve that touches the budget line.
What’s the difference between marginal cost and marginal benefit
- marginal cost is the cost of obtaining one additional unit of a good.
- marginal benefit is the benefit from the consumption of one additional unit of a good
What is a corner solution
It is a situation in which the marginal rate of substitution for one good in a chosen market basket is not equal to the slope of the budget line
When one of the goods is not consumed the market bundle is at the ___ of an indifference curve
corner
What is marginal utility
It is the additional satisfaction obtained from consuming one additional unit of a good
Define diminishing marginal utility
Principle that as more of a good is consumed the consumption of additional amounts will decrease as the more is consumed
What is the equal marginal principle
Principle that utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods
What is the theory of consumer behaviour
Consumers allocate income among different goods and services to maximise their well-being
