Chapter 6 Flashcards
What is the behavioral assumption in economics
individuals and firms maximize
their personal well-being and/or their profits.
May have other goals in addition: philanthropy and the well-being of others
The theory of individual maximization is based on
individuals must act in a rational manner in order to achieve their goals
What is cardinal utility
A measurable concept of satisfaction- not so achieved, also called measurable utility
Total utility is
A measure of the total satisfaction from consumption derived from consuming all of the units over a time period
Total utility is calculated as
The sum of marginal utilities
What is the principle of non-satiation
More is always better
Though more is always better, what happens with increasing units of the good
At the additional unit of good satisfaction goes down -> diminishing marginal utility
Formula for marginal utility
Marginal Utility = additional utility/ additional consumption or, MU = deltaU delta C ,
Total utility __ with the amount consumed, marginal utility __ with the amount consumed
Increases
Declines
MU is ___ of the TU function
a slope
How consumer should allocate income
Where it yields the greatest utility per dollar
When does consumer equilibrium occurs
when marginal utility per dollar spent on the last unit
of each good is equal.
Equilibrium for budget allocation
MUs/Ps=MUj/Pj
or
MUs/MUj=Ps/Pj.
Budget allocation rule
The consumer chooses the quantities based on marginal utility rather than on total utility
The law of demand states
The law of demand states that, other things being equal, more of a good is demanded
the lower is its price
Why demand curve is shaped downwards
MUs/Ps=MUj/Pj
Relationship should stay the same
If the price of any good falls, then, in order for the
equilibrium condition to be re-established, the MU of that good must be driven down also. Since
MU declines when more is purchased, this establishes that demand curves must slope downwards
What is ordinal utility
Ordinal utility assumes that individuals can rank commodity bundles in accordance
with the level of satisfaction associated with each bundle.
What is the budget constraint
The budget constraint defines all bundles of goods that the consumer can afford with
a given budget.
Income is equal to
Expenditure on snowboarding+expenditure on Jazz= Price of Squantity of S+Price of J quantity of J
Slope of the budget line
P(x)/P(y)
What is bound by the budget line
The set of feasible or affordable
the non-affordable set lies strictly above the budget line
The slope of the budget line is the same as
sacrifice cost
What is an indifference curve
defines combinations of goods and services that yield the same
level of satisfaction to the consumer.
Four properties of indifference maps
- Indifference curves further from the origin reflect higher levels of satisfaction.
- Indifference curves are negatively sloped. This reflects the fact that if a consumer gets more
of one good she should have less of the other in order to remain indifferent between the two
combinations. - Indifference curves cannot intersect. If two curves were to intersect at a given point, then we
would have two different levels of satisfaction being associated with the same commodity
bundle—an impossibility. - Indifference curves are convex when viewed fromthe origin, reflecting a diminishingmarginal
rate of substitution.
Slope of the indifference curve shows
the marginal rate of substitution , It defines
the amount of one good the consumer is willing to sacrifice in order to obtain a given
increment of the other, while maintaining utility unchanged.
Diminishing marginal rate of substitution reflects a
higher marginal value being
associated with smaller quantities of any good consumed.
How to determine the combination of goods that will bring the highest satisfaction
Intersection of budget line and the highest indifference curve
Slope of the indifference curve
-Px/Py
What is equal to make indifference curve and budget line to cross
Tangency ( slope) at the intersection point should be the same
How income change will cause changes in the graphics of budget
Parallel outward shift
What happens with graphs when price changes
If jazz (x -axes) costs more, the slope of budget line will change-> become more steeper
How to determine substituents with changing price
These goods are
substitutes in this picture, because snowboarding increases in response to an increase in the price
of jazz.
What is the achievement of subsidies and income transfers
Increase purchasing power
Difference in graph change with government subsidy and income transfer
Income transfer: parallel shift outward
Price subsidy: budget line with rotate- the good with the same price-> no change in axe intercept, where subsidized-> more from 0
