Chapter 9

Question 1

Budget line

Answer 1

The limit to a household’s consumption choices. It marks the boundary between those combinations of goods and services that a household can afford to buy and those that it cannot afford.

Question 2

Real income

Answer 2

A household’s income expressed as a quantity of goods that the household can afford to buy.

Question 3

Relative price

Answer 3

The ratio of the price of one good or service to the price of another good or service. A relative price is an opportunity cost.

Question 4

The relative price of a movie in terms of pop is the magnitude of the _____ of Lisa’s budget line

Answer 4

The relative price of a movie in terms of pop is the magnitude of the slope of Lisa’s budget line

Question 5

Indifference curve

Answer 5

A line that shows combinations of goods among which a consumer is indifferent.

Question 6

Marginal rate of substitution

Answer 6

The rate at which a person will give up good y (the good measured on the y-axis) to get an additional unit of good x (the good measured on the x-axis) while at the same time remaining indifferent (remaining on the same indifference curve) as the quantity of x increases.

Question 7

If the indifference curve is ______, the marginal rate of substitution is high.

Answer 7

If the indifference curve is steep, the marginal rate of substitution is high.

The person is willing to give up a large quantity of good y to get an additional unit of good x while remaining indifferent.

Question 8

If the indifference curve is ______, the marginal rate of substitution is low.

Answer 8

If the indifference curve is flat, the marginal rate of substitution is low.

The person is willing to give up a small amount of good y to get an additional unit of good x while remaining indifferent.

Question 9

Diminishing marginal rate of substitution

Answer 9

The general tendency for a person to be willing to give up less of good y to get one more unit of good x, while at the same time remaining indifferent as the quantity of good x increases.

Question 10

Diminishing marginal rate of substitution - example

Answer 10

Think about your own diminishing marginal rate of substitution. Imagine that in a week, you drink 10 cases of pop and see no movies. Most likely, you are willing to give up a lot of pop so that you can see just 1 movie. But now imagine that in a week, you buy 1 case of pop and see 6 movies. Most likely, you will now not be willing to give up much pop to see a seventh movie. As a general rule, the greater the number of movies you see, the smaller is the quantity of pop you are willing to give up to see one additional movie.

Question 11

When Lisa makes her best affordable choice of movies and pop, she spends all her income and is on her _______ attainable indifference curve.

Answer 11

When Lisa makes her best affordable choice of movies and pop, she spends all her income and is on her highest attainable indifference curve.

Figure 9.6 illustrates this choice: The budget line is from Fig. 9.1 and the indifference curves are from Fig. 9.3(b). Lisa’s best affordable choice is 2 movies and 6 cases of pop at point C—the best affordable point.

Question 12

The best affordable point is ______ the budget line.

Answer 12

The best affordable point is on the budget line.

Question 13

Price effect

Answer 13

The effect of a change in the price of a good on the quantity of the good consumed, other things remaining the same.

Question 14

To derive Lisa’s demand curve for movies…

Answer 14

To derive Lisa’s demand curve for movies, lower the price of a movie and find her best affordable point at different prices.

We’ve just done this for two movie prices in Fig. 9.7(a). Figure 9.7(b) highlights these two prices and two points that lie on Lisa’s demand curve for movies. When the price of a movie is $8, Lisa sees 2 movies a month at point A. When the price falls to $4, she increases the number of movies she sees to 6 a month at point B. The demand curve is made up of these two points plus all the other points that tell us Lisa’s best affordable quantity of movies at each movie price, with the price of pop and Lisa’s income remaining the same. As you can see, Lisa’s demand curve for movies slopes downward—the lower the price of a movie, the more movies she sees. This is the law of demand.

Question 15

Income effect

Answer 15

The effect of a change in income on buying plans, other things remaining the same.

Question 16

For a normal good, a fall in its price always increases the quantity bought. We can prove this assertion by dividing the price effect into two parts:

Answer 16

Substitution effect

Income effect

Question 17

Substitution effect

Answer 17

The effect of a change in price of a good or service on the quantity bought when the consumer (hypothetically) remains indifferent between the original and the new consumption situations—that is, the consumer remains on the same indifference curve.

Question 18

Recall that an inferior good is a good for which demand ________ when income _________.

Answer 18

Recall that an inferior good is a good for which demand decreases when income increases.

Question 19

Inferior Good - information

Answer 19

For an inferior good, the income effect is negative, which means that a lower price does not inevitably lead to an increase in the quantity demanded. The substitution effect of a fall in the price increases the quantity demanded, but the negative income effect works in the opposite direction and offsets the substitution effect to some degree. The key question is to what degree.