CHAPTER 9: Possibilities, Preferences, & Choices Flashcards
Consumption possibilities are choices limited by
income & price
What does the household budget line illustrate?
limits to consumption choices
What are divisible goods?
can be bought in any quantity desired
E.g. electricity & gas
○ When good is divisible, consumption possibilities also include intermediate points that run in between A - F
What is expenditure?
sum of the price of each good multiplied by the quantity bought
○ E.g. Expenditure = (price of cola x quantity of cola) + (price of movie x quantity of movie)
What is real income>
income expressed as a quantity of goods that a household can afford to buy
Maximum quantity one can afford to buy
Point at which the budget line intersects the y-axis (A)
What is relative price?
price of one good divided by the price of another good
○ E.g. Lisa’s relative price of a movie in terms of cola is Pm/Pc
§ Pm/Pc = 8/4 = 2
How do we calculate magnitude of slope?
slope = the change in the variable on the y-axis divided by change in variable on the a-axis
as cola decreases from 10 - 0, movies increase from 0 - 5
§ Magnitude of slope = 10/5 = 2 cases of cola per movie
Explain the changes to the budget line when price changes.
○ Lower the price of the good measured on the x-axis, the flatter the budget line
○ Higher the price of the good measured on the x-axis, steeper the budget line
A change in money income changes ___ ___ but NOT _____ ______
- real income
- relative price
Increase in money income increases real income & shifts budget line rightwards
Decrease in money income decreases real income & shifts budget line leftwards
What is the difference between a preference map & indifference curve?
- Preference Map - based on the intuitively appealing idea that people can sort all the possible combinations of goods into 3 groups: preferred, not preferred, & indifferent
- Indifference curve - shows combinations of goods among which a consumer is indifferent
What is the marginal substitution rate?
rate at which a person will give up good Y (cola) to get an additional unit of good x (movies), while remaining indifferent
what measures the MRS?
Magnitude of the slope of indifference curve measures MRS
What does it mean if the indifference curve is steep?
high MRS
Person willing to give up a large quantity of good Y to get an additional unit of good X
A flat indifference curve indicates…
low MRS
Person willing to give up a small amount of good Y to get an additional unit of good X
What tendency does the diminishing marginal rate of substitution imply?
tendency for a person to be willing to give up less of good y to get one more unit of good x, while remaining indifferent as the quantity of x increases
What does the indifference curve look like for 2 goods that are perfect substitutes?
indifference curves are straight lines that slope downwards
MRS is constant
E.g. different brands of marker pens & pencils
What does the indifference curve look like for complementary goods?
L-shaped
* Complements - goods that don’t substitute for each other but used in conjunction with one another
E.g. left & right running shoes
Indifference curves for ordinary goods are____.
curved
What is the best affordable choice?
occurs when all income is spent & is on the highest attainable indifference curve
What is a price effect?
effect of a change in the price of a good on the quantity of the good consumer
changes best affordable choice
Income effect
effect of a change in income on buying plans
income falls, buy less
T/F: for a normal good, a fall in price always increases the quantity bought
True
Substitution effect
effect of a change in price on the quantity bought when the consumer remains indifferent between the original situation and the new one
○ When relative price of a good falls, the consumer substitutes more of that good for the other
Inferior good
good in which demand decreases when income increases
What occurs when the negative income effect = the positive substitution effect?
fall in price leaves the quantity demanded unchanged
the demand curve is vertical
demand is perfectly inelastic
If the negative income affect is smaller than the positive substitution effect…..
a fall in price increases the quantity bought
demand curve still slopes downward like that for normal good
demand for an inferior a good might be less elastic than that for a normal good
If negative income effect exceeds the positive substitution effect….
all in the price decreases the quantity bought
Demand curve slopes upwards
Why is the substitution effect positive?
consumer can continue to afford a particular product even if prices increase or their incomes decline
Why is the income effect negative?
demand for a product falls even when a consumer’s income increases
How does a relative price and a household’s real income influence its budget line? A change in the relative price _______, and a change in real income _______.
A. shifts the budget line; has no effect on the budget line
B. changes the opportunity cost of purchasing goods and changes the slope of the budget line; shifts the budget line
C. has no effect on the budget line; changes the slope of the budget line
D. changes the opportunity cost of purchasing goods and shifts the budget line; changes the slope of the budget line
B
If a household has an income of $90 and buys only books at $15 each and mushrooms at $6 akilogram, what is the equation of the household’s budget line? (QB is the quantity of books and QM is the quantity of kilograms of mushrooms.)
A.6QM = 9+15.0QB
B. QM = 6−2.5QB
C. QB = 12−0.4QM
D. QM = 15−2.5QB
D
