CHAPTER 9: Possibilities, Preferences, & Choices

Question 1

Consumption possibilities are choices limited by

Answer 1

income & price

Question 2

What does the household budget line illustrate?

Answer 2

limits to consumption choices

Question 3

What are divisible goods?

Answer 3

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

Question 4

What is expenditure?

Answer 4

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)

Question 5

What is real income>

Answer 5

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)

Question 6

What is relative price?

Answer 6

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

Question 7

How do we calculate magnitude of slope?

Answer 7

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

Question 8

Explain the changes to the budget line when price changes.

Answer 8

○ 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

Question 9

A change in money income changes ___ ___ but NOT _____ ______

Answer 9

1. real income
2. relative price

Increase in money income increases real income & shifts budget line rightwards

Decrease in money income decreases real income & shifts budget line leftwards

Question 10

What is the difference between a preference map & indifference curve?

Answer 10

• 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

Question 11

What is the marginal substitution rate?

Answer 11

rate at which a person will give up good Y (cola) to get an additional unit of good x (movies), while remaining indifferent

Question 12

what measures the MRS?

Answer 12

Magnitude of the slope of indifference curve measures MRS

Question 13

What does it mean if the indifference curve is steep?

Answer 13

high MRS
Person willing to give up a large quantity of good Y to get an additional unit of good X

Question 14

A flat indifference curve indicates…

Answer 14

low MRS
Person willing to give up a small amount of good Y to get an additional unit of good X

Question 15

What tendency does the diminishing marginal rate of substitution imply?

Answer 15

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

Question 16

What does the indifference curve look like for 2 goods that are perfect substitutes?

Answer 16

indifference curves are straight lines that slope downwards
MRS is constant
E.g. different brands of marker pens & pencils

Question 17

What does the indifference curve look like for complementary goods?

Answer 17

L-shaped
* Complements - goods that don’t substitute for each other but used in conjunction with one another
E.g. left & right running shoes

Question 18

Indifference curves for ordinary goods are____.

Answer 18

curved

Question 19

What is the best affordable choice?

Answer 19

occurs when all income is spent & is on the highest attainable indifference curve

Question 20

What is a price effect?

Answer 20

effect of a change in the price of a good on the quantity of the good consumer
changes best affordable choice

Question 21

Income effect

Answer 21

effect of a change in income on buying plans
income falls, buy less

Question 22

T/F: for a normal good, a fall in price always increases the quantity bought

Answer 22

True

Question 23

Substitution effect

Answer 23

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

Question 24

Inferior good

Answer 24

good in which demand decreases when income increases

Question 25

What occurs when the negative income effect = the positive substitution effect?

Answer 25

fall in price leaves the quantity demanded unchanged
the demand curve is vertical
demand is perfectly inelastic

Question 26

If the negative income affect is smaller than the positive substitution effect…..

Answer 26

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

Question 27

If negative income effect exceeds the positive substitution effect….

Answer 27

all in the price decreases the quantity bought
Demand curve slopes upwards

Question 28

Why is the substitution effect positive?

Answer 28

consumer can continue to afford a particular product even if prices increase or their incomes decline

Question 29

Why is the income effect negative?

Answer 29

demand for a product falls even when a consumer’s income increases

Question 30

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

Answer 30

B

Question 31

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

Answer 31

D