Consumer Behavior Flashcards
What is an indifference curve?
A curve that shows consumption bundles that give the consumer the same level of satisfaction (i.e. combinations of pizza and Pepsi with which the consumer is equally satisfied.)
What are the four properties of an indifference curve?
(1) Higher indifference curves are preferred to lower ones. People usually prefer to consume more goods rather than less. (2) Indifference curves are downward sloping. The slope of an indifference curve reflects the rate at which the consumer is willing to substitute one good for the other. (3) Indifference curves do not cross. (4) Indifference curves are bowed inward. The slope of an indifference curve is the marginal rate of substitution—the rate at which the consumer is willing to trade off one good for the other.
Explain marginal rate of substitution.
The rate at which the consumer is willing to trade off one good for the other (i.e. how much Pepsi the consumer requires to be compensated for a one-unit reduction in pizza consumption)
What is a budget constraint?
The consumption bundles that the consumer can afford.
How might a budget constraint be impacted by an increase in income?
Additional bundles could be consumed with an increase in income.
What two graphical elements are needed in order to determine a consumer’s optimal point of consumption?
Indifference curve and budget constraint.
How is a consumer’s optimal point of consumption determined precisely? What is the condition that must be met?
The point at which this indifference curve and the budget constraint touch (the best combination of pizza and Pepsi available to the consumer.) The marginal rate of substitution equals the relative price of the two goods.
Total
Sum
Average
Mean
Marginal
Change in a total/ change in number of units
Utility
A measure of happiness
Utility maximization
The idea that we all make choices that make ourselves the happiest we can be
Constrained utility maximization
Ex. My budget constrains me from having what makes me happiest
Utility maximization preference
These are what I prefer
Utility function
An equation that tells me how much your happiness goes up or down when you make different decisions or different things happen to you.
Decreasing marginal utility
As I consume more of something, the ADDED utility gets smaller.
How much of a good will you consume?
Until the marginal (added ) benefit on the next unit you consume equals the marginal cost (the price)
Budget line
The line shows the maximum I can afford
The slope is the ratio of the prices (price of good x/ price of good y)
Indifference curve
A line which shows all the combinations of a good which make you equally happy
The slop is the marginal rate of substitution
What are the 4 properties of indifference curves
- higher indifference curves are preferred to lower one’s
- indifference curves are downward sloping
- indifference curves do not cross
- indifference curves are bowed inward
Why does an indifference curve have a bowed shape
It ensures that people consume a mix of goods
Marginal rate of substitution
The rate of exchange between two goods which keeps a consumer on the same indifference curve
Optimum consumption bundle
Where the budget constraint and the indifference curve meet
What are the conditions for optimal it’s precisely
Marginal rate of substitution = price of good x/ price of good y
How does a change in income affect budget constraint
Keeps the same slope because price has not changed, but shifts the whole budget constraint outward
What does a change in the price of one of the goods do to the Budget constraint
It changes the slope, because the slope is a ratio of the prices
The substitution effect
The change in consumption that results when a price change moves the consumer slog a given indifference curve to a point with a new marginal rate of substitution
The income effect
The change in consumption that results when a price change moves the consumer to a higher or lower indifference curve
What is a demand curve
Shows the relationship between the quantity demanded and the price
It represents the willingness to pay for a good
It shows the marginal benefit to the consumer of consuming the good.
What is the law of demand
As price increases, quantity demanded falls
-This is why the demand curve is ALWAYS downward sloping
