Consumer Choice Theory {3}

Question 1

Define:

Budget Constraint?

3 Causes for shift in graph?

Answer 1

Shows the consumption bundles that a consumer can afford
(1): Increase or decrease in income
(2): Increase or decrease of Good X
(3): Increase or decrease of Good Y

Question 2

Relative Price?

Answer 2

Slope of the two goods - the price of one good compared with the price of the other

Question 3

Define:

Indifference Curve?

Marginal Rate of Substitution?

Answer 3

Shows the various bundles of consumption that make a consumer equally happy

Marginal Rate of Substitution: The rate at which a consumer is willing to substitute one good for the other (*Since they are curves the MRS can vary from point to point)

Question 4

Define:

4 Properties for Indifference Curves?

Answer 4

Property 1: Higher indifference curves are preferred to lower ones
Property 2: Indifference curves slope downard
Property 3: Indifference curves do not cross
Property 4: Indifference curves are bowed inward

Question 5

Define:

Perfect Substitutes vs. Perfect Complements?

Answer 5

Perfect Substitutes: When the MRS is constant (Straight Line Graph)
Perfect Complements: When the specific arrangment of goods do not matter (Right Angle Graph)

Ex: Nickels and Dimes Perfect Substitutes
Left & Right Shoes Perfect Complements

Question 6

Define:

Optimum?

Answer 6

The point at which the indifference curve and the budget constraint touch (Indiff. tangent to budget constraint)
Represents the best OPTIMAL bundle that a consumer can afford

Question 7

Define:

Utility?

Marginal Utility? Diminishing?

Answer 7

An abstract measure of the satisfaction or happiness that a consumer receives from a bundle of goods.

Marginal Utility: The increase in utility that the consumer gets from an additional unit of it
Diminishing marginal utility: The more of a the good the consumer already has, the lower the marginal utility provided by an extra unit of that good.

Ordinal NOT Cardinal

Question 8

Define:

Normal Good? Inferior Good?

Answer 8

Normal Good: When consumers buy more of a good when their incomes rise
Inferior Good: When consumers buy less of a good when their income rises

Question 9

Define:

Income Effect?

Answer 9

The change in consumption that results from the movement to a new indifference curve

Question 9

Define:

Substitution Effect?

Answer 9

The change in consumption that results from moving to a new point on the same indifference curve with different marginal rate of substitution