Consumer Demand And Elasticity? Flashcards
What is the Utility Theory?
Consumers are rational (i.e. able to make decisions to achieve their objectives) and maximize their utility (satisfaction). A utility function allows us to rank a consumption bundle by the total utility (satisfaction).
Marginal utility is a change in total utility (satisfaction) due to the change in consumption of the good.
The law of diminishing marginal utility suggests that as consumption per unit of time increases, marginal
utility decreases.
What is an Indifference Curve?
The indifference curve is an isosatisfaction (isoutility) contour line, which accounts for substitution in consumption for two products.
It represents all combinations of the two goods that
yield an equal level of satisfaction or utility
What are some features of an Indifference Curve?
More is preferred to less (unlimited wants)
Any given pair of consumption goods is preferred (ordering of preferences)
The consumer has an affordable bundle given the income and prices of the goods X and Y
The bundle that the consumer chooses is the one that gives the most satisfaction.
What does the slope of the Indifference Curve look like?
Typically slopes down to the right and is convex. Indicating that the consumer’s willingness to substitute one commodity for another whilst retaining a constant level of satisfaction - (refer to the Figure above).
Implies that there is an opportunity cost associated with the consumption of one commodity (i.e. to consume more of Good Y less of Good X will be consumed).
Along the indifference curve the opportunity cost is equivalent to the opportunity gained.
What is the Budget Line (Income Line)?
Budget line (income line) - a graph showing what combinations of the two goods can be afforded by a consumer with a fixed amount to spend - (see the Figure below) If the prices of the two goods (per unit) are fixed (constant) the budget line is a straight line. Budget line can be expressed as an equation (in terms of the amount to spend, prices and quantity).
What is meant by Consumer Equilibrium?
Combining the indifference curve and the budget line permits analysis of the combination of goods that maximise the consumer’s satisfaction.
A rational consumer wants to get the highest indifference curve given the budget constraint.
Consumer equilibrium is the point where the budget line is a tangent to the indifference curve.
What is the Income And Substitution Effect Of A Price Change?
If the price of either Good X or Good Y changes there will be two effects. For example, if the price of Good Y decrease:
There will be an income effect brought about by an
increase in real income, that the consumer can now afford to buy more of the Good Y.
The other effect is called substitution effect, that the consumer can also substitute Good Y for Good X, because of the relative price decrease for Good Y.
What is the Demand Theory?
Demand theory assist to understand consumer preferences and combine this with market research to assist marketing businesses.
A demand curve shows the relationship between the
prices of a particular good and the corresponding levels of purchases (or sales) or consumption of that good, over a specified time period.
The demand curve is the aggregation of all the consumers in a market.
What is Elasticity?
Elasticity - the ratio between the proportional change in one variable to the proportional change in another.
What is Price Elasticity?
Price elasticity - the ratio of the proportional change in quantity demanded to a proportional change in price.
Price elasticity can be calculated as arc elasticity and point elasticity.
What is Point Elasticity?
Point elasticity is calculated at a specific point on the demand curve. It will have a negative sign (because if price increases the quantity demanded decreases, or the vice versa).
What is Arc Elasticity?
Arc elasticity is an “average” elasticity over a segment of the demand curve.
What is meant by Inelastic Demand?
Inelastic demand - when the proportional change in quantity demanded is less than the proportional change in price. Inelastic demand is typically drawn as a relatively steep line. (vertical line: perfect inelastic).
What are Demand Shifters?
Changes in disposable income, or prices of the substitutes will shift the position of the demand curve.
Consumers preferences can shift the demand.
Consumer preference are influenced by social, demographic, environmental and cultural factors, and also by advertising, fashion trends and quality change.
What are factors that affect The Price Elasticity Of Demand?
Food is generally considered to have a low price elasticity of demand (PED) as it is essential.
The more essential and the fewer substitutes available the less elastic is the demand.
Eg. food is price inelastic in general, and lamb is more price elastic than meat as there are substitutes for lamb.
Goods that take up a small share of our budget will also tend to be price inelastic. Eg. table salt.
