consumers and incentives Flashcards
buyer’s problem (steps)
how to spend
1. what do you like
2. how much does it cost
3. budget
what do you like
tastes and preferences
biggest bang for our buch
how much does it cost (2 characteristics)
the price is fixed
we can buy as much as we want without driving up the price
budget (2 assumptions)
no saving or borrowing, only buying
only purchase whole units
budget set
all possible bundles of g&s that can be purchased with a consumer’s income
budget constraint
what alternative of the budget set is the most beneficial for a person (negative slope)
the opportunity cost of one good (over another)
opportunity cost good 1 = loss in good 2 / gain in good 1
trade-off
ratio of good 1 vs good 2
optimal solution at
marginal benefit of each good should be equal
budget completely spent
optimal solution formula
MB1/ P1 = MB2/P2
budget constraint: price changes (2)
decrease in the price of either causes the budget constraint to pivot outward (can buy more)
increase in the price of either will cause the budget constraints to move inwards (buy fewer)
budget constraint: income changes
increase in income causes an outward shift
decrease in income causes an inwards shift
why does the demand curve have a negative slope
diminishing marginal benefit
consumer surplus
difference between what you are willing to pay and what you have to pay (market price)
consumer surplus formula
base x height / 2
demand elasticity
measure of how sensitive one variable is to the changes in another
price elasticity of demand + formula
how much does the Qd change when the good’s price changes
Ed = % change in Qd / % change in price
elasticity measures
Ed > 1 elastic
Ed < 1 inelastic
Ed = 1 unit elastic
Ed = ∞ perfectly elastic
Ed = 0 perfectly inelastic
total revenue
P x Q
effect of price on revenue (inelastic)
increases more than quantity decreases = total revenue increases
lowers but quantity increases only slightly = total revenue decreases
determinants
nb and closeness of subs
budget share spent on the good
time horizon available to adjust to price changes
determinant: nb and closeness of subs
nb of available subs grows the price elasticity of demand increases
determinant: budget share spent on the good
spend more of budget on a good the price elasticity of demand increases
determinant: time horizon available to adjust to price changes
consumers respond much less to price changes in the short run then in the long run
the cross price elasticity of demand
how much does the quantity demand of one good change when the price of another good changes
cross-price elasticity result
negative = complement
positive = subsidies
income elasticity of demand
how much does quantity demanded change when income changes
