Consumption Choices

Question 1

Marginal Utility

Answer 1

Additional utility gained from one additional unit of consumption

MU = change in utility / change in Q

Question 2

Diminishing MU

Answer 2

Additional utility decreases with each unit added

Question 3

MU per Dollar

Answer 3

Additional utility at a given price

MU/Dollar = MU / Price

Question 4

Maximizing Utility

Answer 4

Utility-maximizing choice between consumption goods occurs where MU per dollar is the same for both goods

MU1 / P1 = MU2 / P2

Question 5

Consumer Equilibrium

Answer 5

Ratio of prices from two goods should be equal to the ratio of MU

P1 / P2 = MU1 / MU2

Question 6

Normal Good

Answer 6

When a rise in income leads to a rise in demand

Question 7

Inferior Good

Answer 7

When a rise in income leads to a decrease in demand

Question 8

What happens to a budget constraint when prices rise?

Answer 8

The budget constraint shifts to the left and overall consumption shrinks.

The budget constraint pivots along the axis for the price that remains constant

Question 9

Income Effect

Answer 9

A higher price means that the buying power of income has been reduced

This happens simultaneously with a substitution effect

Question 10

Substitution Effect

Answer 10

When a price changes, consumers have an incentive to consume less of the good with a higher price and more of the good with a lower price.

Happens simultaneously with an income effect

Question 11

Substitution Effect

Answer 11

When a price changes, consumers have an incentive to consume less of the good with a higher price and more of the good with a lower price.

Happens simultaneously with an income effect

Question 12

How does a decrease in price lead to an increase in purchases of the product? What happens to the budget constraint?

Answer 12

The income effect and substitution effect happen simultaneously.

The decrease in price moves the budget constraint outward (center paribus) and creates an increase in buying power along with an increased demand for that product relative to income remaining the same. The substitution effect says that because the product is now cheaper the consumer will to buy more of the product.

Question 13

What is a positive income effect?

Answer 13

An increase in income will shift the budget constraint outward and a movement along the budget constraint towards the NORMAL GOOD.

Question 14

What is a negative income effect?

Answer 14

A decrease in income will shift the budget constraint inward and a movement along the budget constraint towards the INFERIOR GOOD

Question 15

Labor-Leisure Budget Constraint

Answer 15

A household will choose the combination of labor, leisure, and income that provides the most utility. The result of a change in wage levels can be higher work hours, the same work hours, or lower work hours

Question 16

How does a rise in wages alter the labor-leisure budget constraint?

Answer 16

A rise in wages causes the labor-leisure constraint to swing upward

Question 17

Backward-Bending Supply Curve for Labor

Answer 17

Is created with high-wage people.

At the lower portion of the supply curve an increase in wages creates an increase in hours worked.

The middle of the supply curve is almost vertical and an increase in the wages does not increase hours worked

The top of the supply curve then bends backwards towards the y-axis and an increase in wages creates a decrease in hours worked

Question 18

In the labor-leisure model, what is the price of leisure?

Answer 18

The price of leisure is less hours worked and lower income

Question 19

Intertemporal Budget Constraint

Answer 19

Explains people’s preferences in relation to current consumption and saving for future consumption over the course of their lives

Question 20

What is the impact of education on earnings and unemployment rates?

Answer 20

As education rises median income rises and unemployment rates decrease

Question 21

How will interest rates affect affect the intertemporal budget constraint?

Answer 21

A lower interest rate will make lending cheaper and savings less rewarding creating a flatter intertemporal budget line

A higher interest rate will make lending more expensive and saving more rewarding creating a steeper intertemporal budget line