ECON 101 Chp 9 - Possibilities, Preferences and Choices Flashcards
divisible vs indivisible goods
divisible goods = can be bought in any quantity desired
indivisible goods = cannot be bought in any quantity
what assumption do we hold about house choices?
all goods + services are divisible
define real income
income expressed as a quantity of goods that the household can afford to buy
define relative price
price of 1 good divided by the price of another good
what’s the effect of a change in price on the budget line?
if it falls, then the slope of the budget line tilts outwards (flatter) (slope value is smaller)
if it rises, then the slope of the budget line tilts inwards (steeper) (slope value is larger)
what’s the effect of a change in income on the budget line?
if it rises, the slope stays the same, the budget line shifts leftwards
if it falls, the slope stays the same, the budget line shifts rightwards
define an indifference curve
curve that shows combination of goods among which a consumer is indifferent
define a preference map
a series of indifference curves that resemble the contour lines on a map
define the marginal rate of substitution (MRS)
the rate at which a person will give up good Y (good measured on the y-axis) to get an additional unit of good X (the good measured on the x-axis)
what’s the effect of the slope of the indifference curve and the value of the MRS?
if the indifference curve is steep, the MRS is high
if the indifference curve is flat, the MRS is low
define the diminishing marginal rate of substitution
general tendency for a person to be willing to give up less of good y to get 1 more unit of good x, while remaining indifferent as the quantity of x increases
what’s the shape of indifference curves for goods that are perfect substitutes, perfect complements, and ordinary goods?
perfect substitutes: straight lines that slope downwards
perfect complements: 2 “L” shaped lines
ordinary goods: 2 curved lines
what are the conditions in achieving the best affordable point?
- spends all their income (a point on her budget line)
- on the highest attainable indifference curve
- MRS = slope of the budget line (relative prices of good X and good Y) (willingness to pay for good Y = opportunity cost of good Y)
are all the points on the budget line on the same indifference curve?
no, they are on different indifference curves
define price effect
the effect of a change in price of a good on the quantity of the good consumed
what’s the price effect in terms of the budget line, indifference curve, and demand curve?
budget line flattens (slope change), new best affordable point, new indifference curve, (and new point on the demand curve).
define the income effect
the effect of change in income on buying plans
what’s the effect of income change on the budget line, indifference curve and demand curve?
- the slope of the budget stays constant but the budget line shifts right or left depending on the change
- the indifference curve shifts left or right depending on the change (slope stays constant)
- demand curve shifts left or right
what 2 effects we prove that for a normal good, a fall in its price always increases the quantity bought
- substitution effect
- income effect
define the substitution effect
effect of a change in price on the quantity bought when the consumer remains indifferent between the original situation and the new one
how is the substitution effect demonstrated on the budget line and indifference curve
- price change, slope of the budget line changes
- find new best affordable point (J) on new budget line –> new indifference curve
- find the point where the original indifference curve and the slope of the new budget line meet (point K)
- find the movement along the original indifference curve of the old best affordable point C) and new best affordable point (K) = substitution effect, this movement along the curve shows the new combination of good bought with a change in price (using the same income).
how is the income effect demonstrated on the budget line and indifference curve (normal good)
- price change, slope of the budget line changes
- find new best affordable point (J) on new budget line –> new indifference curve
- find the point (K) where the original indifference curve and the slope of the new budget line meet
- find the magnitude of the shift from point K to new best affordable point on the new indifference curve (point J) = income effect, this shift shows the new combination of goods bought with a change in income
for a normal good, the income effect _____ the substitution effect
reinforces
what’s the substitution and income effect for inferior goods?
income effect for an inferior good is negative
the substitution effect of a fall in price increases the quantity demand
the negative income effect offsets the substitution effect to some degree
to what degree does the negative income effect offset the substitution effect of an inferior good for when the negative income effect equals, is smaller than, or exceeds the positive substitution effect?
equals: a fall in price leads to the quantity bought stays the same, demand curve is vertical (perfectly inelastic)
smaller than: fall in price increases quantity bought and demand curve still slopes downward like a normal good, but demand for an inferior good is less elastic than that for normal good
exceeds: fall in price decreases the quantity bought, demand curve slopes upward ** never happens in real life.
what’s the equation to income = expenditure in terms of goods?
y = PxQx + PyQy
the point at which the budget line intersect the y-axis is ________?
the household’s real income in terms of the food measured on the y-axis
the magnitude of the slope of the budget line is the ________?
relative price of the good measured on the x-axis in terms of the good measured on the y-axis
the magnitude of the slope of an indifference curve is called ____?
marginal rate of substitution (MRS)
