ECON101 Unit 6

Question 1

What is a budget line and what does it constrain?

Answer 1

• A consumers budget line shows the limits of the consumption possibilities when all income is used
• A budget line constrains these consumption choices as you can only purchase whats inside the line

Question 2

What is utility and total utility?

Answer 2

Utility: Benefit/satisfaction from consuming a good/service

Total utility: Total benefit a person gets from the consumption of goods = more consumption gives more utility

Question 3

True or False: Total utility decreases as the quantity of the good increases

Answer 3

False … It increases as quantity increases

Question 4

What is marginal utility?

Answer 4

Change in total utility that results from a unit increase in the quantity of the good consumed

Question 5

Does the marginal utility increase or decreases when quantity consumed increases?

Answer 5

MU decreases as quantity consumed increases

This is called the principle of diminishing marginal utility!

Question 6

What is diminishing marginal utility?

Answer 6

As more is consumed, the marginal utility of it will decline

Question 7

When does total utility peak? What happens when it does?

Answer 7

• TU peaks when marginal utility = 0
• After the peak, TU will start to decline as we consume more
• Form a downward parabola
• MU will turn negative

Question 8

What is consumer equilibrium?

Answer 8

When a consumer allocates all of their available income in a way that maximizes utility given the budget constraint

Question 9

What is marginal utility per dollar and what is the equation for it?

Answer 9

Marginal utility from a good that comes from spending/more dollar on it
Marginal utility/price
- By comparing two goods using that, we can see if the allocated budget has been used to max total utility

Question 10

What is the utility maximizing rule?

Answer 10

1) All available income is spent
2) Equalized marginal utility per dollar for all goods
3) No incentives to change consumption

Question 11

Predictions using marginal utility theory:

Answer 11

When a price of a good falls, equilibrium needs to be restored so increase quantity of that good to restore it
When a price of a good rises, less of that good is drank until the equilibrium is restored

Question 12

What does a rise in income do?

Answer 12

Increases the demand for both goods in question… which SHIFTS the demand curve rightward

Question 13

What is the paradox of value?

Answer 13

Water = marginal utility is small, but total utility is large 
Diamonds = marginal utility is large, but total utility is small

Question 14

How do diamonds and water differ in terms of elasticity and surplus?

Answer 14

Water =
supply of water is perfectly elastic
quantity consumed is large
consumer surplus is large

Diamonds =
supply of diamonds is perfectly inelastic
price is high
consumer surplus is small

Question 15

What is behavioural economics?

Answer 15

Studies the way in which limits on the brains ability to compute rational decisions

Question 16

The three impediments/concepts to making decisions:

Answer 16

Bounded rationality: making choices based on instinct, rule of thumb, other opinions etc.
Bounded willpower = prevents us from making decisions we will regret
Bounded self interest = suppressing our own interest to help others

Question 17

What are the two effects in economic decision making?

Answer 17

Endowment effect = tendency for people to value something more highly because they own it
Neuroeconomics = study of the human brain when people make economic decisions