Lesson 1.2 - Consumer Behaviour and Rational Choice (Chp 3) Flashcards
what does consumer well being arise from?
arising from goods they choose to purchase with the income they have
assumption in indifference curves
a consumer has a choice of 2 goods to purchase, Y and X
what is an indifference curve?
Contains points representing market bundles among which the consumer is indifferent
indifference curve graph
Y axis is amount of product Y, X axis is amount of product X; decreasing with increasing slope
3 things to remember with indifference curves
- A consumer has many indifference curves.
- Indifference curves slope downwards and to the right which assumes that an individual will always prefer more of a commodity to less.
- An individual consumer’s indifference curves cannot intersect one another.
what would be contradicted if indifference curves intersected?
that consumers would always prefer more of a good to less
what bundle does a consumer prefer on the same indifference curve
all bundles provide same utility
what bundle on what indifference curve does a consumer prefer?
the one farthest from the origin
define marginal rate of substitution
number of units of Y product that must be given up to receive an additional unit of product X while maintaining the same level of satisfaction and well-being
MRS formula **
=-1*(slope of indifference curve) = dY/dX = (dU/dx)/(dU/dY) = MUx/MUy
MRS when indifference curve is steep (large slope)
high MRS I.E a consumer is willing to sacrifice a lot of Y product for little extra X product
MRS when indifference curve is flat (small slope)
low MRS I.e. a consumer is willing to sacrifice a lot of X product for a little extra Y product
what does an indifference curve show?
consumer’s tastes and preferences
what is utility?
happiness or satisfaction that a person derives from consumption of a good or service
what are indifference curves also called?
iso-utility curves
what is MUy
marginal utility of product Y; the increase in utility consumer would experience if they were to obtain one more unit of product Y, holding product X constant
what determines if an indifference curve is attainable?
dependant on consumer’s income and product prices
what does a budget constraint line show?
the combinations of market bundles he/she can purchase given his/her income and prevailing market prices.
Budget Line formula
Yprice of Y + Xprice of X = I where I is consumer’s level of income
budget line graph
downward with constant slope; axis Y is amount of product Y, axis X is amount of product X
when will a budget line shift?
if there is a change in consumer income or product prices
budget line of consumer income increases
parallel shift up and to the right
budget line if consumer income decreases
parallel shift down and to the left
budget line if decrease in price of Y
pivot upwards with x point constant
budget line if decrease in price of X
pivot upwards with y point constant
what does equilibrium market bundle show?
market bundle that maximizes consumer’s utility given budget
what market bundles can a consumer choose?
those that are on the budget line
when is utility maximized formula?
when MRS = Price Ratio = Px/Py
when rate consumer is willing to substitute X for Y holding utility constant is equal to rate consumer is able to substitute X for y
when MUx/Px = MUy/y
explain corner solution
market bundle contains only 1 good; when budget line touches highest possible indifference curve on an axis; then MRS does not equal price ratio when utility is maximized
what does an MRS = Px/Py of 4 mean?
consumer is willing (MRS) and must (price ratio) give up 4 of Y to get 1 more of X
what happens when MRS > Px/Py ex. when MRS = 4 and Price ratio = 3
Consumer can give up 3 Y for an extra X, but an extra X is worth 4 Y, so consumer will buy more of X and less of Y - substitute X for Y
what happens when MRS < Px/Py, ex. when MRS = 4 and price ratio = 5
Consumer can give up 5 Y for an extra X, but an extra X is worth 4 Y, so consumer will buy more of Y and less of X - substitute Y for X
derive market demand curve
horizontal sum of all of the individual consumer demand curves; for each price point, all of the individual demands are added up to get the total quantity demanded at that price.
what happens to market demand curve when more consumers enter the market?
market demand curve is pushed to the right due to horizontal summation, as this occurs as as the supply curve remains constant, the market price increases
explain consumer surplus
the difference between what an individual is willing to pay (the person’s reservation price) and what that individual has to pay (the market price) for a product.
what does demand curve tell us about consumer surplus?
for quantities higher than X, consumer is willing to pay more
consumer reservation price/willingness to pay
price at which a consumer values each particular number of units of a good; highest price consumer is willing to pay
what happens if a higher price than reservation price/WTP is charged?
consumer would not buy
formula for consumer surplus
what consumer actually pays (market price) - what consumer would be willing to pay = actual price paid - reservation price
on demand curve, where is consumer surplus?
triangular area below demand curve and above market price line
what is price discrimination
charging higher prices to consumers who value the product more highly
at equilibrium, what does MRS describe?
the number of units of one good that a consumer is willing to trade for an additional unit of another good, holding utility fixed
L shaped indifference curve
for goods that are perfectly complementary, can’t have 1 good without the other since MRS = 0
decreasing indifference curve with constant slope
goods that are perfect substitutes since MRS = 1 and is constant
what is the slope of the budget line?
the price ratio = -Px/Py
where is the equilibrium market bundle on the graph?
where budget line is tangent to the highest feasible indifference curve or at a corner solution
how can managers change consumer choices?
by influencing preferences through advertising strategies and by influencing the budget line through pricing strategies.
when is a coupon good for a consumer?
it is enables the budget line to increase so it is tangent to an indifference curve further from the origin
budget line with a coupon for $18 if you spend $180 on groceries with x axis is groceries and y axis clothing
when budget line hits groceries = 180, the budget line goes straight up for 18 units and then continues with normal slope downwards
how to tell if a coupon was a good idea for managers?
if groceries with the coupon with the higher budget line and the indifference curve minus the original groceries is larger than the coupon
do most individuals prefer a cash gift and why?
yes, it increases their budget line outward if the x axis is one good and the y axis is all other goods
when is market demand the same as firm demand?
in a monopoly only because there is only 1 seller
what happens to buyers who pay a price equal to the reservation price?
they do not capture any consumer surplus
what does consumer surplus measure?
the efficiency of markets and social benefits of market transactions
how many managers capture consumer surplus?
charging different prices to individuals or groups of individuals that are closer to their reservation prices.
