Lesson 4 Consumer Choice Application Flashcards
Optimum
1) Point where highest indifference curve she can reach intersects her budget
2) slope of indifference curve = marginal rate of substitution
3) slope of budget constraint = relative price of two objects
Consumer chooses quantities of two goods so that the
marginal rate of substitution = relative price
Relative price vs marginal rate of substitution
1) relative price = rate which market is willing to trade one good for another
2) marginal rate of substitution = rate at which consumer willing to trade one good for another
Utility
1) Utility = measure of happiness received from goods
2) Higher indifference curve = more utility
3) Marginal utility = increase in happiness from one additional unit (most objects have diminishing marginal utility –> more u have the less u want)
4) SO consumer’s goal is to maximize utility (be on higher indiff curve)
What happens to optimum when income increases
1) Increasing income –> graph shifts outward BUT since cost of goods is same –> slope of new budget constraint is the same
2) Reach a higher indiff curve –> prolly buy more of both goods
Normal vs Inferior Good
1) Normal = Want more of good when income rises
2) Inferior = Want less of good when income rises
How does optimum shift when prices change
1) Change in prices –> Change slope of budget constraint
2) generally if something becomes cheaper –> may buy more of cheaper thing + less of other object BUT possible they buy more of both
Income Effect
1) When you buy more of both goods as a response to decrease in price of one good (then ur income has more purchasing power)
Substitution Effect
1) Buy more of reduced cost good (Pepsi) + less of the normal price good (pizza)
2) Opportunity cost of pizza increases since you can get more bottles of pepsi than before
How to tell income vs substitution effect graphically
1) Income effect = movement to a new indifference curve (buy more of both goods –> go higher up)
2) Substitution effect = movement along the same indifference curve (buy more cheaper good BUT less of the other good)
Bart and Lisa are both optimizing consumers in the markets for shirts and hats, where they pay $100 for a shirt and $50 for a hat. Bart buys 8 shirts and 4 hats, while Lisa buys 6 shirts and 12 hats. From this information, we can infer that Bart’s marginal rate of substitution is
1) 2 for both of them
2) you want relative prices to equal MRS so for 100 dollars you can either get 2 hats or 1 shirt SO MRS should be the same ratio of 2
Market
1) Group of buyers and sellers of a good/service
2) Can be highly organized (auction) but most are less organized where the sellers do not congregate in the same place
Competitive Market
1) market in which so many buyers/sellers in market that each has little effect on market price
Perfectly competitive market
1) goods offered for sale exactly the same
2) so many buyers/sellers that nobody has influence over market price
price takers = buyers can buy as much and sellers can sell as much at market price
Monopoly
1) When there is only one seller –> able to set the price
Quantity Demanded
1) amount buyers willing/able to purchase
2) price plays the biggest role
Law of demand
1) when price rises –> quantity demanded falls
2) when price falls –> quantity demanded rises
Demand schedule
1) table that shows relationship btwn price of good + quantity demand
Demand Curve
1) Line relating price + quantity demanded
2) slopes downward –> increase in prices results in reduced demand
Market Demand
1) sum of individual demands for good or services
2) can calculate by horizontally adding up demand curves
Shifts in demand curve
1) Moves right –> when there is an increase in demand (suppose new discovery finds that it helps cure cancer)
2) Moves left –> when there is a decrease in demand (suppose new discovery finds it’s defective)
What causes shifts in demand curve
1) Income
2) Substitutes
3) Tastes
4) Expectations
5) # buyers
Substitutes
1) two goods for which an increase in the price of one leads to an increase in the demand for the other
2) decrease in ice cream price –> buy more ice cream + less sorbet
Complements
1) when reduction in price of one good increases demand for another good
2) example = decrease in price of hot fudge –> buy more ice cream since ice cream and hot fudge is a good combo
