Module 4: Theory of Consumer Behavior

Question 1

three basic decisions in household choices

Answer 1

1. How much of each product, or output, to demand?
2. How much labor to supply?
3. How much to spend today and how much to save for the future?

Question 2

Determinants of Household Demand

Answer 2

*product price
* income and wealth levels
* The household’s amount of accumulated wealth
* The prices of other products
* household preference
* The household’s expectations about future income, wealth, and prices

Question 3

Households are free to choose what they will and will not buy.
Their ultimate choices are governed by their individual ______

Answer 3

preferences and tastes

Question 4

As long as a household faces a limited budget— and all households ultimately do—the ____________is the value of the other goods and services that could have been purchased with the same amount of money.

Answer 4

real cost of any good or service

Question 5

The real cost of a good or service is its __________

Answer 5

opportunity cost

Question 6

________ is determined by relative prices

Answer 6

opportunity cost

Question 7

Both ____ and ____ affect the size of a household’s opportunity set.

Answer 7

prices and incomes

Question 8

If a price or a set of prices falls but income stays the same, the opportunity set gets _____ and the household is better off.

Answer 8

bigger

Question 9

when money income increases and prices go up even more, we say that the household’s _____ has fallen.

Answer 9

“real income”

Question 10

examines the trade-offs that people face as consumers.

Answer 10

theory of consumer choice

Question 11

As individuals consume more of a good per time period, their ________ or satisfaction _____, but their ______diminishes.

Answer 11

total utility (TU), increases, marginal utility

Question 11

The property of a good that enables it to satisfy human wants.

Answer 11

Utility

Question 12

the extra utility received from consuming one additional unit of the good per unit of time while holding constant the quantity consumed of all other commodities.

Answer 12

Marginal utility (MU)

Question 13

the arbitrary unit of measure of utility.

Answer 13

Marginal utility (MU)

Question 14

Each additional unit of a good eventually gives less and less extra utility.

Answer 14

Law of diminishing marginal utility

Question 15

It means that an individual can attach specific values or numbers of utils from consuming each quantity of a good or basket of goods.

Answer 15

Cardinal utility

Question 16

this only ranks the utility received from consuming various amounts of a good or baskets of goods.

Answer 16

Ordinal utility

Question 17

_______ only ranks various consumption bundles, whereas _______provides an actual index or measure of satisfaction.

Answer 17

ordinal utility, cardinal utility

Question 18

Equating the ratio of the marginal utility of a good to its price for all goods

Answer 18

Utility-Maximizing Rule

Question 19

A higher price for good increases its demand.

Answer 19

false, decreases

Question 20

Equation of the Budget Constraint

Answer 20

PxX + PyY = I

Question 21

Px

Answer 21

price of X

Question 22

X

Answer 22

quantity of X consumed

Question 23

PY

Answer 23

the price of Y

Question 24

Y

Answer 24

quantity of Y consumed

Question 25

I

Answer 25

household income

Question 26

When the price of a good decreases, the budget constraint swivels to the _____, ____ the opportunities available and expanding choice.

Answer 26

right, increasing

Question 27

When there is a rise in income, the budget constraint shifts _____.

Answer 27

outward

Question 28

When the _____, the budget constraint swivels to the right, increasing the opportunities available and expanding choice.

Answer 28

price of a good decreases

Question 29

When there is a fall in income, the budget constraint shifts ____.

Answer 29

inward

Question 30

ASSUMPTIONS FROM INDIFFERENCE CURVE

Answer 30

1. We assume that this analysis is restricted to goods that yield positive marginal utility, or, more simply, that “more is better”. 2. The marginal rate of substitution is defined as MUx/MUy, or the ratio at which a household is willing to substitute X for Y. 3. We assume that consumers have the ability to choose among the combinations of goods and services available. 4. We assume that consumer choices are consistent with a simple assumption of rationality.

Question 31

The _________ is defined as MUx/MUy, or the ratio at which a household is willing to substitute X for Y.

Answer 31

marginal rate of substitution

Question 32

a curve that shows consumption bundles that give the consumer the same level of satisfaction

Answer 32

INDIFFERENCE CURVE

Question 33

the rate at which a consumer is willing to trade one good for another

Answer 33

Marginal rate of substitution

Question 34

The rate at which a consumer is willing to trade one good for the other depends on the amounts of the goods she is already consuming.

Answer 34

Marginal rate of substitution

Question 35

A consumer’s set of indifference curves gives a complete ranking of the consumer’s preferences

Answer 35

TRUE

Question 36

FOUR PROPERTIES OF INDIFFERENCE CURVES

Answer 36

1. Higher indifference curves are preferred over lower ones. 2. Indifference curves are downward-sloping 3. Indifference curves cannot cross. 4. Indifference curves are bowed inward.

Question 37

two goods with straight-line indifference curves, constant MRS

Answer 37

Perfect substitutes

Question 38

two goods with right-angle indifference curves

Answer 38

Perfect complements

Question 39

a property of indifference curve which people usually prefer to consume more rather than less. This preference for greater quantities is reflected in the indifference curves

Answer 39

1. Higher indifference curves are preferred over lower ones.

Question 40

The slope of an indifference curve reflects the rate at which the consumer is willing to substitute one good for the other.

Answer 40

2. Indifference curves are downward sloping

Question 41

A situation like this can never happen. According to these indifference curves, the consumer would be equally satisfied at points A, B, and C, even though point C has more of both goods than point A.

Answer 41

3. Indifference curves cannot cross.

Question 42

hurley is willing to give more mangos for a fish if he has few fish (A) than if he has many (B).

Answer 42

4. Indifference curves are bowed inward.

Question 43

the point on the budget constraint that touches the highest possible indifference curve.

Answer 43

optimum

Question 44

At the ______, slope of the indifference curve equals slope of the budget constraint

Answer 44

optimum

Question 45

another example of "thinking at the margin"

Answer 45

consumer optimization

Question 46

a good for which an increase in income raises the quantity demanded

Answer 46

normal good

Question 47

a good for which an increase in income reduces the quantity demanded

Answer 47

inferior good

Question 48

The fall of the price expands the consumers’ set of buying opportunities, it rotates the budget constraint _______.

Answer 48

outwards

Question 49

The change in consumption that results when a price change moves the consumer to a higher or lower indifference curve.

Answer 49

INCOME EFFECT

Question 50

The change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution.

Answer 50

SUBSTITUTION EFFECT

Question 51

a good for which an increase in price raises the quantity demanded.

Answer 51

Giffen good

Question 52

If income effect > substitution effect

Answer 52

true

Question 53

✓ Shows a person’s tradeoff between consumption and leisure. ✓ Depends on how much time she has to divide between leisure and working. ✓ The relative price of an hour of leisure is the amount of consumption she could buy with an hour’s wages.

Answer 53

Budget constraint

Question 54

✓ Shows “bundles” of consumption and leisure that give her the same level of satisfaction.

Answer 54

Indifference curve

Question 55

A higher wage makes leisure more expensive relative to consumption. The person chooses less leisure, i.e., increases quantity of labor supplied.

Answer 55

Substitution effect (SE)

Question 56

With a higher wage, she can afford more of both “goods.” She chooses more leisure, i.e., reduces quantity of labor supplied.

Answer 56

Income effect (IE)

Question 57

shows the possible combinations of different goods she can buy given her income and the prices of the goods.

Answer 57

budget constraint

Question 58

The slope of the budget constraint ______ the relative price of the goods.

Answer 58

equals

Question 59

shows the various bundles of goods that make the consumer equally happy

Answer 59

indifference curve

Question 60

The consumer ________ by choosing the point on her budget constraint that lies on the highest indifference curve.

Answer 60

optimizes

Question 61

the change in consumption that arises because a lower price makes the consumer better off.

Answer 61

income effect

Question 62

the change in consumption that arises because a price change encourages greater consumption of the good that has become relatively cheaper.

Answer 62

substitution effect