Section 3 Flashcards
Preferences
How much someone values two goods relative to each other.
Indifference Curve
Shows all of the combinations that provide equal utility or satisfaction.
Why do Indifference curves slope dowanwards?
They slope downwards due to trade offs- If you are indifferent between two combinations, the combination that has more of one good must have less of the other.
Marginal Rate of Substitution
The trade off that a person is willing to make between two goods (consumption and free time) determined by their preferences
Marginal Rate of Transformation
The trade-off that one is constrained to make by the budget constraint (feasible frontier) determined by one’s situation.
Constrained Choice Problem
A problem in which a decision maker chooses values of one or more variables to achieve an objective (maximising profit or utility) subject to a constraint that determines the feasible set.
Optimal Choice
Where the slop of the budget constraint is = to the slope of the Indifference curve
At this point MRS=MRT.
What happens when wages rise?
Additional options become feasible and the opportunity cost of free time increases.
Income Effect
An increase in an individual’s income means a change in their consumption. As their income increases, they spend more and opposite to this the spend less.
Substitution effect
The change in consumption of a good because of the change in the good’s relative price.
Feasible set
Contains all the combinations of goods or outcomes that a decision maker could choose, given the economic, physical or other constraints that they may face.
Slope of the Constraint
= -w
Budget Constraint/Feasible Frontier
An equation that represents all combinations of goods and services one could acquire that would exactly exhaust one’s budgetary resources.
Horizontal Intercept
You may enjoy up to 24 hours of free time by not working
Vertical Intercept
Working, you can spend up to 24 hours x w on consumption
w= wage rate
