Topic 2 - Indifference Curve Analysis Flashcards
What does a budget line show?
The limits to its consumption possibilities, so shows the boundary between what’s affordable/unaffordable.
What are divisible and indivisible goods?
Divisible = Can be bought in any quantity desired Indivisible = Can't be bought in any quantity desired.
What’s a household’s real income?
It’s income expressed as a quantity of goods that the household can afford.
What is the relative price?
The price of one good, divided by the price of another good.
What happens when the price of the good on the x-axixs decreases?
The budget line gets flatter.
What happens if income changes?
Increase = shifts rightward Decrease = shifts to the left
What is an indifference curve?
Shows combinations of goods among which a consumer is indifferent.
What is the marginal rate of substitution?
The rate at which someone will give up good y to get an additional unit of good x, while remaining on the same indifference curve.
What does the slope of the indifference curve show?
Steep = MRS is high and they are willing to give up a large quantity of y, to get an additional unit of x Flat = MRS is low and they are willing to give up a small quantity of y, to get an additional unit of x
What is the diminishing MRS?
General tendency for a person to be willing to give up less of good y to get one more unit of good x, while remaining indifferent, as the quantity of x increases.
What are the indifference curves for ordinary goods, perfect substitutes and perfect complements?
Ordinary = curves PS = straight lines that slope downwards PC = L shaped
What is the best affordable choice?
When they spend all their available income and is on their highest attainable indifference curve.
What is the substitution effect?
The effect of a change in price on the quantity bought when the consumer remains indifferent. It always results in an increase in consumption of the good whose relative price has fallen.
What is the income effect?
The effect of a change in income on consumption. For a normal good, the income effect reinforces the substitution effect, whereas for an inferior good it works in the opposite direction.
