week 3 (GPT) Flashcards
What is utility?
The satisfaction a consumer receives from consuming a good or service.
What is marginal utility?
The additional satisfaction from consuming one more unit of a good.
What is the law of diminishing marginal utility?
Each additional unit consumed provides less satisfaction than the one before.
What is total utility?
The total satisfaction received from consuming all units of a good.
When do consumers stop buying a product?
When marginal utility falls below the product’s price.
What is the rational spending rule?
Spend money where the marginal utility per dollar is highest.
How is marginal utility per dollar calculated?
Marginal utility divided by the price of the good.
Why do consumers switch products?
Because another product gives higher marginal utility per dollar.
What is the demand curve?
A graph showing the relationship between price and quantity demanded.
Why does the demand curve slope downward?
Because marginal utility falls as more units are consumed; people are willing to pay less for more.
What causes movement along the demand curve?
A change in the product’s own price.
What causes the entire demand curve to shift?
Changes in income, preferences, population, or the price of other goods.
If the demand curve shifts right, what does it mean?
Consumers are now willing to buy more at each price.
If the demand curve shifts left, what does it mean?
Consumers are now willing to buy less at each price.
What is the substitution effect?
Consumers switch to a cheaper product when the original product becomes more expensive.
What is the income effect?
A fall in price increases real income, allowing more consumption.
What is a normal good?
A good where demand increases when income increases.
What is an inferior good?
A good where demand increases when income decreases.
Give an example of an inferior good.
Instant noodles, home-brand groceries, or cheap wine.
What are substitute goods?
Goods used in place of each other (e.g. car and bus).
What are complementary goods?
Goods used together (e.g. car and petrol).
In a graph, what happens if the price of a substitute decreases?
The demand curve for the original product shifts left.
In a graph, what happens if the price of a complement decreases?
The demand curve for the related product shifts right.
What is horizontal reading of the demand curve?
Given a price, it tells how much a consumer will buy.
What is vertical reading of the demand curve?
Given a quantity, it tells the maximum price a consumer is willing to pay.
What is price elasticity of demand (PED)?
PED measures how much the quantity demanded of a good responds to a change in its price.
What is the formula for PED?
% Change in Quantity Demanded ÷ % Change in Price.
What does it mean if PED > 1?
Demand is elastic – consumers are responsive to price changes.
What does it mean if PED < 1?
Demand is inelastic – consumers are not very responsive to price changes.
What does it mean if PED = 1?
Demand is unit elastic – percentage change in quantity equals percentage change in price.
Is demand for necessities typically elastic or inelastic?
Inelastic, because people will still buy them even if prices rise.
Give an example of an inelastic product.
Insulin or Panadol – demand remains stable even when prices change.
Is demand for luxury goods typically elastic or inelastic?
Elastic, because consumers can cut back if prices rise.
What is the total revenue test?
A method to determine elasticity by observing what happens to total revenue when price changes.
If price increases and total revenue decreases, is demand elastic or inelastic?
Elastic.
If price increases and total revenue increases, is demand elastic or inelastic?
Inelastic.
What is point elasticity?
A measure of elasticity at a single point on the demand curve.
What is the formula for point elasticity?
(1 ÷ slope) × (P ÷ Q)
What happens to elasticity along a straight-line demand curve?
It changes – more elastic at higher prices, more inelastic at lower prices.
What factors affect PED?
Availability of substitutes, necessity vs luxury, time, and share of income spent.
How does the availability of substitutes affect PED?
More substitutes = more elastic demand.
What’s the substitution effect?
When a price rises, consumers switch to similar but cheaper goods.
What’s the income effect?
When a price rises, the consumer’s real income falls, leading to less quantity demanded.
What is price elasticity of supply (PES)?
It measures how much quantity supplied responds to a change in price.
What is the formula for PES?
% Change in Quantity Supplied ÷ % Change in Price.
What factors influence PES?
Time, availability of resources, and mobility of resources.
Is supply more elastic in the short run or long run?
Long run, because firms have more time to adjust.
What does it mean if PES > 1?
Supply is elastic – producers can respond easily to price changes.
What does it mean if PES < 1?
Supply is inelastic – harder to increase output quickly.
Why do firms avoid operating in the inelastic part of the demand curve?
Because lowering price decreases revenue – not efficient for maximizing profits.
