Chapter 5: Concepts/ Theory

Question 1

What does the basic model of consumer theory wish to do?

Answer 1

explain how consumers make their purchasing decisions when they are informed about all things that matter

Question 2

Consumption bundle

Answer 2

combination of specific quantities of goods or services

Question 3

Complete preference

Answer 3

when a consumer can rank all conceivable bundles of commodities

Question 4

What is the notation for the following preferences?
Prefer A to B
Indifference to A and B

Answer 4

A>B
A~B

Question 5

Utility

Answer 5

benefits a consumer gets from the goods and services they consume

Question 6

What is the utility function?

Answer 6

U= f(x,y)

Question 7

Indifference curve+ its properties

Answer 7

set of points representing different bundles of goods and services, each of which yields the same total utility
downward sloping, convex

Question 8

Marginal rate of substitution (MRS)+ Formulas

Answer 8

measure of the number of units of y that must be given up per unit of x added in order to maintain a constant level of unity
MRS= change in y/change in x
MRS= Px/Py

Question 9

Marginal utility

Answer 9

an addition to total utility that is attributed to the addition of one unit of a good to the current rate of consumption, all other goods held constant
change in U= (MUx times change in x)+ (MUy times change in y)

Question 10

Budget line

Answer 10

line showing all bundles of goods that can be purchased at given prices if the entire income is spent, shifts as income (M) or price ratio (Px/Py) changes

Question 11

What shifts vs. pivots the budget line?

Answer 11

changes in M shift the budget line, while a change in the price of good x or y causes the budget line to pivot

Question 12

How does a consumer maximize utility based on an indifference curve?

Answer 12

on the highest indifference curve that the budget line connects with, and at the point where MRS= price ratio

Question 13

Market demand

Answer 13

list of prices and quantities consumers are willing and able to purchase at each price point
the horizontal summation of all demand curves in the market
also the marginal benefit curve

Question 14

Corner solution

Answer 14

utility-maximizing bundle at one of the endpoints of the budget lines where the consumer chooses to consume zero units of one good

Question 15

Substitution effect

Answer 15

change in the consumption of a good that would result if the consumer remained on the same indifference curve after the price of a good changes, movement along the indifference curve

Question 16

Income effect

Answer 16

change in the consumption of a good resulting from a change in the purchasing power after the price of a good changes, changing indifference curves

Question 17

Total effect

Answer 17

sum of the substitution and income effects

Question 18

As Px decreases, what happens if x is…
a normal good?
an inferior good?

Answer 18

normal good:
substitution- x rises
income- x rises
inferior good:
substitution- x rises
income- x falls

Question 19

As Px increases, what happens if x is…
a normal good?
an inferior good?

Answer 19

normal good:
substitution- x falls
income- x falls
inferior good:
substitution- x falls
income- x rises

Question 20

How can you tell when a good is normal or inferior based on the income effect?

Answer 20

For a normal good, the income effect reinforces the substitution effect
For an inferior good, the income effect takes away from the substitution effect