Chapter 2 Flashcards
(17 cards)
Marginal utility
The additional satisfaction that is gained from the consumption of an extra unit of a product
Law of diminishing marginal utility
As a person consumes more units of a product, the satisfaction provided by each unit will be progressively less and less
-qty⬆️MU⬇️
Equi marginal principle
A consumer will maximise total satisfaction by equating the utility per unit of money spent on the marginal unit of each product consumed
Equi marginal principle equation
MUa/ Pa = MUb/ Pb
Limitation of marginal utility theory
Assumption of MUT
1.
Paradox of value
water: consume MU=0 & TU is high
diamonds: MU is high & TU is low
Rational behavior
- Indi will take decision to maximize their own satisfaction
- Individuals have perfect information
- Indi make decisions based on proper CBA
- Decisions will be made by indi based on changes at the margin
- Pref are assumed to be fixed
Behavioral economics
Individuals do not act rationally
-ppl tend to make the same decisions that they always have instead of assessing other factors
Budget lines
Show the possible combinations of two products that a consumer is able to purchase with a given income and fixed prices
Indifference curves
Show the possible combinations of two products between which a consumer is indifferent
What does the slope of the indifference cup represent?
The marginal rate of substitution
What is the marginal rate of substitution?
The number of one good that an indi is prepared to give up in order to obtain addi items of the other good
Price effect
A change in consumption of a product as a result of a change in its price
SE+IE
Income effect
A change in price brings about a change in real income
- no change in nominal income // but a rise or fall in price of product has a real income effect
What happens when a real income effect occurs?
as the price of a good changes, a person will be able to buy more/ less of a product and other products
Substitution effect
- as price of product changes, expenditure is rearranged to maximise the utility gained
- a rational consumer would substitute in favor of another product which has become more relatively cheaper
Is substitution effect negative for all goods? Why?
yes SE is always negative for all goods
- bc price changes relates to the utility gained from the consumption of a product
- switching consumption due to price changes
