Chapter 3 - Consumer Theory Flashcards
(20 cards)
What is total utility?
The total satisfaction or pleasure derived from consuming a product
Total utility can increase with additional consumption but may eventually decrease due to over-consumption.
What is marginal utility?
The additional satisfaction gained from consuming one more unit of a product
Marginal utility can decrease as consumption increases, following the law of diminishing marginal utility.
What does the law of diminishing marginal utility state?
As a consumer consumes more of a product, the marginal utility decreases
The law does not imply that marginal utility will necessarily become negative.
Define utility in the context of consumer theory.
The pleasure or satisfaction that one gets from a product
Utility is subjective and varies from person to person.
What are the two types of utility measurements?
- Cardinal utility
- Ordinal utility
How can a consumer maximize total utility given budget constraints?
By comparing marginal utility-to-price ratios of different products
Consumers should buy the product with the highest MU per rand until the budget is exhausted.
What is the consumer equilibrium in terms of indifference curves?
It is the point where the highest possible indifference curve is tangent to the budget line
At this point, the marginal rate of substitution equals the price ratio.
What happens to the demand curve when the price of a product changes?
The quantity demanded changes in response to the price change
This relationship is derived from the utility-maximizing behavior of consumers.
What is the substitution effect?
The change in consumption of a product due to a change in its price relative to other products
It always leads to increased consumption of the cheaper product.
What is the income effect?
The change in consumption resulting from a change in the consumer’s real income or purchasing power
This effect can be positive for normal goods and negative for inferior goods.
What is an indifference curve?
A graph showing different combinations of two products that provide the same level of utility
Indifference curves are typically downward sloping and convex to the origin.
What is the budget line?
A graphical representation of the different combinations of two products that can be purchased with a given budget
The slope of the budget line represents the opportunity cost of one good in terms of the other.
What does the slope of the budget line indicate?
The ratio of the prices of the two goods
It changes when the price of one good changes, leading to a pivot in the budget line.
How do you derive the demand curve using indifference curve theory?
By analyzing shifts in the equilibrium point as the price of a product changes
Each new equilibrium represents a point on the demand curve.
What is the diamond-water paradox?
The observation that essential goods like water are cheap while non-essential goods like diamonds are expensive
It highlights the difference between total utility and marginal utility.
What is the difference between cardinal and ordinal utility?
- Cardinal utility: quantifiable measurement of utility
- Ordinal utility: ranking of preferences without quantification
What does MRS stand for?
Marginal Rate of Substitution
It measures the rate at which a consumer is willing to give up one good for another while maintaining the same level of utility.
Fill in the blank: The consumer will maximize utility where MU of product A = _______.
MU of product B
This equality must hold true when the budget is exhausted.
True or False: Indifference curves can intersect.
False
Indifference curves represent different levels of utility and cannot cross each other.
What is the main aim of the consumer in consumer theory?
Maximize utility subject to budget constraints
This is achieved by choosing the optimal combination of goods.
