Exam 3

Question 1

theory of consumer behavior

Answer 1

description of how consumers allocate incomes among different goods and services to maximize their well-being

Question 2

steps of consumer behavior

Answer 2

1. consumer preferences
2. budget constraints
3. consumer choices

Question 3

market basket (bundle)

Answer 3

list with specific quantities of one or more goods

Question 4

basic assumptions about preferences

Answer 4

1. completeness
2. transitivity
3. more is better than less
4. diminishing marginal rate of substitution

Question 5

indifference curve

Answer 5

curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction

Question 6

indifference map

Answer 6

graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent

Question 7

indifference curves cannot intersect, why?

Answer 7

then one of the assumptions of consumer theory is violated (transitivity)

Question 8

marginal rate of substitution (MRS)

Answer 8

maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good

Question 9

convex indifference curve

Answer 9

occurs when MRS diminished along an indifference curve

Question 10

perfect substitutes

Answer 10

two goods for which the MRS of one for the other is a constant (always indifferent between one and the other)

Question 11

perfect complements

Answer 11

two goods for which the MRS is zero or infinite, the indifference curves are right angles (an additional 1 give no extra satisfaction unless also an extra 1 of the other)

Question 12

bad

Answer 12

good for which less is preferred rather than more

Question 13

utility

Answer 13

numerical score representing the satisfaction that a consumer gets from a given market basket

Question 14

utility function

Answer 14

formula that assigns a level of unity to individual market baskets

Question 15

ordinal utility function

Answer 15

utility function that generates a ranking of market baskets in order of most to least preferred

Question 16

cardinal utility function

Answer 16

utility function describing by how much one market basket is preferred to another

Question 17

budget constraints

Answer 17

constraints that consumers face as a result of limited incomes

Question 18

budget line

Answer 18

all combinations of goods for which the total amount of money spent is equal to income

Question 19

I=

Answer 19

PfF+PcC

price of food)x(food quantity) + (price of clothes)x(clothes

Question 20

effects of income changes on budget line

Answer 20

shifts parallel to original line
income increase- outward shift
income decrease- inward shift

Question 21

effects of price change on the budget line

Answer 21

budget line rotates around the intercept (point that hits x or y line)
price decrease- rotate outward
price increase- rotate inward

Question 22

conditions to maximize market basket

Answer 22

1. located on the budget line

2. give consumer the most preferred combination of goods/services

Question 23

satisfaction is maximized at what point (equation)

Answer 23

MRS= Pf/Pc

marginal rate of substitution= price of food/ price of clothes

Question 24

marginal benefit

Answer 24

benefit from the consumption of oone additional unit of a good, measured by MRS

Question 25

marginal cost

Answer 25

cost of one additional unit of a good

Question 26

satisfaction is maximized at what point

Answer 26

when the marginal benefit is equal to the marginal cost

Question 27

corner solution

Answer 27

situation in which the marginal rate of substitution for one good in a chosen market basket is not equal to the slope of the budget line

Question 28

how will the consumer maximize their satisfaction in a corner solution

Answer 28

consume only one of the goods

Question 29

marginal utility (MU)

Answer 29

additional satisfaction obtained from consuming one additional unit of a good

Question 30

diminishing marginal utility

Answer 30

principle that as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility

Question 31

equal marginal principle

Answer 31

principle that utility is maximized when consumer has equalized the marginal utility per dollar of expenditure across all goods

Question 32

MUf/MUc=

Answer 32

Pc/Pf

Question 33

cost-of-living index

Answer 33

ratio of the present cost of a typical bundle of consumer goods and services compared with the cost during a base period

Question 34

ideal cost-of-living index

Answer 34

cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices

Question 35

price index

Answer 35

represents the cost of buying bundle A at current prices relative to the cost of bundle A at base-year prices, overstates the ideal cost-of-living index

Question 36

laspeyres price index

Answer 36

amount of money at current year prices that an individual requires to purchase a bundle of goods and services chosen in a base year divided by the cost of purchasing the same bundle at base-year prices

Question 37

ideal cost-of-living vs laspeyres

Answer 37

laspeyres is greater than the ideal cost-of-living index, it overcompensates for the higher cost-of-living

Question 38

paasche index

Answer 38

amount of money at current-year prices that an individual requires to purchase a current bundle of goods and services divided by the cost of purchasing the same bundle of goods and services divided by the cost of purchasing the same bundle in a base year

Question 39

laspeyres vs paasche

Answer 39

laspeyres overstates the ideal cost-of-living, whereas paasche understates because it assumes that the individual will buy the current-year bundle in the base period

Question 40

fixed-weight index

Answer 40

cost-of-living index in which the quantities of goods and services remain unchanged

Question 41

chain-weighted price index

Answer 41

cost-of-living index that accounts for changes in quantities of goods and services

Question 42

price-consumption curve

Answer 42

curve tracing the utility-maximizing combinations of two goods as the price of one changes

Question 43

individual demand curve

Answer 43

curve relating the quantity of a good that a single consumer will buy to its price

Question 44

properties of the individual demand curve

Answer 44

1. the level of utility that can be attained changes as we move along the curve 2. at every point on the demand curve, the consumer is maximizing utility by satisfying the condition that the marginal rate of substitution (MRS) of food for clothing equals the ratio of the prices of food and clothing

Question 45

income-consumption curve

Answer 45

curve tracing the utility-maximizing combinations of two goods as a consumer's income changes

Question 46

engel curve

Answer 46

curve relating the quantity of a good consumed to income

Question 47

two goods are substitutes if

Answer 47

an increase in the price of one leads to and increase in the quantity demanded of the other

Question 48

two goods are complements if

Answer 48

an increase in the price of one good leads to a decrease in the quantity demanded of the other

Question 49

two goods are independent if

Answer 49

a change in the price of one good has no effect on the quantity demanded of the other

Question 50

effects of a fall in the price of a good

Answer 50

1. substitution effect | 2. income effect

Question 51

substitution effect

Answer 51

consumers will tend to buy more of the good that has become cheaper and less of those goods that are now relatively more expensive; change in consumption of a good associated with a change in its price, with the level of utility held constant

Question 52

income effect

Answer 52

because one of the goods is now cheaper, consumers enjoy an increase in real purchasing power; change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant

Question 53

total effect=

Answer 53

substitution effect + income effect

Question 54

something is an inferior good if

Answer 54

the income effect is negative (exception: giffen good)

Question 55

giffen good

Answer 55

a good whose demand curve slopes upward because the (negative) income effect is larger than the substituion effect

Question 56

market demand curve

Answer 56

curve relating the quantity of a good that all consumers in a market will buy to its price

Question 57

fun facts about the market demand curve

Answer 57

1. curve will shift to the right as more consumers enter the market 2. factors that influence the demands of many consumers will also affect market demand

Question 58

price elasticity of demand (Ep)=

Answer 58

(change in Q/Q) / (change in P/P)

Question 59

inelastic demand

Answer 59

the quantity demanded is relatively unresponsive to changes in price; total expenditure on the product increases when the price increases

Question 60

elastic demand

Answer 60

quantity demanded is responsive to change in price; total expenditure on the product decreases as the price goes up

Question 61

isoelastic demand curve

Answer 61

demand curve with a constant price elasticity; total expenditure is constant along the demand curve

Question 62

speculative demand

Answer 62

demand driven not by the direct benefits one obtains from owning or consuming a good but instead by an expectation that the price of the good will increase

Question 63

consumer surplus

Answer 63

difference between what a consumer is willing to pay for a good and the amount actually paid; the area under the demand curve and above the line representing the purchase price of the good

Question 64

network externality

Answer 64

when each individual's demand depends on the purchases of other individuals

Question 65

positive network externality

Answer 65

the quantity of a good demanded by a typical consumer increases in response to the growth in purchases of other consumers

Question 66

negative network externality

Answer 66

the quantity demanded of a good by a typical consumer decreases in response to the growth in purchases of other consumers

Question 67

bandwagon effect

Answer 67

effect of positive network externality in which a consumer wishes to possess a good in part because others do

Question 68

snob effect

Answer 68

effect of negative network externality in which a consumer wishes to own an exclusive or unique good