POSSIBILITIES PREFERENCES AND CHOICES

Question 1

What are characteristics of Consumption Possibilities

Answer 1

1) Limited by Income and Price
2) The Budget Line = Limit to Consumption Choice
3)Divisible Goods (can be bought in any quantity desired)

Question 2

Define Real Income

Answer 2

Quantity of goods that household can afford to buy

Question 3

Define relative price

Answer 3

price of 1 good divided by another good
DETERMINES magnitude of slope of budget line

Question 4

How does lowering the price on x axis change the budget line

Answer 4

Budget line will be flatter

Question 5

How does an increase in price of good on x axis change budget line

Answer 5

Budget line will be steeper

Question 6

How does change in income affect the budget line

Answer 6

The budget line SHIFTS but the slope does not change

Question 7

What is an indifference curve

Answer 7

combinations of goods in which consumer is indifferent

Question 8

What is Marginal Rate of Substitution

Answer 8

Rate at which person will give up good Y to get an additional unit of good X

Question 9

How will the slope changed on Marginal Rate of Substitution

Answer 9

If Marginal Rate of Substitution HIGH: Slope will be steep (willing to give up large quantity of good y for 1 more unit of good x)
If MRS low: slope will be flat (willing to give up small amt of good y for 1 more unit of x)

Question 10

What is Diminishing Marginal Rate of Substitution

Answer 10

As the quantity of X increases person willing to give up less of good Y

Question 11

What are the 3 different Degrees of Substitutability

Answer 11

1) Ordinary Goods: Indifference curves will have slight bend (Diminishing)
2) Perfect Substitutes: 1:1 straight downward slope
3) Perfect Complements: cannot be substituted: L shaped

Question 12

What are the 2 Components of Household Choice

Answer 12

Budget Line
Preference Map

Question 13

What is the Best Affordable Choice

Answer 13

Point on Budget Line that intersects with highest attainable indifference curve

Question 14

What does the Budget Line represent

Answer 14

The relative price of a good

Question 15

What is the Price Effect

Answer 15

The effect of a change in the price of a good on the quantity of good consumed
Demonstrated by demand curve
If the price of a good changes the budget line rotates outward or inward hitting a new indifference curve and most preferred point

Question 16

What is the Income Effect

Answer 16

the effect of a change in income has on buying plans

Question 17

What effect does income have on buying plans

Answer 17

Shifts the budget line
Changes best affordable point
changes demand

Question 18

What is the substitution effect

Answer 18

the effect of a change in price on the quantity bought when the consumer remains indifferent b/w original stituation and new one

Question 19

How is the substitution effect demonstrated on the graph

Answer 19

It is the movement along the same indifference curve from old point to new point

Question 20

How is the income effect demonstrated on the graph

Answer 20

It is the movement on to a new indifference curve from NEW point on old indifference curve to new point on NEW indifference curve
* With an inferior good the income effect will show a backwards mvmt compared to the substitution effect*

Question 21

What is the effect on quantity demanded if negative income effect = substitution effect

Answer 21

There will be no change in quantity demand
Demand is Inelastic and VERTICAL

Question 22

What is the effect on quantity demanded if negative income effect is LESS THAN substitution effect

Answer 22

A fall in price INCREASES quantity bought
Demand is ELASTIC

Question 23

What is the effect on quantity demanded if negative income effect is MORE THAN substitution effect

Answer 23

Fall in price decreases amount bought

Question 24

Compare Income Effect and Substitution Effect for a Normal Good

Answer 24

Income effect REINFORCES Substitution effect

Question 25

Compare Income Effect and Substitution Effect for an INFERIOR good

Answer 25

The Income effect is OPPOSITE of Substitution effect

Question 26

Budget Equation

Answer 26

Budget=(PaQa)+(PbQb)

Question 27

What is the Substitution Effect

Answer 27

The effect of a change in price on quantity bought