Term

Definition
a contour line that maps consumption bundles yielding the same amount of total utility
an individual is always indifferent between any two bundles that lie on the same indifference curve
for a given consumer, there is an indifference curve corresponding to each possible level of total utility



Term

Definition
a collection of indifference curves that represents a given consumer's entire utility function, with each indifference curve corresponding to a different level of total utility 


Term
what are the properties of indifference curves? 

Definition
* they never cross
* the farther out an indifference curve lies  the farther from the origin  the higher the level of total utility it indicates (we assume the more the better + only consider consumption bundles for which the consumer is not satiated)
*they slope downward (b/c th more the better, if you consume more of good x you have to consume less of good y to stay in the bundle)
*they have a convex shape (as you move down the curve to the right it gets flatter and as you move up to the left it gets steeper, convex b/c bowed in toward the origin, arises b/c of diminishing marginal utility)



Term

Definition
goods that satisfy all four properties of indifference curves
the vast majority of goods in any consumer's utility function fall into this category
a pair of goods are ordinary goods in a consumer's utility function if they posess two properties: the consumer requires more of one good to compensate for less of the other, and the consumer experiences a diminishing marginal rate of substitution when substituting one good for another 


Term
what is the marginal rate of substitution? 

Definition
of good R in place of good M is equal to MU_{R}/MU_{M}
the ratio of the marginal utility of R to the marginal utility of M
this happens because as you move down the indifference curve, the slope changes and the condition changes. ex: at one point high on the curve you may have all M and no R, so it increases your utility greatly to get some R and you don't mind giving up M(steep slope), but at a certain point you won't want to give up as much M for R because you won't have as much of it (flatter slope) 


Term
Describe how utility changes as you move along the indifference curve using math 

Definition
(if i have restaurants meals vs housing (more rooms))
1. change in total utility due to lower restaurant meal consumption + change in total utility due to higher housing consumption = 0
2. change in total utility due to lower restaurant meal consumptoin = change in utility due to higher housing consumption
3. change in total utility due to a change in restaurant meal onsumption = MU_{M}xΔQ_{M}
and
4. change in total utility due to a change in housing consumption = MU_{R}xΔQ_{R}
5. along the indifference curve: MU_{M}xΔQ_{M = }MU_{R}xΔQ_{R }
right side is neg b/c rep loss in total utility from decreased restaurant meal consumption
6. now to find how this translates to the indifference curve, you divide both sides of equation 5 by ΔQ_{R} and again by MU_{M} in order to get the chang in quantity of m and change in quantity of R terms on one side and the MUr MUm terms on the other. this results in:
along the indifference curve: (ΔQ_{M}/ΔQ_{R})=(MU_{R}/MU_{M})
the left side of this equation is the slope of the indifference curve
the right side of the equation is what is gained from one or more room to what is gained from one or more meal



Term
diminishing marginal rate of substitution 

Definition
represented by the flattening of the indifference curve as you slide down to the right  which represents the same logic as the principle of diminishing marginal utility
states that an individual who consumes only a little bit of good A and a lot of good B will be willing to trade off a lot of B in return for one more unit of A
an individual who already consumes a lot of A and not much of B will not be willing to make that trade off



Term

Definition
between the indifference curve and the budget line holds when the indifference curve and the budget line just touch (the budget line is tangent to the indifference curve)
this condition determines the optimal consumption bundle when the indifference curves have the typical convex shape 


Term
How do you find the optimal bundle using the tangency condition? 

Definition
1. use (Q_{R}xP_{R})+(Q_{M}xP_{M})=N
where N stands for income, R represents one good and M represents another good
2. to find the slope of the budget line, divide its vertical intercept by its horizontal intercept, the vertical intercept is the point where all income is spent on one good (Q_{R}=0), solve for Q_{M }and then do the opposite to solve for Q_{R}
3. slope of the buget line = (vertical intercept)/(horizontal intercept)
((N/P_{M})/(N/P_{R}))=(P_{R}/P_{M}) 


Term
what is the relative price? 

Definition
P_{R}/P_{M}
differs from the ordinary price in terms of dollars, because buying one more R requires giving up P_{R}/P_{M }quantity of M we can interpret the relative price P_{R}/P_{M }as the rate at which one R trades for one M in the market
at the optimal consumption bundle, the marinal rate of substitution between two goods is equal to their relative price
a change in relative price will lead to a change in slope of the budget line 


Term
how will a change in income affect the budget line? 

Definition
a rise in income will cause the budget line to shift outward, a shrink in income will cause the budget line to shift inward
the slope of the budget line will not change because the relative price of one good in terms of the other does not change 


Term
what is the equation for the slope of the indifference curve? 

Definition


Term

Definition
at the optimal consumption bundle:
(MU_{R}/MU_{M})=(P_{R}/P_{M)}
the marginal rate of substitution between any two goods is equal to the ratio of their prices 


Term
what happens if you divide the relative price rule by P_{R} and multiply by MU_{M}? 

Definition
it becomes the optimal consumption rule
(MU_{R}/P_{R})=(MU_{M}/P_{M})
this tells us that either using the optimal rule or the relative price rule, we find the same optimal consumption bundle



Term
what determines whether two goods are substitutes or compliments? explain using the examples of perfect substitues and perfect compliments. 

Definition
it depends on the shape of a consumer's indifference curves
perfect substitutes: when indifference curves are straight lines, there is only one relative price at which consumers will be willing to purchase both goods; a slightly higher or lower relative price will cause them to buy only one of the two goods. to see where a consumer's demand lies between two possible indifference curves representing two prices, draw a line from the top of the indifference curve with the lower price to the bottom of the other indifference curve.
perfect compliments: when a consumer wants to consume two goods in the same ratio regardless of their price. the grave has indifference curves that are bent at a 90 degree angle so if the budget line moves, the consumer will buy more/less of the items but in the exact same proportions. 


Term
what happens to the budget line after a price increase? 

Definition
it moves to the left because now less of one or both goods can be purchased. if only one good is effected, the other good stays in the same place on the graph. a new optimal consumption bundle will be found. 


Term
how does change in income affect the budget line? 

Definition
a drop in income results in a parallel inward shift of the budget line while a rise in income results in a parallel outward shift of the budget line 


Term
what happens to the optimal consumption bundle if income falls? 

Definition
if it is a normal good: consumption of both goods fall, optimum consumption bundle falls
if it is an inferior good: consumption of one (or both if they're somehow both inferior) actually increases (shifts right along the new indifference curve), OR one good increases but the other good falls, indidcating that one is a normal good and one is inferior
the OCB falls overall 


Term
what happens to the budget line when income decreases and the price of a good increases 

Definition
the budget line shifts inward and becomes steeper
this is because there was first a movement along the original indifference curve as reletive price changes  pure substitution effect. that part shows how consumption would change if given a hypothetical increase in income that compensates her for increase in price of rooms. then the movement inward from the hypothetical indifference curve to the inward indifference curve is the change in consumption when we remove that hypothetical income compensation. it is the income effect of the price increase  how consumption changes as a result of the fall in purchasing power 


Term
which is stronger, the substitution effect or the income effect? 

Definition
the substitution effect because even if the income effect moves in the opposite direction of the substitution effect in the case of an inferior good, the substitution effect is still stronger.
ex: after loss of income the budget line shifts down, even if there is an inferior good and you're consuming more of it, the bundle overall consumes less than in the original budget line 


Term

Definition
a type of inferior good in which the income effect is so strong that it dominates the substitution effect causing the demand curve for that good to slope upward
very rare but it happens sometimes, generally not important when discussing income and substitution effects 

