# Shared Flashcard Set

## Details

Microeconomics
Chapter 11 - Consumer Preferences and Consumer Choice
21
Economics
04/05/2010

Term
 Indifference Curve
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
 Indifference Curve Map
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
 what are ordinary goods?
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 MUR/MUM 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 = MUMxΔQM and 4. change in total utility due to a change in housing consumption = MURxΔQR 5. along the indifference curve: -MUMxΔQM = MURxΔQR 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 ΔQR and again by -MUM 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: (ΔQM/ΔQR)=(MUR/MUM) 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
 tangency condition
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 (QRxPR)+(QMxPM)=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 (QR=0), solve for QM and then do the opposite to solve for QR 3. slope of the buget line = -(vertical intercept)/(horizontal intercept) ((N/PM)/(N/PR))=-(PR/PM)
Term
 what is the relative price?
Definition
 PR/PM differs from the ordinary price in terms of dollars, because buying one more R requires giving up PR/PM quantity of M we can interpret the relative price PR/PM 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
 -MUR/MUM
Term
 relative price rule
Definition
 at the optimal consumption bundle: -(MUR/MUM)=(PR/PM)   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 PR and multiply by MUM?
Definition
 it becomes the optimal consumption rule (MUR/PR)=(MUM/PM)   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
 Giffen good
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
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