Chapter 21 E-BOOK

the optimum represents the best bundle that the consumer can _________

afford

the substitution effect is reflected by a movement.....

along an indifference curve to a point with a different slope

the impact of a change in the price of a good on the quantities purchase can be decomposed into two effects:

and income effect and substitution effect

the marginal rate of substitution is the rate at which the _____________ is willing to trade one good for the other

consumer

the slope of an indifference curve at any point is the...

consumer's marginal rate of substitution

the increase in income, therefore shifts the budget constraint _____________

outward because the relative price of the two goods has not changed, the slope of the new budget constraint is the same as the slope of the initial budget constraint. That is, an increase in income leads to a parallel shift in the budget constraint

The substitution effect is the change in consumption that results from...

moving to a new point on the same indifference curve with a different marginal rate of substitution

because the budget constraint slopes downward the slope is a ....

negative number

if a consumer wants more of a good when her income rises, economists call it a ___________ ___________

normal good

the consumers choices, however, depends not only on her budget constraint but also...

on her preferences regarding the two goods. Therefore, the consumer's preferences are the next piece of of our analysis.

a consumer's demand curve is a summary of the...

optimal decisions that arise from her budget constraint and indifference curves

the point at which this indifference curve and the budget constraint touch is called the ____________

optimum

the lowering price of one of the two goods. you can then buy more of one or the other good, or both, which expands the set of opportunities. the budget constrain shifts _____________

outward

The indifference curves, therefore are right angles. In this case of right angle indifference curves, we say that the two goods are _____________ ______________

perfect complements

because the marginal rate of substitution is constant, the indifference curves are straight lines. In this case of straight indifference curves, we say that the two goods are ________________ ______________

perfect substitutes

a consumer's budget constraint shows the...

possible combinations of different goods she can buy given her income and the prices of the goods.

the consumer's indifference curves represents her ___________

preferences

whatever point is higher on the indifference curve is the bundle that is....

preferred

because indifference curves represent a consumer's preferences, they have certain __________ that reflect those preferences

properties there are 4 properties

a consumer's set of indifference curves gives a complete ranking if the consumer's preferences. That is, we can use the indifference curves to...

rank any two bundles of goods

notice that the slope of the budget constraint equals the ________ ____________ of the two goods-the price of one good compared to the price of the other

relative price

for most goods, the indifference curves are bowed inward, but not so bowed that they become ____________ _______________

right angles

assume one of the two prices fall, the lower price expands the consumer's set of buying opportunities and leads to a ....

rotational outward shift in the budget constraint

the expansion in the consumer's opportunities is represented by a ______________ ___________ rather than a __________ __________

rotational shift parallel shift

the budget constraint shows the opportunities available to the consumer. It is drawn given the consumers income and given the prices of the two goods. if the consumers income or the prices change, the budget constraint ________________

shifts

as a matter of economic theory, however, demand curves can sometimes slope upward. In other words, consumers can..

sometimes violate the law of demand and buy more of a good when the price rises

"Now that the price of Pepsi has fallen, I get more liters of Pepsi for every pizza that I give up. Because pizza is now relatively more expensive, I should buy less pizza and more pepsi" this is the ______________ ______________

substitution effect

we say that the indifference curve is _____________ to the budget constraint

tangent

the income effect is...

the change in consumption that arises because a lower price makes the consumer better off

the substitution effect is...

the change in consumption that arises because a price change encourages greater consumption of the good that has become relatively cheaper.

the slope of the budget constraint equals...

the relative price of the goods

the slope of the budget constraint is the...

the relative price of the goods

as we have discussed , an increase in income leads to a parallel outward shift in the budget constraint. Because the relative price of the two goods has not changed, the slope of the new budget constraint is...

the same as the slope of the initial budget constraint

notice that because the indifference curves are not straight lines, the marginal rate of substitution is not...

the same at all points on a given indifference curve

at the optimum, the slope of the indifference curve equals...

the slope of the budget constraint

the theory of consumer choice examines...

the trade-offs that people face as consumers. when a consumer buys more of one good, she can afford less of other goods. when she spends more time enjoying leisure and less time working, she earns less and therefore consumes less. when she spends more of her income in the present and saves less of it, she reduces the amount she will be able to consume in the future

Now that we have developed the basic theory of consumer choice, lets use it to shed light on 3 questions about how the economy works. The 3 questions are...

-Do all demand curves slope downward? - How do wages affect labor supply? - How do interest rates affect household savings?

the theory of consumer explains why...

-demand curves can potentially slope upwards -why higher wages can either increase or decrease the quantity of labor supplied -why higher interest rates can either increase or decrease savings

after developing the basic theory of consumer choice, we apply it to three questions about household decisions. in particular we ask:

-do all demand curves slope downward? -how do wages affect labor supply? -how do interest rates affect household savings?

two extreme examples of indifference curves

-perfect substitutes -perfect complements

economists use the term ___________ __________ to describe a goof that violates the law of demand

Giffen good

four properties of indifference curves property 1:

Higher indifference curves are preferred to lower ones. People usually prefer to consume more rather than less This preference for greater quantities is reflected in the indifference curves. Higher indifference curves represents larger quantities of goods than lower indifference curves. Thus, a consumer prefers being on higher indifference curves

four properties of indifference curves property 4:

Indifference curves are bowed inward The slope of an indifference curve is the marginal rate of substitution- the rate at which the consumer is willing to trade off one good for the other. The marginal rate of substitution (MRS) usually depends on the amount of each good the consumer is currently consuming In particular, because people are more willing to trade away goods of that they have in abundance and less willing to trade away goods of which they have little, the indifference curves are bowed inward toward the graphs origin

four properties of indifference curves property 3:

Indifference curves do not cross If they did cross, this contradicts our assumption that the consumer always prefers more of both goods to less. Thus, indifference curves cannot cross.

Four Properties of Indifference Curves property 2:

Indifference curves slope downward The slope of an indifference curve reflects the rate at which a consumer is willing to substitute one good for the other. In most cases, the consumer likes both goods. Therefore, if the quantity of one good decreases, the quantity of the other good must increase for the consumer to be equally happy.

indifference curve-

a curve that shows consumption bundles that give the consumer the same level of satisfaction an indifference curve shows the various bundles of consumption that make the consumer equally happy

a fall in the price of either good shifts ..... and by changing the relative price of the 2 goods, changes the...

a fall in the price of either good shifts the budget constraint outward and by changing the relative price of the two goods, changes the slope of the budget constraint as well

normal good-

a good for which a increase in income raises the quantity demanded

inferior good-

a good for which an increase in income reduces the quantity demanded

giffen good-

a good for which an increase in the price raises the quantity demanded

the line, called the ___________ ___________, shows the consumption bundles that a consumer can afford

budget constraint

The consumer optimizes by choosing the point on her budget constraint that lies on the highest indifference curve. At this point, the slope of the indifference curve (the marginal rate of substitution between the goods) equals the slope of.... and the consumer's valuation of the two goods (measured by the marginal rate of substitution equals.....

budget constraint ( the relative price of the goods) the market's valuation (measured by the relative price)

the consumer would like to end up with the combination on her highest possible indifference curve. But the consumer must also end up on or below her....

budget constraint, which measures the total resources available to her

an indifference curve shows the various...

bundles of goods that make the consumer equally happy

the expanded budget constraint allows the consumer to...

choose a more desirable combination of a bundle of products and therefore reach a higher indifference curve

people consume less than they desire because their spending is ______________, or _____________, by their income

constrained or limited

in the real world, most goods are neither perfect substitutes nor perfect complements. Perfect substitutes and perfect complements are _____________ ____________

extreme cases

the demand curve for a good reflects consumers' willingness to pay for that good. When the price of the good rises, consumers are willing to pay for fewer units, so the quantity demanded __________

falls

points on _________ indifference curves are preferred to points on _____________ indifference curves

higher lower

the consumer optimizes by choosing the point on her budget constraint that lies on the...

highest indifference curve

the theory of consumer choice can be applied....

in many situations

"Great news! Now that Pepsi is cheaper, my income has greater purchasing power. I am, in effect, richer than I was. Because I am richer, I can buy both more pizza and more Pepsi." this is the ___________ _____________

income effect

when the price of a good falls, the impact on the consumer's choices can be broken down into an _______________ _____________ and a ______________ ______________

income effect substitution effect

we can represent the consumer budget constraint graphically. and we can also represent her preferences graphically as well, we do this with an ___________ _____________

indifference curve

if you offer the consumer two different bundles, she chooses the bundle the best suits her taste. If the two bundles suit her tastes equally well, we say that the consumer is ____________ between the two bundles

indifferent

if a consumer buys less of a good when her income rises, economists call it an _________________ __________

inferior good

normally, when the price of a good rises, people buy less of it. This typical behavior, called the ________ __________ ___________, is reflected in the downward slope of the demand curve

law of demand

the essence of the time-allocation problem is the trade-off between ______________ and _______________

leisure and consumption

when the goods are easy to substitute for each other, the indifference curves are __________ ____________

less bowed

the income effect is reflected in the movement from a _____________ to a ____________ indifference curve

lower higher

he theory of consumer choice examines how consumers facing these trade offs....

make decisions and how they respond to changes in their environment

the slope at any point on an indifference curve equals the rate at which the consumer is willing to substitute one good for the other. this rate is called the _________ ____________ _____________ _______________

marginal rate of substitution (MRS) this slope is usual negative

the slope of the indifference curve is the...

marginal rate of substitution between the goods

the relative price is the rate at which the ____________ is willing to trade one good for the other

market

substitution effect-

the change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution

income effect-

the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve

our goal is to understand how consumers make choices. the budget constraint is one piece of this analysis: it shows....

the combinations of goods a consumer can afford given her income and the prices of the goods.

the consumer is happy at what points on the indifference curve?

the consumer is equally happy at all points on any given indifference curve, but she prefers some indifference curves to others. because she prefers more consumption to less, higher indifference curves are preferred to lower ones.

marginal rate of substitution is the rate at which...

the consumer is willing to trade one good for the other

how such a change in the budget constraint alters the quantities of the two goods purchased depends on...

the consumer's preferences

The goal is to understand how a consumer' makes choices. We have the two pieces necessary for this analysis:

the consumers budget constraint (which shows what bundles of goods she can afford) and the consumers preferences ( which show what bundles of goods she most likes). Now put these two pieces together and consider the consumer's decision about what to buy.

the rate at which a consumer is willing to trade one good for the other depends on the amounts of..

the goods she is already consuming in other words, the rate at which a consumer is willing to trade pizza for Pepsi depends on whether she is hungrier or thirstier, and her hunger and thirst in turn depends on her current consumption of pizza and Pepsi

budget constraint-

the limit on the consumption bundles that a consumer can afford

the consumer's valuation of the two good is measured by...

the marginal rate of substitution

the slope of the indifference curve is...

the marginal rate of substitution between bundles

The income effect is the change in consumption that results from....

the movement to a new indifference curve

the slope of the budget constraint measures...

the rate at which the consumer can trade one good for the other.

the consumer chooses the quantities of the two goods so that the marginal rate of substitution equals ....

the relative price

the market's valuation is measured by...

the relative price

the slope of the budget constraint is...

the relative price of the bundle

perfect complements-

two goods with right-angle indifference curves examples-a bundle of 5 left shoes and 7 right shoes yields only 5 pairs

perfect substitutes-

two goods with straight-line indifference curves example- bundles of nickels and dimes, you would only care about the total monetary value of each bundle

when the goods are hard to substitute, the indifference curves are ________ ____________

very bowed

the shape of an indifference curve reveals the consumer's....

willingness to trade one good for the other