Econ 351 ch 5 and 6
IF THE MRS IS < OR > THAN THE PRICE RATIO..._________
CONSUMER SATISFACTION HAS NOT BEEN MAXIMIZED
The shape of the indifference curve describes...
the willingness of a consumer to shubstittue one good for another
Fall in price of good has two effects: (1) consumers will tend to buy ____________of the good that has become cheapter and less of those goods that are now relatively more expensive - (SUBSTITUTION EFFECT) (2) because one of the goods is now __________, consumers enjoy an (increase/ decrease) in real purchasing power (INCOME EFFECT)
(1) consumers will tend to buy MORE of the good that has become cheapter and less of those goods that are now relatively more expensive - (SUBSTITUTION EFFECT) (2) because one of the goods is now cheaper, consumers enjoy an INCREASE in real purchasing power (INCOME EFFECT)
indifference curve represents what
- represents all combinations of market baskets that provide a consumer with the same level of satisfaction
what is Marginal cost - marginal cost = magnitude of slope of budget line
- the cost of the additional unit of food magnitude of slope of budget line
-new, imaginary budget line reflects the fact that the __________________ was reduced in order to accomplish our conceptual goal of isolating the _______________ when the price of food declines, the substitution effect ALWAYS leads to an (increase or decrease) in the food demanded
-new, imaginary budget line reflects the fact that the nominal income was reduced in order to accomplish our conceptual goal of isolating the substitution effect when the price of food declines, the substitution effect ALWAYS leads to an increase in the food demanded
Maximizing market basket must satisfy two conditions
1. it must be located on the budget line (b/c that means all income is being spent) 2. it must give the consumer the most preferred combination of goods and services\
5.1 Consumer Preferences what is market basket (bundle) method of measurement is ____ described in _____ We ask whether consumers ________one market basket to another (makes assumptions)
5.1 Consumer Preferences market basket (bundle) - list with specific quantities of one or more goods (group of items) Method of measurement arbitrary describe items as "untis" prefer
5.3 Consumer Choice consumers choose goods to... > ______________the satisfaction they can achieve, given the _____________available to them
> maximize the satisfaction they can achieve, given the limted budget available to them
Bads -describe and give example
Bads - good for which less is preferred to more Ie. Air pollution
what are the Basic assumptions about preferences...?
Basic assumptions about preferences... (1) completeness - preferences assumed to be compelte. Consumers can compare and rank all possible baskets (2) Transitivity - preferences are transitive. Meaning if consumer prefers A to B and B to C, then they must prefer A to C (3) More is better than less - consumers always prefer more of any good to less, more is always better (even if just a little better)
does ratioinig hurt others ? How?
But ratioinig hurts others by limiting the amt of gas they can buy
Differences... Laspeyers index vs Paasche index:
Differences... Laspeyers index: the amt of $$ at current year prices that an individual requires to purchase the bundle that was CHOSEN IN THE BASE YEAR / cost of purchasing the same bundle at base-year prices Paasche index: the amt of $$ at current-year prices that an individual requires to purchase the bundle that was CHOSEN IN THE CURRENT YEAR / cost of purchasing the same bundle in the base year
People face trade offs. What does the shape of an indifference curve describe?
How a consumer is willing to substitute one good for another
WHERE ENGLE CURVE SLOPES DOWNWARD = INCOME RANGE WITHIN X IS AN _________________
INCOME RANGE WITHIN X IS AN INFERIOR GOOD
what is Income consumption curve - ? X = Good A; Y = Good B (Good A inferior if goes _____)
Income consumption curve - curve tracing the utility maximizing combinateion of two goods as a consumer's income changes X = Good A; Y = Good B (Good A inferior if goes backwards)
what is Indifference map - can indifference curves intersect?
Indifference map - graph containing a set of indifference curves showing the market baskets among with a consumer is indifferent * indifference curves cannot intersect. Why? violates rule of trasntivity
Individaul preferences can be represented by a series of ___________ If a consumer chooses one market basekt over another, and if the chosen market basket is _____________ than the alternative, then the consumer must _______________the chosen market basekt
Individaul preferences can be represented by a series of indifference curves If a consumer chooses one market basekt over another, and if the chosen market basket is more epxensive than the alternative, then the consumer must PREFER the chosen market basekt
Individual demand curve - relates the qty ___________ that a single consumer will buy to the _____________ what are the-two important features? MRS varies along demand curve tells us what? Change in price of good corresponds to a movement along a demand curve
Individual demand curve - relates the qty of a good that a single consumer will buy to the price fo that good -two important features (1) the level of utility that can be attained changes as we move along the curve the lower the price of the product, the higher the utility (2) at every point on the demand curve, the consumer is maximizing utility by satisfying the condition that the MRS of food for clothing = ratio of prices of food and clothing MRS varies along demand curve tells us how consumer value the consumption of a good or service Change in price of good corresponds to a movement along a demand curve how consumer value the consumption of a good or service
are there a finite or infinite number of nonintersecting indifference curves? are all indifference curves downward sloping?
Infinite number of nonintersecting indifference curves - All indifference curves are downarad sloping Why?? follows assumption that more is better than less
what is Isoutility curve - what is another name for it?
Isoutility curve - (AKA INDIFFERENCE CURVE!!!) At all points along curve, utility is the same
what is Laspeyres Index - formula example Costs that much more to get same bundle -assumes that consumers do not alter their consumption pattern
Laspeyres Index - amt of money at current year prices that an individual requires to purchase a bundle of goods/services choisen in a base year divided by the cost of purchasing the same bundle at base year prices (SAME BUNDLE) Ex. 100 x $1720/$500 = 344 344 is the laspeyres index. Costs that much more to get same bundle -assumes that consumers do not alter their consumption patterns as prices change
UI graph MRS indifference curve formulas when is it steeper than budget line? when is it not as steep as budget line? units of food units of clothing UI is ______ than the budget line
MRS >Pi/Py (Right corner) Indifference curve steeper than budget line MRS < Pi/Py (left corner) Indifference curve not as step as budget line Indifference curve slope = MRS (marginal benefit) Budget curve slope = Marginal Cost
MRS is... ratio of the ___ of food to the ____ of clothing MRS= (formula)
MRS is... The raio of the MU of food to the MU of clothing MRS= 〖MU〗_F/〖MU〗_C
Consumers Maximize satisfaction when MRS=
MRS= P_F/P_C
what is Marginal rate of substitution (MRS) what does it measure?
Marginal rate of substitution (MRS) - max amt of a good that a consumer is willing to give up in orer to obtain one additional unit of another good -measures the balue that the individual places on 1 extra unit of a good in terms of another -the amt of the good on the vertical axis that the consumer is willing to give up in order to obstain 1 extra unit of horiz axis. (ΔY/ΔX) -THUS, THE MRS AT ANY POINT = SLOPE OF INDIFFERENCE CURVE
Normal vs Inferior Goods When income-consumption crve has potive slope, the qty demanded (increase or decrease) with income TF, income elasticity of demand is positive or negative? greater shifts to the right of demand curve, the _(greater or less) the income elasticity? normal goods - consumers want to buy more as their income (decreases or increases)?
Normal vs Inferior Goods When income-consumption crve has potive slope, the qty demanded increases with income TF, income elasticity of demand is positive greater shifts to the right of demand curve, the greater the income elasticity normal goods - consumers want to buy more as their income increases
Now, use index in which the base weights are updated ___________ so now there is less _______
Now, use index in which the base weights are updated every few years Chain-weighted price index - cost of living index that acocunts for changes in quanitites of goods and services now less overcompensation happens
what is Paasche index?
Paasche index - amt of money at current-year prices that an individual requires to purchas a current bundle of goods and services divided by the cost of purchasing the same bundle in a bse year
what are Perfect complements - example
Perfect complements - two goods for which the MRS is zero or infinite; indifference curves are shaped as right angles -left shoe will not increase her satisfaction unless she can obtain matching right shoe -TF, MRS of left shoes for right shoes is zero whenever there are more right shoes than left shoes (she wont give up any left shoes to get more right shoes) -TF, MRS of lefts shoes for right shoes is infinite whenever there are more left shoes (she will give up all but one excess left shoe in order to obtain addtl rright)
Price Indexes in the United states: Chain Weighting... Historically the CPI and PPI were measured as _____price index so price of living was _____. People over compenstated or undercompensated?
Price Indexes in the United states: Chain Weighting... Historically the CPI and PPI were measured as Laspeyres price indexes (so price of living was overstated, ppl overcompensated)
what is Price consumption curve -
Price consumption curve - curve tracing the utility maximizing combinations of two goods as the price of one changes
Utility function is simly a way of what?
RANKING different market baskets
Ratioing is a less efficient means of allocating goods and service BUT
Ratioing is a less efficient means of allocating goods and service BUT Undery any particular rationing scheme some individuals may be better off even those others will be workse off
Rationing... Rationing can provide ppl with access to___________
Rationing... Rationing can provide ppl with access to a product they could not otherwise afford
Because each demand curve is measured for a partcualr level of income, any change in income must lead to a ___________ (whereas change in price corresponds to shift _____________ a demand curve)
SHIFT IN THE DEMAND CURVE ITSELF (whereas change in price corresponds to shift ALONG a demand curve)
What are substitutes? Increase in price of one causes a ____ of the other.
Substitutes - increase in price in one causes increase in demand of other PRICE CONSUMPTION CURVE SLOPE NEGATIVE (A B)
The Paasche index will... undetrate the ideal cost of living (b'c
The Paasche index will... undetrate the ideal cost of living (b'c assumed individual will buy the current year bundle in the base period
The changes give us a new budget constraint given by the equation __________ Is the person in the example worse or better off?
The changes give us a new budget constraint given by the equation QM = I/PM-( PT/PM)QT , or QM = 8 - 5/3 QT, which is drawn in the diagram to the left. Note that the two budget constraints both pass through the bundle containing 3 meals and 3 tickets. We know this because she can still buy 3 tickets (at $50 each) plus 3 meals (at $30 each) with her $240 budget. Hence, we know for certain that she is not worse off now than before because she can buy exactly the same bundle. In fact, we would say she is better off now because she has available some bundles that she didn't used to be able to afford, so she can substitute some meals for the now higher-priced theater tickets.
what is The market demand curve - ? Algebraically, this means that the quantity demanded by each of them at any given price must be_______ to accomplish this we need to find the _________ Adding these equations together gives us the market __________ Inverting again gives us ____________
The market demand curve - the horizontal, or quantity-direction, summation of the individuals' demand curves. Algebraically, this means that the quantity demanded by each of them at any given price must be summed. To accomplish this, we need to find the respective demand functions, starting with the inverse demand functions. For Tom, it is QT = 50 - 2.5 P. For Helen, it is QH = 100 - 5P. For Arnold, it is QA = 40 - 2 P. Adding these equations together gives us the market demand function: QM = 190 - 9.5 P. Inverting again gives us the market's inverse demand function: PM = 20 - 0.1053 Q. As shown in the diagram, the market price intercept is 20, and the quantity intercept is 190.
What is Theory of consumer behavior - ? Conumer behavior is best understood in three distinct setps:
Theory of consumer behavior - the explanation of how consumers allocate incomes to the purchase of different goods and services Conumer behavior is best understood in three distinct setps: 1. consumer preferences - find practical way to describe the reasons ppl prefer one good to another 2. Budget constraints - 3. Consumer choices - consumers choose to buy combinations of goods that maximize their satisfaction
substitution effect - the change in food consumption associated with a ________________, with the level of utility held _____ -captures change in food consumption that occurs as a result of the price change that makes food relatively _________ than cloting how is it marked?
change in the price of food, with the level of utility held constant cheaper MARKED BY MOVEMENT ALONG AN INDIFFERENCE CURVE
5.2 Budget Constraints what are budget constraints - <
constraints that consumers face as a result of limited incomes
individual consumer surplus vs aggregate consumer surplus consumer surplus is found by adding__________ to calculate the aggregate consumer surplus in a market Measures.. Aggregate benefit that consumers obtain from buying goods in a market
consumer surplus is found by adding the excess values or surpluses for all units purchased to calculate the aggregate consumer surplus in a market find area below the market demand curve and above the price line Measures.. Aggregate benefit that consumers obtain from buying goods in a market
Numbers attached t indfifference curve are for what?
convenience only
indifference curve convexity how is it bowed indifference curve is convex if__________ Is it Reasonable to expect indifference curves to be convex?. Ppl generally prefer balanced market baskets vs baskets with just ________
convexity... -convex torward origin (bowed inward) -MRS falls as wel move down indifference curve -AN INDIFFERENCE CURVE IS CONVEX IF.... the MRS diminished along the curve Reasonable to expect indifference curves to be convex. Ppl generally prefer balanced market baskets vs baskets with just one product
what is Fixed weight index -
cost of living index in which the quantities of goods and services remained unchanged
Engel curve - curver relating the _____________ of a good consumed to _________. Y = ______; X = __________
curver relating the quantity of a good consumed to income Y = Income; X = qty consumed
What are Complements? - increase in price of one causes PRICE CONSUMPTION CURVE SLOPE POSITIVE (B D)
decrease in demand of other PRICE CONSUMPTION CURVE SLOPE POSITIVE (B D)
isoelastic demand curve - demand curve with a _____________price elasticity
demand curve with a constant price elasticity
6.4 What is Consumer Surplus ? Difference between what a consumer is willing to pay and the_________________________________ what does it measure?
difference between what a consumer is wiling to pay for a good and the amt actually paid -measures how much better off individuals are bc they can buy goods in the market
what are Utility functions... It provides the same info as what?
formula that assigns a level of utii.ty to individual market baskets -utility function provides same info as indifference map (order consumer choices in levels of satisfaction)
What is Giffen good?
good whose demand curve slopes upward because the negative income effect is larger than the substitution effect
The basket that maximizes satisfaction must lie on the __________________ curve that __________________the budget line * * TF, satisfaction is maximized at the point where_____________ formula THE MARGINAL RATE OF SUBSTITUTION =
highest indifrerence curve that touces the budget line * * TF, satisfaction is maximized at the point where ..... MRS= P_F/P_C * THE MARGINAL RATE OF SUBSTITUTION = PRICE RATIO AND MARGINAL COST = MARGINAL BENEFIT
what is ideal cost of living index - ? example formula: ___________ is the ideal cost of living index that accounts for price changes relative to time. Costs that much more to get same utility.
ideal cost of living index - cost of attaining a given level of utility at current prices relative to the cost of attining the same utility at base pries (SAME UTILITY) ex. $1260/$500 = 2.52 2.52 is the ideal cost of living index that accounts for price changes relative to time. Costs that much more to get same utility.
inferior goods - qty demanded falls as income (increases or decreases?) in this case is income elasticity negative or positive? ex. hamburger falls w/ income b/c
inferior goods - qty demanded falls as income increases income elasticity negative ex. hamburger falls w/ income b/c want more steak
positive network externality -examples: what is -bandwagon effect - -when price goes down, shows more people are buying it, so ___ -what does this do to the DEMAND CURVE?
microsoft word, social media sites positive network eternatity in which a consumer wishes to possess a good in part because others do others jump on board MAKES MORE ELASTIC DEMAND CURVE
Independedn t- change in price of one good has ______ effect on qty demanded of other
no
is INCOME EFFECT ALWAYS THE SAME?: -However, even with inferiror goods, the income effect is ________(_rarely or often) large enough to outweigh sub effect (tf, consumption almost always increases)
no inferior goods neg income effect (consumption falls as income rises); normal goods positive income effect (consumption rises as income rises) However, even with inferiror goods, the income effect is rarely large enough to outweigh sub effect (tf, consumption almost always increases)
Does the MAGNITUDE of the utility difference between any two market baskets tell us anything? we know one is preferred ot the other, but do NOT know ______
no, the magnitutde of the utility difference between any two market baseksts doesn't tell us anything. no, the magnitutde of the utility difference between any two market baseksts doesn't tell us anything. we know one is preferred ot the other, but do NOT know BY HOW MUCH one is preferred to the other (useful for ranking only) HOW MUCH one is preferred to the other (useful for ranking only)
Large income effects are often associated with? normal goods or inferior goods? which one?
normal goods NOT inferior goods
what are perfect substitutes? what does the slope look like
perfect substitutes - two goods for which the marginal rate of substitution of one for the other is constant Slope is straight line Slope does NOT need to be -1 (ex. 2 8gb memory chips could equal 1 16gb memory chip. TF, that indifference curve slope would be -2)
ANY MARKET BASKET ABOVE AND TO THE RIGHT OF INDIFFERENCE CURVE IS _______________________TO ANY MARKET BASKED ON THE LINE
preferred
what is Equal marginal pricnicpal -
principal that utility is maximized when the consumer has equalized the Marginal utility per dollar of expenditure across all goods
what is cost of living index ?
r atio of the present cost of a typical bundle of cosumer goods and services compared with the cost during a base period
network externatlity - situation in which each individual's demand depends on________.
situation in which each individual's demand depends on the purchases of other individuals
what is a Corner solution -
situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line
Utility is maximized when.....
the MU per dollar of expenditure is the same for each good..... 〖MU〗_F/P_F=〖MU〗_C/P_C
When a corner solution arises, the consumer's MRS does equal the price ratio? yes or no when does it happen? MB does NOT = MC here because can they go negative?
the consumer's MRS does not necessarily equal the price ratio Happens when someone consumes all of one product (cannt consume negative amts of the product) MB does NOT = MC here because slopes of indifference curve and budget line are not equal here. But can't go negative
The demand curve of an individual consumer follows form the consumption choices tha ta person makes hwen faced with a ___________________________
the consumption choices tha ta person makes hwen faced with a budget constraint
maximize utility by finding the _______indifference curve that can be reached given the ____________
the highest indifference curve that can be reached, given that budget constraint
The slope of the budget line is?
the negative of the ratio of the prices of the two goods
what does The magnitude of the budget line slope tells us?
the rate at which the two goods can be substituted for each other without changing the total amt of money spent
what is Ordinal utility function -?
utility function that generates a ranking of market baskes in order of most to least preferred
How do we account for bads in analysis of consumer preferences?
we redefine the product under stdy so that consumer tastes are represented for less of the bad (turns the bad into a good) ie. Nstead of preference for air pollution, discuss the preference for clean air
are Both the Laspeyres (LI) and Paasche Indexes (PI) ... Fixed-weight index?
yes
The Laspeyres index will.. overstate the ideal cost of living b/c
{assumes that ocnsumers do not alter their consumption patterns as prices change, changing consumption (increasing purchases of items that have become relatively cheaper, vice versa) can help consumers achieve same level of utility without having to consume exact same bundle}
what is income effect ?
change in demand resulting from this change in real puchaising power, can buy somame amt of good for less money,
what is Diminishing marginal utility -
as more of a good is consumed, the consumption of additional amts will yeld smaller amts of utility
what is Marginal benefit - marginal benefit =
benefit form the consumption of one additional unit of a good marginal benefit = MRS = magnitude of slope of indifference curve
what is Cardinal utility function
c - utility function describing by how much one market basket is referred to another • we Only work with ordinal utility functions • we know preferences, but not by HOW MUCH they prefer it
Tom's preferences for restaurant meals (M) and theater tickets (T) can be described by a utility function, U(QM,QT) = QM1/2 QT1/2 , where QM is the number of meals per month and QT is the number of tickets per month. (Another way of writing the same function would be {√(Q_M )}{√(Q_T )} .) Because these are rates of consumption per month, Tom is not restricted to consuming integer quantities of the two goods. Tom's marginal utility of meals is given by 〖MU〗_M=1/2 Q_M^(-1/2) Q_T^(1/2) (another way to write this would be 〖MU〗_M=1/2 (Q_T^(1/2))/(Q_M^(1/2) ) ) and his marginal utility of tickets is given by 〖MU〗_T=1/2 Q_T^(-1/2) Q_M^(1/2) . (Another way to write this would be 〖MU〗_T=1/2 (Q_M^(1/2))/(Q_T^(1/2) ) .) (If you know calculus, you will recognize that the marginal utility is just the partial derivative of the utility function. But if you don't know calculus, don't worry about it. That's why I have given you the equations for the marginal utilities.) The price of meals (PM) is $32, and the price of tickets (PT) is $48. Tom's budget for restaurant meals and theater tickets is $240 per month. (a) Find how many of each good Tom will buy each month if she maximizes his utility, subject to his budget constraint. (b) If Tom's budget stays the same at $240, and the price of tickets stays at $48 each, how many meals would he now buy if the price of meals fell to $24?
U(QM,QT) = QM1/2 QT1/2 ,Recall that a person who maximizes utility will meet the condition that the marginal utility per dollar spent on each good will be equal. That condition can be represented as 〖MU〗_T/P_T = 〖MU〗_M/P_M , but that is the same as 〖MU〗_T/〖MU〗_M = P_T/P_M . So substituting the equations for marginal utilities into this condition, we find Q_M/Q_T = P_T/P_M . Now, substituting the values in for PT and PM, we find that QM = 1.5 QT. We have found that Tom will buy one-and-a-half times as many meals as tickets. But we need another equation to solve for the actual values. Recall that Tom has $240 to spend, so his budget constraint is 240 = QTPT + QMPM. Substituting 1.5 QT in for Q¬M allows us to find that Tom will buy 2.5 tickets, and because he buys 1.5 times as many meals as tickets, he must buy 3.75 meals per month. b. Using the same conditions of equilibrium as shown in (a) above, we find that Q_M/Q_T = P_T/P_M =48/24, so he now buys twice as many meals as tickets, or QT = ½ QM. Substituting ½ QM into the budget constraint for QT and solving for QM yields 5 meals per month. So lowering the price of meals to $24 causes Tom to increase the quantity he buys each month from 2.5 to 5. Two points on Tom's demand for meals are (P,Q) = ($32 , 3.75) and (P,Q) = ($24 , 5).
what is Utility... is there a numerical value of level of satisfaction with each market basket consumed?
Utility... Not necessary to associate a numerical level of satisfaction with each market basket consumed Utility - numerical score representing the satisfaction that a consumer gets from a given market basekt -device used to simplify the ranking of market baskets -if buying 3 copies of this textbook makes you happier than buying 1 shirt, we say the three books gives you more utility than the shirt
What is purchasing power ? can it double?
ability to generate utilty through the purchase of goods and services purchasing power can double b/c income doubles or price of good cut in half
what is Marginal utility -
additional satisfaction obtained from consuming one additional unit of a good
what is budget line -
all combinations of goods for which the total amt of money spent is equal to income assume consumer will spend entire income on the two products slope measures? the relative cost of food and clothing
income effect - change in consumption of a good resulting from
an increase in purchasing power, with relative prices held constant INDIFFERENCE CURVE TO ANOTHER lower price of food has increased her level of utility
