Topic 2 - Consumer Choice

How does a consumer maximise his utility?

when he recieves the same marginal utility per dollar from both goods. MYx/Px=MUy/Py

A consumption bundle that contains more of both goods than another bundle.....

will be on a higher indifference curve

How to figure out the absolute value of a slope?

x/y

Farley Farm, a dairy company, has total costs of $15,000 and total variable costs of $2,000. Farley Farm's total fixed costs are

$13,000.

Three determinants of saving are:

1. Income (from which people save) 2. The interest rate (which yields a return to saving) 3. How much people care about current consumption relative to future consumption (time preference).

An increase in the price of one good rotates the BL. The price change has two effects on the BL.

1. The Substitution effect - It alters the slope of the BL, which reflects the change in relative prices. 2 - The Income effect - some bundles are no longer affordable.

On a diagram of an indifference curve and budget constraint for an individual, a change of gradient of the budget constraint indicates

A change in relative prices.

IE

As the price of a good rises, the purchasing power of the consumer's real income falls. As a result they cannot afford to buy as much of a good. The IE focuses on a consumer's response to the change in real purchasing power as price changes. It can be positive or negative depending on how the person regards the good (normal or inferior).

If a household's income and the prices of all goods it consumes doubles, its budget constraint will....

Be unaffected.

Consider an individual who spends all their income on beer and food. Following an increase in the price of beer (with income fixed), the individual consumes more beer. From this, we can infer that

Beer is inferior and food is normal to the individual.

Many people who receive low wages travel to their work by bus because they cannot afford to buy cars. Following an increase in wage rates, some of these people buy cars and use them to travel to their work. This implies that...

Bus travel is an inferior good.

Four elements in consumer choice:

Consumer income Prices of goods Consumer preferences Rationality

When a consumer's disposable income falls, the individual's demand curve for a particular commodity...

Could shift to the left, right or not at all. Explaination: A consumer's response to an income change depends on her preferences. The question does not provide information on the person's preferences

Consider two substitute gods, glasses and contact lenses. If the price of glasses increases, the quantity demanded of glasses will.........and the demand for contact lenses will............

Decrease, increase.

A decrease in income will cause the individual's utility to....

Decrease.

Suppose a production exhibits constant returns to scale. If a firms inputs were doubled from their current level, a firm's output would...

Double.

The savings decision is a choice between two goods:

Goods today and goods in the future

The bundle that maximises a consumer's utlity is found by bringing together their...

ICs (what they like) Their BL (what they can afford).

SE

It is the consumer response due to the chnage in OC of a good. i.e as price increases, you buy less of the good in favour of cheaper alternatives. It foucses on the chnage in relative prices, i.e the response due to the chnage in the slope of the BL. The SE is always negative for a change in its own price.

At the point where the slope of the firm's total cost curve (TC) is parallel to its total revenue curve (TR)...

Its profits are maximised. Explanation: the slopes of the TR and TC functions are marginal revenue and marginal cost. When MR = MC, the firm maximises its profits. For a given level of output, a firm maximises its profit by minimising its costs. This involves selecting the least cost production plan: the technically efficient production plans.

A move left (up) along an indifference curve...

Leaves the peron's utility constant.

A move right (down) along an indffierence curve...

Leaves the person's utility constant.

A rational consumer....

Make choices in order to maximise his utility.

When the price of commodity A increases, the quantity demanded of commodity B increases. This implies that A and B are....

Substitutes.

When the price of good falls and customers tend to buy it instead of other goods, this is called the....

Substitution effect.

If the individual's income increases (and they have a positive marginal utility for goods), then we know that....

Their expenditure will increase. Note!!: NOTTTT 'increse consumption of goods'.

The quantity a person can purchase depends on:

Their income and product prices.

TE

The TE of a price change is the sum of the SE and IE. It may be positive or negative deoending on whether the IE is positive (and bigger) than the negative SE.

Diminishing marginal utility:

The additional utility falls with extra units.

What is the equi-marginal principle?

The consumer should continue to adjust his consumption so that MUx/Px falls and MUy/Py rises until they are equal. A bundle where MUx/Px = MUy/Py means that person dervies that same satisfaction per dollar of expenditure from each good. With such bundle, there is no reallocation that can increase their utility (assuming they are spending all their income already).

Marginal utility:

The extra utility or happiness a consumer receives from one additional unit of good.

Why does marginal utility tend to diminish?

The more we can consume of a good, the less value it is to us. Less satisfaction comes overtime.

Workers are interested in the real wage. What is the 'real wage'?

The nominal wage adjusted for inflation. W = nominal wage; P = price of consumption. Real wage = w = W/P Therefore, an hour of work buys $w (W/P) units of good.

Income and prices together determine:

The possible bundles of goods that consumer can afford.

On an individual's indifference-curve diagram, the point of tangency between the budget line and an indifference curve indicates the combination of purchases where.....

Utility is maximised.

How to calculate slope?

Y/X

The budget set is...

all the different bundles of goods a consumer can afford/buy when they spend all their income. It represents a limit or constraint a consumer has on their spending.

When income rises, consumption...

rises for normal goods, falls for inferior goods.

Features of an IC:

shows a particular level of utility. higher indifference curves represent greater utility. their slope gets flatter to the right (due to DMU). the shape of the indifference curve reflects the person's preferences.

Prefereces can be viewed as a relationship between potential consumption bundles. We assume:

the preferences are complete (able to rank any two consumption bundles) and transative (rankings between bundles are consistent).