Chapter 21: Consumer Choice

if the substitution effect dominates, an increase in wages causes what

-less leisure -more work

if the income effect dominates, an increase in wages causes what

-more leisure -less work

an increase in income does what to budget constraint and quantity of goods?

-shifts it outward -quantity of normal goods increases -quantity of inferior goods decreases

wage and labor supply application

-the two goods are consumption (income) vs leisure (nonworking hours awake) -time will be fixed (hours/week) -wage will be fixed ($/hour) -graph = budget constraint

points on a budget constraint

1) inside = affordable but not preferable 2) on the line = affordable and preferable 3) outside = unaffordable but more preferable

deriving individual good demand from budget constraint graph

1) plot the optimum point 2) change the price, observe the pivot of the budget constraint, plot the new optimum point 3) two points = demand curve

properties of indifference curves

1) typically downward sloping 2) higher curves are preferred 3) curves cannot cross 4) typically bowed inward (concave up)

consumption is based on what

1) what we can afford 2) what we like

slope at the optimum

=MRS =opportunity cost *tangent point between the two curves

indifference curve

shows consumption bundles that give the consumer the same level of satisfaction; has nothing to do with price

slope of indifference curve

MRS

income effect

a fall in the price of one good boosts the purchasing power of income, allowing one to buy more of both goods -budget constraint pivots outwards and you jump to a higher indifference curve -when dominating, creates downward sloping supply

substitution effect

a fall in the price of one good makes the substitute good more expensive relative to the first good, causing one to buy fewer of the substitute good and more of the cheaper good -shift along indifference curve -when dominating, creates upward sloping supply

some speculate the actual labor supply curve is ___, meaning ___

a leftward facing parabola -upward sloping (substitution effect) for lower wages -downward sloping (income effect) for higher wages

consumption bundle

a particular combination of two goods; x amount of one good and y amount of the other good

slope of budget constraint

constant/linear; opportunity cost of one x-good in terms of the other y-good

a decrease in income does what

decreases the budget constraint (shifts left), but the slope stays the same

when the income effect dominates the supply curve of labor is ___

downward sloping

as you move down the curve MRS ___

falls/decreases

an increase in the price of one good does what

pivots the budget constraint inward, and the slope changes

optimum

the bundle most preferred out of all the affordable bundles; the point on the budget constraint that touches the highest possible indifference curve

budget constraint

the limit on the consumption bundles that a consumer can afford

marginal rate of substitution (MRS)

the rate at which a consumer is willing to trade one good for another

perfect complements

two goods with right-angle indifference curves (left vs right shoes)

perfect substitutes

two goods with straight-line indifference curves and constant MRS (nickels vs dimes)

when the substitution effect dominates the supply curve of labor is ___

upward sloping

Giffen good

when an increase in price raises the quantity demanded; income effect > substitution effect; reverse of Law of Demand

why are indifference curves bowed inwards?

you're less likely to give up something you have little of, so you want to be compensated higher