MicroEconomics Chapter 9:Possibilities, Preferences, and Choices

Income Effect

The effect of a change in income on buying plans. A drop in income shift both budget line and demand curve to the left. A rise in income shifts both budget line and demand curve to the right.

Price Effect

The effect of a change in the price of a good on the quantity of a good consumed. Drop in price rotates budget line right or moves down in demand curve. Rise in price rotates budget line left or moves up in demand curve.

A Change in Income

An increase in money income increases real income and shifts the budget line rightward. A decrease in money income decreases real income and shifts the budget line leftward. Has the same slope and a change in money income changes real income, but does not change the relative price.

Marginal Rate of Substitution(MRS)

Is the rate at which a person will give up a good on the y-axis to get an additional good on the x-axis while remaining indifferent (Remaining on the same indifference curve) - If the indifference curve is steep, the MRS is high and a person is willing to give up a large quantity of a good to get an additional unit of another while remaining indifferent. - If the indifference curse is flat, the MRS is low and a person is willing to give up a small quantity of a good to get an additional unit of another while remaining indifferent.

Real Income

It is income expressed by the quantity of goods that the household can afford. It is money income divided by Pa or Pb.

A Change in Price

If the price of of a product falls, the budget line rotates outwards and becomes less steep. If the price of a product rises, the budget line rotates inwards and becomes steeper. Has the same point on one axis and changes relative price, but does not change real income.

Diminishing Marginal Rate of Substitution

Is a general tendency for someone to be willing to give up less of a good on the y-axis to get one more unit of a good on the x-axis, while at the same time remaining indifferent as the quantity on the x-axis increases.

Indifference Curve

Is a line that shows the combinations of goods among which a consumer is indifferent. A consumer prefers a combination to the right of an indifference curve or on the indifference curve and does not prefer a point to the left of the indifference curve.

A Preference Map

Is a series of indifference curves that resemble the contour lines of a map. By looking at the shape of the indifference curves, we can draw conclusions about a persons preferences.

Substitution Effect

Is the effect of a change in price on the quantity bought when the consumer (hypothetically) remains indifferent between the original situation and the new one.

Relative Price

Is the price of one good divided by the price of another. Pa/Pb tells you what amount of Qa gives you one amount of Qb.

Degrees of Sustainability

Perfect Substitutes: Their indifference curves are straight lines that slope downwards. The MRS is constant. Perfect Complements: Their indifference curves are L-shaped. The MRS is not constant Ordinary Goods: The indifference curves are sloped and are generally typical. MRS is diminishing.

Measure MRS

To measure the magnitude draw a straight line against the point on the indifference curve. Divide the number on the y-axis where the line reaches by the number on the x-axis where the line reaches. This gives you the rate at which someone is willing to give up a good on the y-axis, for a good on the x-axis.

Budget Equation

Describes the budget line. The equation starts with the fact that Expenditure=Income. - Expenditure is (PaQa)+(PbQb) - Income is Y Step 1: Equation looks like. (PaQa)+(PbQb)=Y Step 2: Divide both sides of the equation by Pa. (Qa)+(Pb/Pa)(Qb)=Y/Pp Step 3: Now subtract (Pb/Pa)(Qb) from both sides. Qa=(Y/Pp)-(Pb/Pa)(Qb) Step 4:Sub in the quantity for Qb and get Qa=Qb