Theory of Consumer Behavior - McGraw Hill Chapter 5

As price of a good increases,

quantity of the good demanded decreases

The rate at which a consumer is able to substitute one good for another is determined by the ...

ratio of the prices of the goods.

The rate at which a consumer is willing to substitute one good for another is measured by ...

slope of the line tangent to the indifference curve.

Consumer theory requires...

that consumers be able to rank/order various combinations of good and services according to level of satisfaction with each combo.

The optimal level of pollution is that level at which ...

the total benefit of pollution reduction exceeds the total cost of pollution reduction by the greatest amount.

Transitive Preference Ordering

IF A>B and B>C, then A>C

Shifting Budget Line

If income (M) or the price ratio (Px/Py) changes, the budget line will shift.

Consumer's Optimization Problem

Individuals make consumption decisions with the goal of maximizing their total satisfaction from consuming various good and services, subject to the constraint that their spending on goods exactly equals income.

Budget Line

Line showing all bundles of goods that can be purchased at given prices if the entire income is spent.

Market Demand

List of prices and the quantities consumers willing and able to purchase at each price on list

Slope of Indifference Curve

MRS -dY/dX Tangent of point on curve

Utility Maximized

MUx/Px = MUy/Py

Maximizing Utility with Budget

Marginal utility of X per dollar = Marginal utility of Y per dollar; MUx/Px = MUy/Py

Individual Consumer Demand Curve

Max utility when budget line is tangent to indifference curve

Marginal Rate of Substitution (MRS)

Measure of units of Y that must be given up per unit of X added to maintain constant utility

Nonsatiation

More is preferred to less

Consumption Bundles

Particular combinations of specific goods or services

Indifference Maps

Plot of more than one indifference curve (that do not intersect)

MRS equals

- MUx/MUy

Slope of the Budget Line

1) -Px/Py 2)How much good Y must be given up to afford good X 3) is negative

Intercept of Vertical Axis of Demand Curve

1) Maximum price consumers will pay 2) Marginal benefit (value) individuals place on last unit consumed

True of Utility

1) Not easily measured 2) U= f(X,Y) 3) Measured in utility units

Caveats of Consumer Optimization

1) Spending = Income. No savings/borrowing 2) Completely informed - aware of all options

Which assumption is NOT made in consumer behavior? 1) Consumers can rank all bundles of goods 2) Consumers have complete information 3) Consumers can measure the utility they get from all bundles of goods 4) None of the above

3) Consumers can measure the utility they get from all bundles of goods

Marginal Utility (MU)

Addition to total utility attributed to the one additional unit of a good at current rate of consumption (All other goods constant) dU/dX

Horizontal Summation

Aggregating individual demand curves to determine market demand curve

MRS is 1/2

At point B, marginal rate of substitution is...

Shape of Indifference Curves

Downward sloping because gain X requires less Y. Convex - The consumer is willing to accept a smaller decrease in Y for each X

Utility

Benefits consumers obtain from the goods and services they consume.

Complete Preference Ordering

Consumers are able to rank all conceivable bundles of commodities.

The MRS increases/decreases along the indifference curve

Decreases or diminishes

Utility Function

Equation that shows an individual's perception of level of utility derived from consuming each conceivable bundle. U = f(X,Y)

Indifference Curve

Set of points representing different bundles of goods and services, each of which yields the same level of total utility.

Corner Solutions

Utility max bundle lies at one endpoint of budget line. Consumer chooses not to consume other good.

Along an indifference curve

consumer utility is constant.

A decrease in price of Y ...

increases ability to buy good Y, rotating budget line out on the Y axis

Given NB at 100 of activity = $20, ...

increasing activity by one unit will increase by $20.

Market demand curve...

is the sum over prices of all individual consumers' quantities demanded

Marginal Utility (MU)

the change in total utility that results from increasing the amount of a good consumed by one unit.

A firm will maximize profit by producing that level of output at which ...

total revenue exceeds total cost by the largest amount.