Micro Economics Chapter 4

Front 1

Law of demand

Back 1

People do less of what they want to do as the cost of doing it rises.

Front 2

Cost-Benefit Analysis

Back 2

An activity should be pursued if, and only if, its benefits are at least as great as its costs.

Front 3

Reservation price

Back 3

The highest price we would be willing to pay to pursue it

Front 4

Wants (preferences, tastes)

Back 4

A clearly important determinant of a consumer's reservation price for a good

Front 5

The origins of demand

Back 5

wants, peer influence and social forces

Front 6

Utility

Back 6

Represents the satisfaction people derive from their consumption activities

Front 7

Utility maximisation

Back 7

That people try to allocate their incomes so as to maximize their satisfaction.

Front 8

Bentham's "Utility maximization model"

Back 8

affords important insights about how rational consumers ought to spend their incomes.

Front 9

Marginal utility

Back 9

Change in utility/change in consumption

Front 10

Marginal utility

Back 10

The additional utility gained from consuming an additional unit of a good

Front 11

Diminishing marginal utility (DMU)

Back 11

The tendency for the additional utility gained from consuming an additional unit of a good to diminish as consumption increases beyond some point

Front 12

Optimal combination of goods

Back 12

The affordable combination that yields the highest total utility.

Front 13

Rational spending rule

Back 13

Spending should be allocated across goods so that the marginal utility per euro is the same for each good.

Front 14

Two reasons that the quantity demanded changes

Back 14

Substitution effect and the income effect

Front 15

Substitution effect

Back 15

When the price of good goes up, substitutes for that good become relatively more attractive, causing some consumers to abandon the good for its substitutes.

Front 16

Income effect

Back 16

Refers to the effect that a price change makes the consumer either poorer or richer in real terms.

Front 17

Ratio of marginal utility to price

Back 17

If the price of one good goes down, the ratio of its current marginal utility to its new price will be higher than for other goods.

Front 18

Demand for good falls

Back 18

when the real price of a substitute falls or the real price of a complement rises

Front 19

Preference ordenring

Back 19

Having some means whereby we can in principle define an individual's preferences as to various bundles of goods or services he might consume.

Front 20

Assumption 1

Back 20

The individual's preferences are complete. The individual can compare any two bundles of goods and services and say which is preferred or whether one is as good as the other.

Front 21

Assumption 2

Back 21

The individual's preference ordering over bundles is ordinal, rather than cardinal. Require a ranking but don't require the individual to be able to answer the type of question given about "How much happier". 1st, 2nd, 3rd.

Front 22

Assumption 3

Back 22

The individual's preferences are transitive. Meaning that if you say you prefer bundle A to bundle B, and bundle B to bundle C, you must prefer bundle A to bundle C.

Front 23

Assumption 4

Back 23

The individual's satisfaction level is monotonically increasing with respect to any good. The individual is better off with more of any one good as long as she has the same amount as before all other goods.

Front 24

Assumption 5

Back 24

The individual's preferences are continuous. The individual can rank bundles very similar, for example containing a small amount more or less of any good or goods.

Front 25

Assumption 6

Back 25

Require them to display a diminishing marginal rate of substitution.

Front 26

Utility function

Back 26

The implication of these assumptions is that the preference ordering can be written as a utility function: this permit trade-offs. (U = U(X,Y....,Z))

Front 27

Budget constraint

Back 27

Budget line

Front 28

Diminishing marginal rate of substitution (DMRS)

Back 28

The less you have of good A the more B you will have to be given to make up for a further reduction in the quantity of A.

Front 29

Indifference curve

Back 29

A smoothly convex curve; it's slope is the consumer's marginal rate of substitution (MRS) between two goods.

Front 30

Consumer rationality

Back 30

Allocate spending so that MRS equals relative price.

Front 31

The substitution effect

Back 31

The impact of relative prices on the consumer's allocation of his income over the goods bought.

Front 32

The income effect

Back 32

The consumer's real income has fallen because the quantity of goods he can buy from a given money income has fallen.

Front 33

Inferior good

Back 33

An inferior good is a good whose quantity demanded decreases when consumer income rises (or quantity demanded rises when consumer income decreases).

Front 34

Normal goods

Back 34

Normal goods are those for which consumers' demand increases when their income increases.

Front 35

Horizontal addition

Back 35

The process of adding individual demand curves to get the market demand. A term used to emphasize that we are adding quantities, which are measured on the horizontal axes of individual demand curves.

Front 36

Consumer surplus

Back 36

The difference between a buyer's reservation price for a product and the price actually paid