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41 Cards in this Set

  • Front
  • Back

Choices made as a buyer of goods and services is influenced by two factors that economists call?

1) Consumption possibilities

2) Preferences

Consumption possibilities

Are all the things that you can afford to buy.

Consumers budget line

-consumption possibilities are limited by income, the price of a movie, and the price of pop.

-lisa spends all income = reaches limits of her consumption possibilities

-budget line shows the limits of her consumption possibilities

Example of budget line

- Lisa has $40 - income to spend

price of a movie is $8, and price of a pop is $4 a case

-Can afford any points A to F

-budjet line is what runs through all these pints


The choices that lisa makes depends of her preferences (likes and dislikes)


Benefit or satisfaction from consuming a good or service is called utility.

Total utility

is the total benefit a person gets from the consumption of goods. More consumption gives more total utility

-total utility of a good increases as the quantity of the good increases

-Ex, lisa sees more movies in a month, her total utility for movies increases

Marginal utility

from a good is the change in total utility that results from a unit increase in the quantity of the good consumed.

-as quantity consumed of a good increases, the marginal utility from it decreases.

-decrease in marginal utility as the quantity of the good consumed increases is called the principle of diminishing marginal utility.

Maximizing utility

-marginal utility decreases as the quantity of the good increases.

- ex. as the number of movies seen in a month increases marginal utility from movies decreases.

Marginal utility

from a good is the change in total utility that results from a unit increase in the quantity of the good consumed.

-Decreases as the quantity of the good increases.

Diminishing marginal utility

-lisa increases the quantity of pop she drinks

-her marginal utility from pop diminishes

Utility decreased, Quantity increases

Uitlity maximizing choice

-household does not always choose the consumption possibility that maximizes utility.

How to maximize utility

1) just affordable combinations - find total utility for each just affordable combo

2) find total utility (for each just affordable combo)

3) utility maximizing combination = consumers choice

Consumer equilibrium

is the situation in which Lisa has allocated all of her available income in a way that maximizes her total utility.

(where ever the highest total utility column is on the table)

marginal utility per dollar

results from spending on more dollar on the good.

MUPD equation

MUPD (Marginal utility per dollar) = MU / P or (marginal utility) / (price)

Utility maximizing rule

1) spend all available income

2) equalize the marginal utility per dollar for all goods.

How to equalize:

start by picking one point on the budget line

ex. MUp /Pp < MUm / Pm

Above the consumer equilibrium will be equal to too much

and below the consumer equilibrium will be too little

Predictions of marginal utility theory analyze

1) Fall in the price of a good (ex. good x)

2) a rise in the price of pop (good y)

3) Rise in income

fall in price of good (ex. good x)

-results in the quantity demanded of the good to increase

-the curve will slope downwards

- increase amount of movies seen to drive up utility and restore balance

(results in a downwards shift along the demand curve and a shift of the demand curve to the left)

rise in the price of pop - good y

-decreases the quantity of pop demanded

-upwards movement along the demand curve

rise in income - Y

income increases, demand for a normal good increases too.

-ex. lists income increases from $40-$56 a month she will buy more movies and pop

-because they are normal

(shift to the right on the demand curve due to income increase)

paradox of value

MU for water = low

total utility = high

MU for diamonds = high

total utility = low

Paradox resolved

by distinguishing total vs. marginal utility

-marginal utility per dollar is the same for water and diamonds

value and consumer surplus

Supply of water = perfectly elastic

-quantity consumed is large + surplus (consumer) is large

(surplus of water is large because there is a large amount available to us)

DIamonds consumer surplus

perfectly elastic supply of diamonds (vertical line) - because of its low quantity

temperature -> utiltiy

- both are abstract concepts

-both use a unit of measurement that is arbitrary

(made up based on the belief of many individuals)

-temp helps predict when water will turn to steam (etc)

- utility help us understand why people buy more of one good for many reasons

behavioural economic

studies the way in which limits on the humans brain ability to compute/implement rational decision - influences economic behaviour

3 impediments to rational choice

1) bounded rationality

2) bounded willpower

3) bounded self interest

bounded rationality

bound by computing power of the humans brain

bounded willpower

less than perfect willpower that prevents us from making decision we know we will later regret

bounded self interest

limited self interest that sometimes results in suppressing our own interests to help others

endowment effect

tendency for people to value something more high simply because they won it


study of activity of the human brain when a person makes an economic decision

-pre forntal cortex - memories are stored (deemed rational)

- hippocampus - memories of anxiety and fear are stores (deemed irrational)

household consumption choices are constrained by...

its income and the prices of the goods and services available

budget line

describes the limits to the households consumption choices

consumption possibilities

lisa can afford any of the combinations at points A-F

-some goods are indivisible and must be bought in whole units at the points markers

-other goods are divisible and can be bought in any quantity such as gasoline

budget line (on graph)

(all points a-f are affordable, and within the budget line so under it are also affordable options)

budget equation

the budget equation states that

expenditure = income

PpQp + PmQm = Y (income)

a households real income

goods a household can afford to buy

-real income in terms of pop is the point on the budget line that meets the y axis

(opposite in terms of movies)

relative price

price of a good divided by the price of another good

-magnitude of the slope of the budget line

(how many case forgone to see an addition movie - also opportunity price)