Microeconomics Chapter 8

What limits your consumption choices?

A: Your consumption choices are limited by your income and the prices of goods and services.

What does a budget constraint represent?

A: The budget constraint represents all the combinations of goods and services that a consumer can afford given their income and prices.

How does a raise in income affect the budget constraint?

A: A rise in income shifts the budget constraint outward, allowing more combinations of goods and services to be affordable, but the slope remains the same.

How does a change in the price of a good affect the budget constraint?

A: A change in the price of a good changes the slope of the budget constraint, altering the trade-off between the two goods.

On a graph, what does the budget line illustrate?

A: The budget line shows the boundary between affordable and unaffordable combinations of two goods.

What does it mean if a point lies below the budget line?

A: The combination is affordable but does not use all available income.

What does it mean if a point lies above the budget line?

A: The combination is unaffordable given the consumer's income and prices.

What do preferences describe in consumer choice theory?

A: Preferences describe a consumer’s likes and dislikes for different goods and services.

What is utility?

A: Utility is a measure of the satisfaction or happiness a consumer derives from consuming goods and services.

What is total utility?

A: Total utility is the overall satisfaction gained from consuming all units of goods and services.

What is marginal utility?

A: Marginal utility is the additional satisfaction gained from consuming one more unit of a good or service.

What is the law of diminishing marginal utility? 

As a consumer consumes more units of a good, the marginal utility from each additional unit tends to decrease.

How does marginal utility relate to consumer choices?

A: Consumers make choices to maximize total utility by considering the marginal utility of each additional unit of goods within their budget constraints

What shape do total utility and marginal utility curves usually take?

A: Total utility curves slope upward (utility increases with consumption), while marginal utility curves slope downward (marginal utility decreases as consumption increases).

What does marginal utility theory explain?

A: It explains consumer choice by stating that consumers allocate their income to maximize total utility.

What is marginal utility?

A: Marginal utility is the additional satisfaction gained from consuming one more unit of a good or service.

According to marginal utility theory, how do consumers decide how to spend their income?

A: Consumers allocate their income so that the marginal utility per dollar spent is equal across all goods and services.

What is the utility-maximizing rule?

A: To maximize total utility, spend all available income and equalize the marginal utility per dollar for all goods.

How is marginal utility per dollar calculated?

A: Marginal utility per dollar = Marginal utility of the good ÷ Price of the good.

What should a consumer do if the marginal utility per dollar of one good is higher than that of another?

A: The consumer should spend more on the good with the higher marginal utility per dollar and less on the other to increas

When is a consumer said to be in consumer equilibrium?

A: When the marginal utility per dollar spent is equal for all goods, and all income is allocated.

According to marginal utility theory, what happens when the price of a good falls?

A: You will consume more of that good because the marginal utility per dollar spent on it increases.

Why does consumption increase when the price of a good decreases?

A: Because the good becomes relatively cheaper, increasing the marginal utility per dollar and encouraging consumers to buy more.

What is the effect of an increase in income on the consumption of normal goods?

A: Consumption of normal goods increases as income rises.

How does a price change affect the budget constraint?

A: A price decrease rotates the budget line outward (flatter slope), allowing more consumption of that good within the same income.

What is the difference between a change in quantity demanded and a change in demand?

A: A change in quantity demanded is movement along the demand curve due to price change; a change in demand is a shift of the entire demand curve due to factors like income changes.

How does marginal utility theory explain the law of demand?

A: It predicts that as the price of a good falls, the quantity demanded increases because consumers maximize utility by buying more of the now cheaper good.

What happens to the demand for substitute goods when the price of a related good falls?

A: The demand for substitutes decreases because consumers switch to the now cheaper good

What is the paradox of value?

A: It is the question of why essential goods like water are cheap, while non-essential goods like diamonds are expensive.

How does marginal utility theory explain the paradox of value?

A: Water has a low marginal utility because it is abundant, whereas diamonds have a high marginal utility due to their scarcity.

What is marginal utility’s role in determining the price of goods?

A: Prices reflect the marginal utility per dollar; goods with higher marginal utility per dollar tend to have higher prices.

Why does water, despite being essential, have a low price?

A: Because its abundance means its marginal utility is low, reducing consumers' willingness to pay high prices

Why are diamonds expensive even though they are not essential?

A: Because diamonds are scarce, their marginal utility is high, leading to a higher willingness to pay.

How does the concept of consumer surplus help explain the paradox of value?

A: Consumer surplus for water is large due to its low price and high total utility, while consumer surplus for diamonds is small because of their high price and low quantity.

What do behavioral economics and new approaches add to traditional consumer choice theory?

A: They incorporate psychological factors and social influences that affect decisions beyond just utility maximization.

What is bounded rationality in behavioral economics?

A: It is the idea that people have limited cognitive resources and often use shortcuts or heuristics instead of perfect rational calculation.

Define bounded willpower in the context of consumer decisions.

A: It refers to people sometimes making choices they later regret due to a lack of self-control at the moment of decision.

What does bounded self-interest mean?

A: Sometimes consumers prioritize others’ welfare over their own, even if it reduces their personal utility.

What is the endowment effect and how does it challenge traditional utility theory?

A: It is the tendency to value items more highly simply because you own them, which contradicts the idea that value is based purely on marginal utility.

How does neuroeconomics contribute to understanding consumer choices?

A: It studies brain activity during economic decisions to reveal underlying psychological processes influencing choices.

How do dopamine levels relate to consumer utility?

A: Dopamine increases with pleasurable events and decreases with disappointing ones, potentially reflecting the experience of utility.

What does the slope of the budget line represent in consumer choice theory?

A: The opportunity cost of one good in terms of the other.

What is an indifference curve?

A: A curve showing combinations of two goods that give the same level of utility.

Where does consumer equilibrium occur on a graph with indifference curves?

A: Where the budget line is tangent to the highest attainable indifference curve.

What is the substitution effect of a price change?

A: The change in quantity demanded due to a good becoming relatively cheaper or more expensive.

What is the income effect of a price change?

A: The change in quantity demanded caused by a change in real purchasing power

What is consumer surplus?

A: The difference between what a consumer is willing to pay and what they actually pay.