The Theory of Consumer Choice Lecture Notes

This set of vocabulary flashcards covers the micro-foundations of consumer demand, including budget constraints, indifference curve properties, optimization conditions, and applications like Giffen goods and labor-leisure trade-offs.

Theory of Consumer Choice

An economic theory that examines the micro-foundations behind the demand curve, applying the principle that people face trade-offs to the context of spending, saving, and time allocation.

Budget Constraint

The limit on the consumption bundles a consumer can afford given their income and market prices, expressed by the equation $p_{x}x + p_{y}y = I$.

Slope of the Budget Constraint

The rate at which a consumer can trade one good for another, equal to the relative price of the two goods ($- \frac{p_{x}}{p_{y}}$). For example, 5 liters of Pepsi per pizza reflects the opportunity cost of one pizza.

Indifference Curves

Graphs showing various consumption bundles that provide the consumer with the same level of satisfaction ($U(x, y) = k$).

Marginal Rate of Substitution (MRS)

The slope of the indifference curve at any given point, representing the rate at which a consumer is willing to trade one good for another while maintaining constant happiness.

Convexity (Bowed Inward)

A property of indifference curves showing that people are more willing to trade away goods they have in abundance, reflecting diminishing marginal utility.

Perfect Substitutes

Goods with a fixed Marginal Rate of Substitution (MRS), such as two nickels for one dime, resulting in straight-line indifference curves.

Perfect Complements

Goods consumed in fixed proportions, such as left shoes and right shoes, resulting in right-angled (L-shaped) indifference curves.

Consumer's Optimum

The point where the budget constraint is tangent to the highest possible indifference curve, satisfying the condition $MRS = - \frac{p_{x}}{p_{y}}$.

Optimization Condition (Marginal Utility)

The state where the marginal utility per dollar spent is equal across all goods, represented as $\frac{MU_{x}}{P_{x}} = \frac{MU_{y}}{P_{y}}$.

Normal Goods

Goods for which consumption increases as the consumer's income rises.

Inferior Goods

Goods for which consumption decreases as the consumer's income rises.

Substitution Effect

The change in consumption resulting from moving along a given indifference curve to a point with a new Marginal Rate of Substitution (MRS), triggered solely by a change in relative prices.

Income Effect

The change in consumption resulting from moving to a new indifference curve due to a change in the consumer's purchasing power.

Giffen Good

A highly inferior good for which an increase in price raises the quantity demanded because the income effect outweighs the substitution effect (e.g., Irish potatoes during the 19th-century famine).

Price of Leisure

The hourly wage ($w$), which represents the opportunity cost of not working.

Labor-Leisure Budget Constraint

The trade-off between consumption and leisure, modeled as $p_{c}c + wl = w100$ for 100 hours of awake time per week.

Backward-Bending Labor Supply Curve

A supply curve that occurs when the income effect of a wage increase dominates the substitution effect, causing a person to work less as wages rise.

Consumption-Saving Decision

The choice between consumption when young and consumption when old, where the relative price is determined by the interest rate ($r$).

Household Saving Budget Constraint

The constraint for intertemporal choice, expressed as $p_{O}c_{O} + (1 + r) p_{Y}c_{Y} = (1 + r) I$.