Microeconomics chapter 9

What does a household’s budget line represent?

A: The combinations of goods and services that can be purchased given the household’s income and the prices of those goods and services.

What happens to the budget line when the price of a good decreases?

A: It pivots outward, allowing more of that good to be purchased.

What happens to the budget line when the price of a good increases?

A: It pivots inward, limiting how much of that good can be purchased.

How does a change in income affect the budget line?

A: It shifts parallel to the original line—outward with more income, inward with less—without changing the slope.

What does the slope of the budget line represent?

A: The relative price of one good in terms of another (opportunity cost).

What are divisible goods?

A: Goods that can be bought in any quantity (e.g., gasoline, electricity).

What combinations are affordable and unaffordable?

A: Points on or inside the budget line are affordable; points outside are unaffordable.

What is the budget equation?

A: PcQc + PmQm = Y (price × quantity of each good = income).

What is the relative price of movies in terms of cola?

A: Pm/Pc = 8/4 = 2cases of cola per movie.

How does a price decrease affect the slope of the budget line?

A: It flattens the slope because the relative price falls.

How does a change in income affect the slope?

A: It doesn’t; only the position of the line changes.

What does an indifference curve show?

A: Combinations of goods that provide the same level of satisfaction.

What is a preference map?

A: A collection of indifference curves showing higher and lower satisfaction levels.

What is the shape of an indifference curve?

A: Downward sloping and bowed toward the origin (concave up).

What area represents preferred combinations?

A: Points above an indifference curve.

What area represents less preferred combinations?

A: Points below an indifference curve.

What does the principle of diminishing marginal rate of substitution (MRS) state?

A: As more of one good is consumed, less of the other is given up for an additional unit.

• Example: As more of one good (say, pizza) is consumed, the consumer is willing to give up less of the other good (say, soda) to get an additional slice of pizza.

Define MRS.

A: The rate at which a consumer gives up one good to gain another while remaining equally satisfied.

What does a steep indifference curve indicate?

A: A high MRS—willing to give up a lot of one good for another.

What does a flat indifference curve indicate?

A: A low MRS—willing to give up little of one good for another.

What happens to MRS as more of one good is consumed?

A: As consumption of one good increases, MRS falls (diminishes) — reflecting diminishing willingness to substitute one good for another.

What does the shape of an indifference curve tell us?

A: The degree of substitutability between goods.

Describe indifference curves for ordinary goods.

A: Downward sloping, bowed toward the origin (concave up).

Describe indifference curves for perfect substitutes.

• Straight lines with constant MRS.

• Goods that can replace each other perfectly, such as different brands of marker pens.

• Their indifference curves are straight lines with a constant marginal rate of substitution.

Describe indifference curves for perfect complements.

A: L-shaped; extra units of one good don’t increase satisfaction without the other.

How does MRS behave for perfect substitutes and complements?

A: Constant for substitutes; undefined at the kink for complements.

What is the best affordable choice?

A: The point on the budget line that touches the highest possible indifference curve.

What is true at the best affordable point?

A: MRS (Marginal Rate of Substitution) = relative price.

What is the price effect?

A: The change in quantity consumed due to a change in price.

What happens when the price of a movie falls from $8 to $4?

A: Lisa’s budget line flattens, and she moves from 2 to 6 movies per month.

What is the substitution effect?

A: Consumers buy more of the cheaper good (movies) and less of the relatively expensive one (cola).

How is the demand curve derived?

A: By plotting price-quantity pairs from different budget lines (e.g., 2 movies at $8, 6 at $4).

What is the income effect?

A: The change in consumption due to a change in income, holding prices constant.

what happens when Lisa’s income decreases from $40 to $28?

A: She buys fewer movies (4) and less cola (3).

Are movies and cola normal or inferior goods for Lisa?

A: Normal—she buys less when income falls.

What happens to the demand curve when income decreases?

A: It shifts leftward.

For a normal good, what is the direction of substitution and income effects when price falls?

A: Both increase quantity demanded.

What happens for an inferior good when income rises?

A: Quantity demanded decreases.

When do the substitution and income effects offset each other completely?

A: When the negative income effect exactly equals the positive substitution effect—perfectly inelastic demand.

Can demand ever slope upward?

A: Only rarely, if the negative income effect exceeds the substitution effect.

What does “utility” mean in economics?

A: Satisfaction or pleasure derived from consuming goods and services.

Who introduced the concept of utility?

A: Jeremy Bentham.

What is Bentham’s “greatest happiness principle”?

A: Actions are right if they promote the greatest happiness for the greatest number.

Why is utility important in consumer theory?

A: It helps explain how individuals make choices under scarcity.

What is the general form of the budget equation?

A:
PxQx + PyQy = Y
(where Px and Py​ are prices of goods X and Y, Qx​ and Qy​ are quantities, and Y is income.)

What is the slope of the budget line in Lisa’s example given that the price of a movie is $8 and cola is $4?

A:
Slope = −Pm/Pc = −8/4 = −2
Meaning: to get one more movie, she must give up 2 cases of cola.

What does “real income in terms of a good” mean?

A:
It measures how many units of that good your income can buy.

formula for real income in terms of good X?

A:
Real income in terms of X = Y/Px

What is the relative price of good X in terms of good Y?

A:
Px/Py

What does MRS measure?

A:
The rate at which a consumer is willing to give up one good (Y) to get one more unit of another good (X) while maintaining the same satisfaction level.

How is MRS represented mathematically?

A:
MRS=−(slope of the indifference curve)=ΔY/ΔX

At the consumer’s optimal (best affordable) choice, what equality must hold?

A:
MRS=Px/Py

What does this equality mean conceptually?

A:
The consumer’s willingness to trade between goods (MRS) equals the market’s trade-off (relative price).

In other words, satisfaction is maximized when the personal rate of substitution matches the actual price ratio.

What happens if MRS > relative price?

A:
The consumer values the good more than the market does → they will buy more of that good until equality holds.

What happens if MRS < relative price?

A:
The consumer values the good less than the market does → they will buy less of that good until equality holds.