Consumer and Producer Theory: Utility, Budget Constraints, and Profit Maximization

What is a consumption bundle?

A bundle of different goods for a consumer to choose from, influenced by preferences, budget constraints, and rationality.

What does utility measure?

Utility measures happiness or satisfaction derived from consuming goods.

What is marginal utility?

The change in utility from consuming an additional unit of a good, which typically diminishes as consumption increases.

What is the relationship between total utility and marginal utility?

Total utility can be found by adding marginal utility to the previous total utility.

What are indifference curves?

Curves that represent bundles of goods that provide the same level of utility to the consumer.

What are the four properties of indifference curves?

1. Higher curves are preferred. 2. They slope downwards. 3. They do not cross. 4. They are convex.

What is a budget constraint?

A line on a graph that shows the combinations of goods a consumer can afford given their income.

What happens to the budget constraint when income increases?

The budget constraint shifts outward, increasing both the x-intercept and y-intercept while keeping the slope the same.

What are normal goods?

Goods for which demand increases as income rises.

What are inferior goods?

Goods for which demand decreases as income rises.

What is the income effect?

The change in consumption of two goods as a result of an increase in income.

What is the substitution effect?

The change in consumption due to a change in the relative prices of goods.

What is the profit function?

Profit is calculated as total revenue minus total cost (π = TR - TC).

What is the condition for maximizing profits?

To maximize profit, the slope of the profit function should be zero, which occurs when marginal revenue equals marginal cost (MR = MC).

What are variable costs?

Costs that depend on the level of output, such as labor and materials.

What are fixed costs?

Costs that do not change with the level of output, such as rent and salaries.

What is marginal cost?

The change in total cost that results from producing one additional unit of output.

What is average cost?

Total cost divided by the quantity of output produced.

What is the optimal quantity for a firm?

The quantity where marginal revenue equals marginal cost (MR = MC).

When should a firm enter a market?

A firm should enter when profits are greater than zero (π > 0).

When should a firm exit a market?

A firm should exit when profits are less than zero (π < 0) or when costs exceed revenues.

What distinguishes ordinary goods from Giffen goods?

Ordinary goods see a decrease in demand when prices rise, while Giffen goods see an increase in demand despite rising prices.