Consumers and Incentives - Key Vocabulary (Chapter 5)

Vocabulary flashcards covering the core concepts from the Consumer and Incentives section (Chapter 5), including the Buyer’s Problem, budget concepts, consumer equilibrium, and elasticity.

Buyer’s problem

The consumer’s decision problem: how to allocate spending among goods given tastes, prices, and a fixed budget.

Tastes and preferences

What a consumer likes or dislikes; in this framework, buyers seek the biggest bang for their buck and purchases reflect their preferences.

Budget set

All bundles of goods a consumer can afford with the given money, assuming no saving/borrowing and that purchases are in whole units.

Budget constraint

The boundary of the budget set showing the combinations of goods that exhaust the consumer’s budget given prices.

Opportunity cost

The value of the next-best alternative foregone when choosing one option over another.

Marginal benefits

The additional total benefit obtained from consuming one more unit of a good.

Marginal benefits per dollar spent

Marginal benefit divided by the price of the good; used to compare which goods give the most value per dollar.

Consumer equilibrium

The condition where the consumer equalizes marginal benefit per dollar across all goods: MBs/Ps = MBj/Pj.

Prices of goods

The monetary cost of goods; assumed fixed and exogenous in this model; prices do not rise with quantity due to demand.

Demand curve

A downward-sloping relationship between price and quantity demanded, reflecting consumers’ willingness and ability to pay.

Elasticity

A measure of how responsive one variable is to changes in another (e.g., price, income, or prices of other goods).

Price elasticity of demand

The percentage change in quantity demanded divided by the percentage change in price.

Arc elasticity of demand

A symmetric measure of elasticity that uses the average of starting and ending price and quantity to compute elasticity.

Cross-price elasticity of demand

The percentage change in quantity demanded of one good in response to a percentage change in the price of another good; indicates substitutes, complements, or independence.

Income elasticity of demand

The percentage change in quantity demanded in response to a percentage change in income; identifies inferior, normal (necessity), and normal (luxury) goods.

Substitutes

Goods with positive cross-price elasticity; an increase in the price of one good raises the demand for the other.

Complements

Goods with negative cross-price elasticity; a rise in the price of one reduces demand for the other.

Inferior goods

Goods with negative income elasticity; demand falls as income rises.

Normal goods (necessities vs luxuries)

Normal goods have positive income elasticity; necessities have 0–1, luxuries have greater than 1.

Determinants of price elasticity of demand

Factors affecting elasticity: closeness of substitutes, budget share spent on the good, and available time to adjust.

Total revenue and elasticity

If demand is inelastic, a price increase raises total revenue; if elastic, a price increase lowers total revenue; unit elastic leaves revenue unchanged.

Unit elastic

Elasticity equal to 1; price changes do not change total revenue.

Perfectly elastic

Elasticity tends toward infinity; quantity demanded changes infinitely with a tiny price move (horizontal demand curve).

Perfectly inelastic

Elasticity equals 0; quantity demanded does not respond to price changes (vertical demand curve).

Demand curve slope vs elasticity

The slope of a linear demand curve is constant, but elasticity varies along the curve.

Consumer surplus

The difference between what a buyer is willing to pay for a good and what the buyer actually pays.

Evidence-Based Economics (incentives)

Use of empirical experiments to evaluate how incentives (e.g., taxes or payments) affect behavior, such as smoking decisions.