ECON C2001H

What’s the equation for an optimal consumption bundle?

MU₁ / P₁ = MU₂ / P₂

How do you find the optimal consumption bundle?

marginal utility per dollar is equal for both goods

normative statement

opinion

positive statement

objective fact

Law of Demand

as price increases, quantity demanded decreases

Law of Supply

as the price rises, the quantity supplied rises

income effect

higher prices make you feel poorer

substitution effect

switch to cheaper alternatives

Supply ____ when the graph shifts right.

increases

Supply ____ when the graph shifts left.

decrease

Price control set below equilibrium price does what?

prevents market from reaching balance; leads to a shortage

What causes shortages in the market?

quantity demanded exceeds quantity supplied

How does a decrease in average income affect normal goods?

Demand curve shifts left.

Two goods that are complements have ____.

negative cross-price elasticity

Negative marginal utility means _____.

consuming an additional unit decreases total utility

scarcity

everything is limited

opportunity cost

value of the next best alternative given up when making a choice

Movements along the demand / supply curve are only caused by ____.

a change in the price of the good itself

Demand shifts are caused by _____.

changes in income, taste, prices of subs / comps, expectations

Supply shifts are caused by _____.

changes in input costs, technology, number of sellers, production stocks

market equilibrium

Q_D = Q_S

Prices above equilibrium cause _____

a surplus

Prices below equilibrium cause _____

a shortage

elastic

E > 1

inelastic

E < 1

unitary elastic

E = 1

cross-price elasticity

negative for complements; positive for substitutes

income elasticity

positive for normal goods; negative for inferior goods

relativity (decoy effect)

the tendency to estimate the value of things based on how they compare to other available options, rather than their absolute value

anchoring

when a person relies too heavily on the first piece of information offered when making decisions

social proof

psychological phenomenon where people assume the actions of others in an attempt to reflect correct behavior for a given situation

arbitrary coherence

once an “anchor” is established, it shapes both the present price and willingness to pay for future products

If the income elasticity is positive, it is a _____ good

normal good

If the income elasticity is negative, it is a _____ good

inferior good

If the cross-price elasticity is positive, it is a _____

substitute

If the cross-price elasticity is negative, it is a _____

complement