Consumer Choice Theory Flashcards

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What do indifference curves graphically represent?

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Combinations of two goods that offer the same level of satisfaction to a consumer.

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What are the three primary characteristics of indifference curves?

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Downward sloping, Convex to the Origin, and Non-Intersecting.

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Flashcards based on lecture notes about indifference curves, budget lines, and consumer behavior.

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33 Terms

1
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What do indifference curves graphically represent?

Combinations of two goods that offer the same level of satisfaction to a consumer.

2
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What are the three primary characteristics of indifference curves?

Downward sloping, Convex to the Origin, and Non-Intersecting.

3
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What does 'utility' represent in the context of indifference curves?

The level of satisfaction or happiness a consumer derives from consuming a combination of goods.

4
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What is the Marginal Rate of Substitution (MRS)?

The rate at which a consumer is willing to give up one good in exchange for another while maintaining the same level of utility; the slope of the indifference curve.

5
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What does the budget line represent?

All the combinations of two goods that a consumer can purchase given their income and the prices of these goods.

6
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In the budget line equation PxX + PyY = I, what do Px and Py represent?

The prices of goods X and Y, respectively.

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How does an increase in income or a decrease in the price of either good affect the budget line?

It causes the budget line to shift outwards, allowing a consumer to afford a higher combination of goods.

8
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What is consumer equilibrium?

The point where the budget line is tangent to an indifference curve; the consumer achieves the highest possible satisfaction within their budget constraints.

9
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What does the tangency point between the budget line and indifference curve indicate?

The slope of the budget line (price ratio of the two goods) is equal to the MRS; indicates the optimal consumption bundle.

10
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How does an increase in income typically affect the consumption of normal goods?

It results in the consumer moving to a higher indifference curve due to the outward shift of the budget line, indicating higher consumption.

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How might an increase in income affect the consumption of inferior goods?

It might lead to a decrease in consumption, as consumers prefer more desirable substitutes.

12
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What is one limitation of indifference curve analysis related to utility?

Utility is a subjective concept and cannot be directly measured or observed.

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What does the convex shape of an indifference curve towards the origin reflect?

The principle of diminishing marginal utility.

14
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What do straight-line indifference curves indicate?

Perfect substitutes, indicating a constant MRS.

15
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How do income changes influence the budget line?

An increase in income shifts the budget line outward, allowing access to higher indifference curves.

16
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How do price changes influence the budget line?

A decrease in the price of one good pivots the budget line outward from that axis, increasing the affordable quantity of that good.

17
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What is a budget line?

A boundary that illustrates the limit of consumption possibilities for a consumer, based on their income and the prices of goods.

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How does an income increase impact the budget line?

An increase in income shifts the budget line outward, consumer can afford more quantities of both goods.

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How does a rise in the price of one good affect the budget line?

It causes the budget line to pivot inward around the unchanged good's axis.

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What does the slope of the budget line indicate?

The rate at which a consumer can trade one good for another, based on their relative prices.

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What does elasticity measure in relation to the budget line?

How sensitive consumers are to changes in income and prices.

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What is the income effect?

The impact of changes in a consumer's income on their purchasing behavior.

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What is the substitution effect?

Occurs when consumers change their preference between goods due to a change in relative prices, keeping their level of satisfaction constant.

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What is the price effect?

The cumulative impact of the income and substitution effects resulting from a change in the price of a good.

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How does an increase in income affect the demand for normal goods?

Demand typically increases as these goods become more affordable.

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What happens to the demand for inferior goods as income increases?

Demand decreases as consumers opt for better alternatives.

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How sensitive are luxury goods to changes in income?

Highly sensitive; an increase in income often leads to a disproportionate increase in demand.

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How are necessity goods affected by changes in income?

Less affected; demand remains relatively constant despite changes in income.

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What is a key assumption underlying the income, substitution, and price effects?

Consumers always make rational decisions to maximize their utility.

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What is a key limitation of the indifference curve model?

The assumption of rationality, disregarding emotional, cultural, and social influences.

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What does the assumption of complete information imply in the indifference curve model?

Consumers have complete and perfect information about the goods they are choosing from, which is often not the case in reality.

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What does the assumption of divisibility of goods mean in the indifference curve model?

Goods are considered divisible into infinitely small units, ignoring the fact that many goods are indivisible.

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What is homothetic preference

Consumers scale up their consumption patterns proportionally with income changes