Study Guide for Exam 2: Consumers & Incentives

A collection of flashcards based on key concepts, theories, and definitions from the study guide for Exam 2 on Consumers and Incentives.

What are the three components of the buyer's problem?

What the buyer likes, Prices of goods and services, How much money the buyer has to spend.

What is the consumer's ultimate goal when making a purchasing decision?

Maximize their utility (happiness).

What theory states that the best way to measure an individual's preferences is to observe their purchasing behavior?

Revealed Preference Theory.

When is a decision considered incentive compatible?

When an individual achieves their optimal outcome by acting according to their actual preferences.

What can we learn from hypothetical decisions made in surveys about individual preferences?

Stated Preference Theory.

Why are prices considered the most important incentives that economists study?

Because they allow us to formally measure relative tradeoffs between goods.

What is the budget set for a consumer?

The set of all possible bundles of goods and services that a consumer can buy with her income.

What does the budget constraint represent?

The set of all possible bundles of goods and services that a consumer can buy that exactly spends all of her income.

If a consumer's income decreases, how does this affect her budget constraint?

Her budget constraint will include fewer bundles than before.

What is the marginal benefit from eating the 4th slice of pizza if total benefits for 3 slices are $9 and for 4 slices are $10?

$1.

What is the decision rule for finding the consumer's optimal consumption bundle?

The marginal benefit that you gain from the last dollar spent on each good should be equal for all goods.

What equation shows the decision rule for finding the consumer's optimal bundle for two goods (X and Y)?

(MBX / PX) = (MBY / PY).

What does consumer surplus measure?

The difference between the consumer’s total benefit received and the consumer’s total cost paid for the good.

What does the Law of Demand state about quantity demanded and marginal benefit?

As quantity demanded increases, the consumer’s marginal benefit decreases.

What is the measure of total social surplus?

The sum of consumer surplus (CS) and producer surplus (PS).

What is the 'Golden Rule' that firms use to find the optimal, profit-maximizing quantity of output?

Marginal Cost (MC) = Marginal Revenue (MR).