Econ Chapter 25

Utility

the benefit consumers get from consuming goods

Budget Constraint

shows all the consumption bundles a consumer can afford, given the consumers income and prices

Budget Line

shows all the consumption bundles where spending = income

relative price equation

price in question / price of other object

Marginal Utility

the change in utility from consuming an additional unit

Diminishing Marginal Utility

each additional unit of a good adds less utility than the previous did

Total utility is reached when…

marginal utility A / price A = marginal utility B / price B

if marginal utility A / price A > marginal utility B / price B

total utility will rise if the consumer buys more of unit A and vise versa

Optimal Consumption Rule

to maximize utility, a consumer should allocate spending so that the marginal utility per dollar is equal for all purchases

Indifference Curve

a curve connecting all combinations of goods that give the consumer the same utility

Marginal Rate of Substitution

the rate at which the consumer is willing to trade one good for another and remain indifferent (neg slope of indifference curve)

the further away the indifference curve is from the origin, the more or less utility it gives

more

Optimal Consumption Bundle

on the highest indifference curve but still on the budget constraint (slope of indifference curve = slope of budget constraint)

what happens on a budget constraint graph when income increases

it pushes it outward and parallel to the old budget constraint

What happens on a budget constraint graph when prices increase

increases the slope and pushes the constraint inward along the horizontal axis

The substitution effect

the change in demand of a good as a result of a change in price compared to its substitutes

The income effect

the change in consumption caused by the change in purchasing power from a price change