Chapter 3: Consumer Behavior

Question 1

Define market basket

Answer 1

It is a list with specific quantities of one or more goods (for example, units of food against units of clothing)

Question 2

The theory of consumer behavior begins with which three basic assumptions

Answer 2

1. Completeness - preferences are assumed to be complete, in other words consumers can compare and rank all possible baskets
2. Transitivity - preferences are transitive, this means that if a consumer prefers basket A to basket B and basket B to basket C, then the consumer also prefer A to C
3. More is better than less - consumers always prefer more of any good to less

Question 3

What is an indifference curve

Answer 3

It is a curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction

Question 4

Why does the indifference curve slope downwards

Answer 4

If it did not, it would violate the assumption that more is better than less

Question 5

What is an indifference map

Answer 5

Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent

Question 6

Indifferent curves cannot intersect, why?

Answer 6

It violates the assumption of transitivity as well as more is better than less

Question 7

If the price of one good increases the quantity of the other ___

Answer 7

Decreases

Question 8

What does the magnitude of the slope of an indifference curve measure

Answer 8

It measures the consumers marginal rate of substitution (MRS) between two goods

Question 9

Define what the marginal rate of substitution is

Answer 9

Maximum amount of a good that a consumer is willing to give up in order to obtain an additional unit of another good

Question 10

True or False

The slope of the curve becomes less negative as we move down (difference becomes smaller)

Answer 10

True

Question 11

*What are perfect complements

Answer 11

Two goods for which the MRS is zero or infinite, the indifferent curves are shaped as the right angles

Question 12

What are perfect substitutes

Answer 12

Two goods for which the marginal rate of substitution of one for the other is a constant (straight downward sloping)

Question 13

What is utility

Answer 13

Numerical score representing the satisfaction that a consumer gets from a given market basket

Question 14

What is the first consumer theory assumption

Answer 14

That consumers rely on relative rankings of market baskets

Question 15

What’s the difference between ordinal utility function and cardinal utility function

Answer 15

• ordinal utility function generates a ranking of market baskets in order of most to least preferred.
• cardinal utility function describes how much one market basket is preferred to another

Question 16

What is the second consumer theory assumptionI

Answer 16

Budget constraints consumers, based on limited income

Question 17

What is a budget line

Answer 17

Show all combinations of goods for which the total amount of money spent is equal to income

Question 18

Income changes alters the intercepts of the

Answer 18

Budget line but not the slope. If income increases budget line shifts outward and if income decreases budget line shifts to the left

Question 19

If price changes of one good ___

Answer 19

The intercept of that good will change.

If the price of a good increases, the intercept moves inward and if the price of a good decreases, the intercept moves outward. This is based on the effect of purchasing power of the consumer

Question 20

What two conditions need to be met under consumer choices

Answer 20

1. It must be located on the budget line - any market basket to the left or right leaves portion of the income and spent
2. It must give the consumer the most preferred combination of goods and services

Question 21

A market basket that maximises satisfaction will always lie on

Answer 21

On the highest indifference curve that touches the budget line.

Question 22

What’s the difference between marginal cost and marginal benefit

Answer 22

• marginal cost is the cost of obtaining one additional unit of a good.
• marginal benefit is the benefit from the consumption of one additional unit of a good

Question 23

What is a corner solution

Answer 23

It is a situation in which the marginal rate of substitution for one good in a chosen market basket is not equal to the slope of the budget line

Question 24

When one of the goods is not consumed the market bundle is at the ___ of an indifference curve

Answer 24

corner

Question 25

What is marginal utility

Answer 25

It is the additional satisfaction obtained from consuming one additional unit of a good

Question 26

Define diminishing marginal utility

Answer 26

Principle that as more of a good is consumed the consumption of additional amounts will decrease as the more is consumed

Question 27

What is the equal marginal principle

Answer 27

Principle that utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods

Question 28

What is the theory of consumer behaviour

Answer 28

Consumers allocate income among different goods and services to maximise their well-being