What is the budget constraint of a consumer?
All combinations of goods the customer can afford given their income and prices of goods
Draw the budget constraint of a consumer that can consume only two goods.
Straight downward sloping line
Y Intercept = Income/price of good on y axis
X Intercept = Income/price of good on x axis
What is the slope of the budget constraint of a consumer?
Slope = -Px/Py
One X will cost the consumer SLOPE# of Y
What happens to the budget constraint of a consumer when the price of one good decreases.
When the price of one good decreases, since the goods are based on a ratio, the customer can now buy more of one good as compared to the other good.
The intercept of the good that got cheaper pivots outward along that axis.
Draw this change (budget constraint of a consumer when the price of one good decreases.) when the consumer can consume only two goods.
draw it rn
What happens to the budget constraint of a consumer when the income of the consumer increases. Draw this change when the consumer can consume only two goods.
When the income of a customer increases, the budget constraint’s intercepts also shift towards the right since now the consumer can afford more of the goods with the condition that they can only consumer 2 goods. Same slope maintains.
What is the “utility” for a consumer?
Utility is the satisfaction or happiness a consumer derives from consuming goods and services.
Utility increases as consumption increases but not at a constant rate. The rate at which this happens diminishes (Law of Diminishing Marginal Utility).
Define marginal utility of a consumer.
the additional satisfaction gained from consuming one more unit of a good or service.
What are indifference curves for a consumer?
Indifference curves show combinations of two goods that give a consumer the same level of satisfaction or utility.
Show all combinations of two goods that provide the same level of utility to a consumer
Points on the same curve make the consumer equally happy receiving that quantity
Higher curves = higher utility
Points A and B give the customer the same amount of utlity.
Points C gives the customer a higher amount of utility
These are drawn on Income/Price of good terms on each access.
Define the marginal rate of substitution of two goods for a consumer.
MRS is the rate at which a consumer is willing to give up one good to get more units of another good while keeping the same level of satisfaction.
MRS = MUx/MUy = slope of indifference curve
What is the slope of an indifference curve for a consumer?
Indifference curve slope = negative marginal rate of substitution
Slope = –MRS = –MUx/MUy
The slope is negative because the gain of one good they must give up some of the other
Downward sloping and bowed toward the origin due to diminishing marginal utility.
Explain how a consumer chooses the optimal bundle when she can consume only two goods.
It is where the highest indifference curve is tangent to the budget constraint = where highest indifference curve meets the budget constraint curve
AT THIS POINT → MUx/Px = MUy/Py
What would a rational consumer do if her marginal utility per dollar spent on bananas is higher than her marginal utility per dollar spent on watermelons?
A rational consumer would buy more bananas and less watermelon until the marginal utility per dollar is equal for both goods, maximizing total satisfaction.
–
She would buy more bananas and less watermelons since she gets more utility from each unit of banana compared to each unit of watermelons until the marginal utility is equalized on both goods.
Consumer stops adjusting when
MUbanana/Pbanana = MUwatermelon/Pwatermelon
What would a rational consumer do if her marginal utility per dollar spent on bananas is lower than her marginal utility per dollar spent on watermelons?
A rational consumer would buy more watermelons and fewer bananas until the marginal utility per dollar is equal for both goods.
–
She would buy fewer bananas and more watermelons to increase total utility.
Continues also until the marginal utility per dollar spent on each good is the same.
Equal marginal utility per dollar ensures that consumers allocate their income to maximize satisfaction.
