Microeconomics Key Concepts Quiz

Key Concepts in Consumer Behavior

• Budget Set: The collection of all possible combinations of goods a consumer can afford given their income and the prices of those goods.
• Budget Line: Represents the maximum possible expenditure on two goods, showing the trade-off between them at given prices.
• Downward Sloping Budget Line: Indicates that as a consumer increases consumption of one good, consumption of the other must decrease, due to limited income.
• Indifference Curve: Represents combinations of two goods that provide the same level of satisfaction to the consumer.
• Marginal Rate of Substitution: The rate at which a consumer is willing to substitute one good for another while maintaining the same level of utility.
• Utility Function: Reflects consumer preferences and satisfaction derived from different consumption bundles.

Consumer Preferences and Choices

• Monotonic Preferences: Consumers prefer more of a good to less, reflected in the upward direction of indifference curves.
• Diminishing Rate of Substitution: As a consumer substitutes one good for another, the additional satisfaction gained decreases.
• Consumer’s Optimum: The point where the budget line is tangent to an indifference curve, indicating maximum utility.
• Demand: The quantity of a commodity that consumers are willing and able to purchase at various price levels.

Laws and Effects on Demand

• Law of Demand: As the price of a good decreases, the quantity demanded generally increases, and vice versa.
• Demand Curve: A graphical representation of the relationship between price levels of a good and the quantity demanded; typically downward sloping.
• Substitution Effect: When the price of a good falls, consumers tend to buy more of that good instead of substitutes.
• Income Effect: As consumers' real income increases (due to lower prices), they may purchase more of a good, even if its price remains unchanged.

Types of Goods

• Normal Good: Demand increases as income rises.
• Inferior Good: Demand decreases as income rises.
• Substitutes: Goods that can replace one another; an increase in the price of one leads to an increase in demand for the other.
• Complements: Goods that are consumed together; an increase in the price of one results in a decrease in demand for the other.

Graphical Representations

• Demand Curve Representation: Price on the vertical axis, quantity on the horizontal axis; reflects how quantity demanded changes with price.
• Increasing and Decreasing Functions: Functions that describe demand behavior; increasing function rises with price, decreasing function falls with price.

Consumption Scenarios

• A consumer with an income (Rs 20) and prices (Rs 4 and Rs 5 for two goods) can calculate their budget line equation, maximum consumption of goods, and determine the slope.
• Changing income (Rs 40) expands the budget line outward; a decrease in the price of one good shifts the budget line outward along the other axis.
• If both prices and income double, the budget set remains proportionate, but real purchasing power changes.

Demand Function and Pricing

• The demand function illustrates the relationship between the price of a good (P) and the quantity demanded (X), typically expressed in the form (X = f(P)).
• A drop in the price of a good generally results in an increase in the quantity demanded, reinforcing the negative slope of the demand curve.
• Consumption equilibrium for two goods can be illustrated graphically with shifts in the budget line when prices or income change effectively.