Principle of Economics Chapter 5: Consumer Behaviour
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Questions and Answers

What does consumer behavior refer to?

The study of consumers while engaged in the process of consumption.

What does 'utility' mean?

The satisfaction obtained from consuming goods or services.

Ordinal utility theory says that utility is measurable.

False (B)

What is the index used to measure utility in cardinal utility theory?

<p>Utils</p> Signup and view all the answers

What does the budget constraint depict?

<p>The limit on the consumption 'bundles' that a consumer can afford.</p> Signup and view all the answers

Why do people consume less than they desire?

<p>Their spending is constrained, or limited, by their income.</p> Signup and view all the answers

What does the budget constraint show?

<p>The various combinations of goods the consumer can afford given his or her income and the prices of the two goods.</p> Signup and view all the answers

What are Lisa's consumption choices limited by?

<p>Income, the price of a movie, and the price of soda.</p> Signup and view all the answers

What does Lisa's budget constraint show?

<p>The limits of her consumption choices</p> Signup and view all the answers

What is the equation for the budget constraint?

<p>I = PxX + PYY</p> Signup and view all the answers

What is the budget equation?

<p>Expenditure = Income</p> Signup and view all the answers

What is Lisa's budget equation?

<p>PSQS + PMQM = I or Y</p> Signup and view all the answers

What are the steps for deriving the budget constraint?

<p>Step 1: Find intercept on axis X and Y. Step 2: Draw the budget constraint.</p> Signup and view all the answers

What is the formula for the intercept on axis X?

<p>I/Px</p> Signup and view all the answers

What is the intercept on axis X for Lisa's budget constraint?

<p>5 (point F)</p> Signup and view all the answers

What does any point on the budget constraint line indicate?

<p>The consumer's combination or trade-off between two goods</p> Signup and view all the answers

What can Lisa afford if she buys no movies?

<p>10 case of Soda (point A)</p> Signup and view all the answers

What is the equation for calculating Lisa's real income in terms of soda?

<p>Qs = Y/PS - (PM/PS)QM</p> Signup and view all the answers

What does Y/Ps represent?

<p>Lisa's real income in terms of soda</p> Signup and view all the answers

What is a household’s real income?

<p>The income expressed as a quantity of goods the household can afford to buy</p> Signup and view all the answers

Where does Lisa's real income in terms of soda appear on her budget line?

<p>The point on her budget line where it meets the y-axis</p> Signup and view all the answers

What is a relative price?

<p>The price of one good divided by the price of another good</p> Signup and view all the answers

What is the magnitude of the slope of the budget line?

<p>Relative price (Px/Py)</p> Signup and view all the answers

What does the relative price show?

<p>How many cases of soda must be forgone to see an additional movie</p> Signup and view all the answers

What are the two factors that influence changes in budget constraints?

<ol> <li>Changes in price 2) Changes in income.</li> </ol> Signup and view all the answers

What happens to the slope of the budget line when the price of the good on the x-axis changes?

<p>The slope of the budget line changes</p> Signup and view all the answers

What happens to the budget line when there is a change in money income?

<p>It brings a parallel shift of the budget line</p> Signup and view all the answers

The slope of the budget line changes when there is a change in money income.

<p>False (B)</p> Signup and view all the answers

What does an indifference curve represent?

<p>All the possible combinations of two goods which will give the same level of satisfaction</p> Signup and view all the answers

What is an indifference schedule?

<p>A list of combination of two goods that give equal satisfaction to the consumer</p> Signup and view all the answers

What is an indifference map?

<p>A set of indifference curve</p> Signup and view all the answers

What is the slope of an indifference curve called?

<p>Marginal rate of substitution</p> Signup and view all the answers

What does a steep indifference curve indicate?

<p>The MRS is high</p> Signup and view all the answers

What is a diminishing marginal rate of substitution and what is it a key assumption of?

<p>A diminishing marginal rate of substitution is a general tendency for a person to be willing to give up less of good y to get one more unit of good x, while at the same time remaining indifferent as the quantity of good x increases. It is a key assumption of consumer theory.</p> Signup and view all the answers

A consumer is always willing to give up the same amount of one good for one more unit of another good.

<p>False (B)</p> Signup and view all the answers

Higher indifference curves are preferred to lower ones.

<p>True (A)</p> Signup and view all the answers

Indifference curves are upward sloping.

<p>False (B)</p> Signup and view all the answers

Indifference curves cross.

<p>False (B)</p> Signup and view all the answers

Indifference curves are bowed outward.

<p>False (B)</p> Signup and view all the answers

What does consumer equilibrium represent?

<p>The combination of goods on the highest possible indifference curve that the consumer can afford</p> Signup and view all the answers

What is the condition for consumer equilibrium?

<p>The slope of the indifference curve is equal to the slope of the budget constraint, or equivalently, MRS = - Px/Py</p> Signup and view all the answers

What is total utility?

<p>The total benefit a person gets from the consumption of goods</p> Signup and view all the answers

More consumption always leads to higher total utility.

<p>False (B)</p> Signup and view all the answers

What is marginal utility?

<p>The change in total utility that results from a unit-increase in the quantity of the good consumed</p> Signup and view all the answers

The principle of diminishing marginal utility states that as consumption increases more and more, marginal utility will be less and less.

<p>True (A)</p> Signup and view all the answers

What is the law of diminishing marginal utility based on?

<p>The idea that if a good has a variety of uses but only 1 unit of the good is available, then the consumer will use the first unit to satisfy his or her most urgent want</p> Signup and view all the answers

How does marginal utility from a good change as the quantity of the good increases?

<p>Marginal utility from a good decreases as the quantity of the good increases</p> Signup and view all the answers

If a consumer maximizes their utility, then what are the marginal utilities per dollar from all the goods consumed equal to?

<p>They are all equal</p> Signup and view all the answers

What happens to the marginal utility per dollar when the price of a good falls?

<p>The marginal utility per dollar rises</p> Signup and view all the answers

What is the consumer equilibrium condition in terms of marginal utilities per dollar?

<p>The marginal utility per dollar of all goods consumed is equal</p> Signup and view all the answers

What does the paradox of value refer to?

<p>The observation that water, which is essential to life, is much cheaper than diamonds, which are not essential</p> Signup and view all the answers

How is the paradox of value resolved?

<p>By distinguishing between total utility and marginal utility</p> Signup and view all the answers

Flashcards

Consumer Behavior

The study of consumer behavior while consuming goods and services.

Utility

The satisfaction obtained from consuming goods or services.

Ordinal Utility Theory

A theory that assumes utility is not measurable, but can be compared.

Cardinal Utility Theory

A theory that assumes utility is measurable and can be added by assigning numerical values to each option.

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Budget Constraint

A constraint that depicts the limit on consumption bundles a consumer can afford, based on their income and the prices of goods.

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Budget Constraint Line

A line illustrating the various combinations of two goods a consumer can afford with their income and the prices of the goods. It shows the trade-offs between different goods.

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Consumption Choices

The limit on the consumption 'bundles' that a consumer can afford. This concept is based on the idea that people consume less than they desire because their spending is constrained by their income.

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Household Real Income

Expressed as a quantity of goods the household can afford to buy, taking into account the prices of those goods.

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Relative Price

The ratio of one good's price to the price of another good. It shows the trade-off between two goods and how many of one good you must give up to get another.

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Slope of the Budget Constraint

The slope of the budget constraint, which is calculated as -Px/Py. It represents the rate at which one good must be forgone to obtain an additional unit of another good.

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Indifference Curve

A curve that represents all combinations of two goods that give a consumer the same level of satisfaction.

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Indifference Schedule

A list of different combinations of two goods that yield the same level of satisfaction for a consumer.

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Indifference Map

A set of indifference curves demonstrating the consumer's preferences for different combinations of goods. Higher indifference curves represent higher levels of satisfaction.

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Marginal Rate of Substitution (MRS)

The rate at which a consumer is willing to substitute one good for another while remaining indifferent. It is the slope of the indifference curve at any given point. It reflects the value they place on one good compared to another.

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Diminishing Marginal Rate of Substitution

The tendency for a consumer's willingness to substitute one good for another to decrease as the quantity of the first good increases. This means they are willing to give up less of the second good to obtain an additional unit of the first good.

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Consumer Equilibrium

The point where a consumer's budget constraint is tangent to the highest achievable indifference curve. This point represents the optimal allocation of income to maximize utility.

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Utility

The benefit or satisfaction a person derives from consuming a good or service.

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Total Utility (TU)

The total benefit or satisfaction derived from consuming all units of a good.

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Marginal Utility (MU)

The change in total utility that results from consuming one more unit of a good. It is the additional satisfaction from consuming an extra unit.

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Diminishing Marginal Utility

The principle that as the consumption of a good increases, the additional satisfaction (marginal utility) gained from each extra unit decreases.

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Utility Maximization

The maximum amount of total utility a consumer can achieve given their budget and the prices of goods.

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Marginal Utility Per Dollar

The marginal utility per dollar spent on a good, calculated by dividing MU by the price (MU/P). This helps consumers allocate their budget for maximum utility.

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Consumer Equilibrium

The situation where a consumer has allocated all their income in a way that maximizes their total utility, given the prices of goods. It occurs when MUM/PM = MUS/PS.

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Paradox of Value

A situation where essential goods like water are cheaper than non-essential goods like diamonds, seemingly contradictory to their values. It is resolved by understanding the distinction between total utility and marginal utility.

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High Total Utility, Low Marginal Utility

The total utility derived from consuming a good is large, while the marginal utility from consuming an additional unit is small.

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Low Total Utility, High Marginal Utility

The total utility derived from consuming a good is small, while the marginal utility from consuming an additional unit is large.

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Equal Marginal Utility Per Dollar

A condition that must be met in consumer equilibrium: Each ringgit spent on every commodity must yield the same marginal utility. This ensures the budget is allocated for maximum satisfaction

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Total Expenditure Equal to Budget

A condition that must be met in consumer equilibrium: The total sum of the expenditure on all goods must equal the total budget allocated to maximize utility.

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Study Notes

Course Title

  • Principle of Economics

Chapter 5: Theory of Consumer Behaviour

  • Consumer Behaviour: The study of consumer while engaged in the consumption process
  • Utility: The satisfaction obtained from consuming goods or services
  • Cardinal Utility Theory: Utility is measurable and can be added. Using the index called 'utils' to measure the utility.
  • Ordinal Utility Theory: Utility is not measurable but can be compared. This approach ranks consumer preferences(e.g., first, second, third etc).
  • The Budget Line/Constraint: Illustrates the available consumption "bundles" a consumer can afford. The budget is limited by income and the prices of the goods.

Concepts of Utility

  • Total Utility: The overall satisfaction a person derives from consuming a good or service

  • Marginal Utility: The change in total utility that occurs when a consumer consumes one additional unit of a good or service.

  • Diminishing Marginal Utility: As the quantity consumed of a good increases, the additional satisfaction (marginal utility) from it decreases. This is the key assumption in consumer theory

  • The Budget Equation. Expenditure = Income.

    • Budget equation for Lisa is:
    • PsQS + PMQM = I or Y
      • Where Ps = price of soda
      • Qs = quantity of soda
      • PM = price of a movie
      • QM = quantity of movies .
      • I or Y = Income

Deriving Budget Constraint

  • Step 1: Find the intercepts on the x-axis and y-axis using formulas.

    • Intercept on axis X = I/Px
    • Intercept on axis Y = I/Py

  • Step 2: Draw the budget constraint.

Indifference Curve

  • Indifference Curve: A curve that represents all possible combinations of two goods that give the same level of satisfaction to a consumer.

  • An indifference schedule is a list of combinations of two goods that yield equal satisfaction to the consumer.

  • Indifference Curve (Properties):

    • Higher indifference curves are preferred to lower ones
    • Indifference curves are downward sloping.
    • Indifference curves do not cross.
    • Indifference curves are bowed inward.

  • Marginal Rate of Substitution (MRS):

    • The rate at which a consumer is willing to trade one good for another
    • The slope of an indifference curve
    • Decreases as you move along an indifference curve

The Consumer Equilibrium

  • Consumer Equilibrium: The situation in which a consumer has allocated all of their available income to maximize their total utility.
  • It occurs at the point where the highest indifference curve and the budget constraint are tangent.

Predicting Consumer Choices

  • Choices at the Margin: Consumers make choices at the margin: spending one more dollar will result in greater utility if the MU per dollar is greater

  • Marginal Utility per Dollar (MU/P): The marginal utility from one additional dollar spent on a good compared to its price.

  • Consumer Utility Equilibrium: Achieved when the marginal utility per dollar from all goods are equal.

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Principle Of Economics Chapter 5 PDF

Description

This quiz explores Chapter 5 of the Principle of Economics, focusing on the Theory of Consumer Behaviour. It covers concepts such as utility, cardinal and ordinal utility theories, and the budget constraint, providing insight into how consumers make choices based on their preferences and limitations.

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