Micro-Economics AP Chapter 7 Vocabulary & Review

The principle that as a consumer increases the consumption of a good or service, the marginal utility obtained from each additional unit of the good or service decreases.

The want-satisfying power of a good or service; the satisfaction or pleasure a consumer obtains from the consumption of a good or service (or from the consumption of a collection of goods and services).

The total amount of satisfaction derived from the consumption of a single product or a combination of products.

The extra utility a consumer obtains from the consumption of 1 additional unit of a good or service; equal to the change in total utility divided by the change in the quantity consumed.

Utility is the benefit or satisfaction a person receives from consuming a good or a service.
The law of diminishing marginal utility indicates that gains in satisfaction become smaller as successive units of a specific product are consumed.
Diminishing marginal utility provides a simple rationale for the law of demand.

Human behavior based on comparison of marginal costs and marginal benefits; behavior designed to maximize total utility.

The limit that the size of a consumer's income (and the prices that must be paid for goods and services) imposes on the ability of that consumer to obtain goods and services.

The principle that to obtain the greatest total utility, a consumer should allocate money income so that the last dollar spent on each good or service yields the same marginal utility (MU). For two goods X and Y, with prices Px and Py, total utility will be maximized by purchasing the amounts of X and Y such that MU x Px= MUy Py for the last dollar spent on each good.

In marginal utility theory, the combination of goods purchased that maximizes total utility by applying the utility - maximizing rule. In indifference curve analysis, the combination of goods purchased that maximizes total utility by enabling the consumer to reach the highest indifference curve, given the consumer's budget line (or budget constraint).

A change in the quantity demanded of a product that results from the change in real income (purchasing power) caused by a change in the product's price.

(1) A change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in the good's own price; (2) the reduction in the quantity demanded of the second of a pair of substitute resources that occurs when the price of the first resource falls and causes firms that employ both resources to switch to using more of the first resource (whose price has fallen) and less of the second resource (whose price has remained the same).

The theory of consumer behavior assumes that, with limited income and a set of product prices, consumers make rational choices on the basis of well-defined preferences.
A consumer maximizes utility by allocating income so that the marginal utility per dollar spent is the same for every good purchased.
A downsloping demand curve can be derived by changing the price of one product in the consumer-behavior model and noting the change in the utility-maximizing quantity of that product demanded.
By providing insights on the income effect and substitution effect of a price decline, the utility-maximization model helps explain why demand curves are downsloping.

1. Define and explain the relationship between total utility, marginal utility, and the law of diminishing marginal utility.
The law of diminishing marginal utility states that beyond a certain quantity, additional units of a specific good will yield declining amounts of extra satisfaction to a consumer.
2. Describe how rational consumers maximize utility by comparing the marginal utility-to-price ratios of all the products they could possibly purchase.
The utility-maximization model assumes that the typical consumer is rational and acts on the basis of well-defined preferences. Because income is limited and goods have prices, the consumer cannot purchase all the goods and services he or she might want. The consumer therefore selects the attainable combination of goods that maximizes his or her utility or satisfaction.
A consumer's utility is maximized when income is allocated so that the last dollar spent on each product purchased yields the same amount of extra satisfaction. Algebraically, the utility-maximizing rule is fulfilled when
The Marginal Utility of product A divided by the price of product A equals the Marginal Utility of product B divided by the price of product B.
and the consumer's total income is spent.
3. Explain how a demand curve can be derived by observing the outcomes of price changes in the utility-maximization model.
The utility-maximizing rule and the demand curve are logically consistent. Because marginal utility declines, a lower price is needed to induce the consumer to buy more of a particular product.
4. Discuss how the utility-maximization model helps highlight the income and substitution effects of a price change.
The utility-maximization model illuminates the income and substitution effects of a price change. The income effect implies that a decline in the price of a product increases the consumer's real income and enables the consumer to buy more of that product with a fixed money income. The substitution effect implies that a lower price makes a product relatively more attractive and therefore increases the consumer's willingness to substitute it for other products.
5. Give examples of several real-world phenomena that can be explained by applying the theory of consumer behavior.
The theory of consumer behavior can explain many real world phenomena, including the rapid adoption of popular consumer goods like the iPad that feature disruptive technologies, the over consumption of products like health care that have artificially low prices, and why people often prefer gifts of cash to receiving particular items or objects of the same monetary value as gifts.