MicroEconomics Chapter 9:Possibilities, Preferences, and Choices

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Budget Equation

answer

Describes the budget line. The equation starts with the fact that Expenditure=Income.
- Expenditure is (PaQa)+(PbQb)
- Income is Y
Step 1: Equation looks like.
(PaQa)+(PbQb)=Y
Step 2: Divide both sides of the equation by Pa.
(Qa)+(Pb/Pa)(Qb)=Y/Pp
Step 3: Now subtract (Pb/Pa)(Qb) from both sides.
Qa=(Y/Pp)-(Pb/Pa)(Qb)
Step 4:Sub in the quantity for Qb and get Qa=Qb

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Real Income

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It is income expressed by the quantity of goods that the household can afford. It is money income divided by Pa or Pb.

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Relative Price

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Is the price of one good divided by the price of another. Pa/Pb tells you what amount of Qa gives you one amount of Qb.

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A Change in Price

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If the price of of a product falls, the budget line rotates outwards and becomes less steep. If the price of a product rises, the budget line rotates inwards and becomes steeper. Has the same point on one axis and changes relative price, but does not change real income.

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A Change in Income

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An increase in money income increases real income and shifts the budget line rightward. A decrease in money income decreases real income and shifts the budget line leftward. Has the same slope and a change in money income changes real income, but does not change the relative price.

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Indifference Curve

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Is a line that shows the combinations of goods among which a consumer is indifferent. A consumer prefers a combination to the right of an indifference curve or on the indifference curve and does not prefer a point to the left of the indifference curve.

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A Preference Map

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Is a series of indifference curves that resemble the contour lines of a map. By looking at the shape of the indifference curves, we can draw conclusions about a persons preferences.

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Marginal Rate of Substitution(MRS)

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Is the rate at which a person will give up a good on the y-axis to get an additional good on the x-axis while remaining indifferent (Remaining on the same indifference curve)
- If the indifference curve is steep, the MRS is high and a person is willing to give up a large quantity of a good to get an additional unit of another while remaining indifferent.
- If the indifference curse is flat, the MRS is low and a person is willing to give up a small quantity of a good to get an additional unit of another while remaining indifferent.

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Measure MRS

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To measure the magnitude draw a straight line against the point on the indifference curve. Divide the number on the y-axis where the line reaches by the number on the x-axis where the line reaches. This gives you the rate at which someone is willing to give up a good on the y-axis, for a good on the x-axis.

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Diminishing Marginal Rate of Substitution

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Is a general tendency for someone to be willing to give up less of a good on the y-axis to get one more unit of a good on the x-axis, while at the same time remaining indifferent as the quantity on the x-axis increases.

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Degrees of Sustainability

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Perfect Substitutes: Their indifference curves are straight lines that slope downwards. The MRS is constant.
Perfect Complements: Their indifference curves are L-shaped. The MRS is not constant
Ordinary Goods: The indifference curves are sloped and are generally typical. MRS is diminishing.

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Price Effect

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The effect of a change in the price of a good on the quantity of a good consumed. Drop in price rotates budget line right or moves down in demand curve. Rise in price rotates budget line left or moves up in demand curve.

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Income Effect

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The effect of a change in income on buying plans. A drop in income shift both budget line and demand curve to the left. A rise in income shifts both budget line and demand curve to the right.

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Substitution Effect

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Is the effect of a change in price on the quantity bought when the consumer (hypothetically) remains indifferent between the original situation and the new one.

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question

Budget Equation

answer

question

Real Income

answer

It is income expressed by the quantity of goods that the household can afford. It is money income divided by Pa or Pb.

question

Relative Price

answer

Is the price of one good divided by the price of another. Pa/Pb tells you what amount of Qa gives you one amount of Qb.

question

A Change in Price

answer

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A Change in Income

answer

question

Indifference Curve

answer

question

A Preference Map

answer

Is a series of indifference curves that resemble the contour lines of a map. By looking at the shape of the indifference curves, we can draw conclusions about a persons preferences.

question

Marginal Rate of Substitution(MRS)

answer

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Measure MRS

answer

question

Diminishing Marginal Rate of Substitution

answer

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Degrees of Sustainability

answer

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Price Effect

answer

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Income Effect

answer

The effect of a change in income on buying plans. A drop in income shift both budget line and demand curve to the left. A rise in income shifts both budget line and demand curve to the right.

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Substitution Effect

answer

Is the effect of a change in price on the quantity bought when the consumer (hypothetically) remains indifferent between the original situation and the new one.

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MicroEconomics Chapter 9:Possibilities, Preferences, and Choices

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