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Microeconomics: Consumer and Demand Concepts

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Terms in this set (25)

  • Utility

    measures the satisfaction or benefit a consumer receives from consuming goods and services.

  • Budget constraint equation

    The budget constraint shows all combinations of goods that exactly exhaust income: \(p_1x_1 + p_2x_2 = I\).

  • Budget set

    The budget set includes all affordable allocations, on or inside the budget line, defined by \(p_1x_1 + p_2x_2 \leq I\).

  • Budget-line slope

    If x1 is horizontal and x2 vertical, slope = \(-\frac{p_1}{p_2}\), representing opportunity cost of one more unit of good 1 in units of good 2.

  • Effect of income change on budget line

    An increase in income shifts the budget line outward in parallel; a decrease shifts it inward. The slope remains unchanged because prices are constant.

  • Effect of price change on budget line

    A price change of one good rotates the budget line by changing one intercept while the other stays fixed.

  • Opportunity cost

    Opportunity cost is the value of the next-best alternative given up when making a choice; it is not always monetary.

  • Sunk cost

    A sunk cost is a cost already incurred and unrecoverable; it should not affect current decisions.

  • Marginal benefit

    Marginal benefit is the additional benefit from consuming one more unit, usually diminishing as quantity increases.

  • Optimization using marginal benefit per dollar

    Consumers optimize by equalizing marginal benefit per dollar spent: \(\frac{MB_1}{p_1} = \frac{MB_2}{p_2}\), staying within budget.

  • Quantity demanded vs. demand

    Quantity demanded is the amount consumers buy at a specific price; demand is the entire price-quantity relationship.

  • Effect of price change on demand curve

    A change in a good's own price causes movement along the demand curve (change in quantity demanded), not a shift in demand.

  • Demand shifters

    Non-price factors like income, tastes, expectations, number of buyers, and prices of related goods shift the demand curve.

  • Normal goods

    For normal goods, demand increases when income rises and decreases when income falls.

  • Inferior goods

    For inferior goods, demand decreases when income rises and increases when income falls.

  • Substitutes

    Substitutes are goods used in place of each other; if the price of one rises, demand for the other increases.

  • Complements

    Complements are goods consumed together; if the price of one rises, demand for the other decreases.

  • Substitution effect

    The substitution effect occurs when a price change makes a good relatively cheaper or more expensive, changing consumption toward the cheaper good.

  • Income effect

    The income effect occurs when a price change alters purchasing power, affecting the quantity demanded as if real income changed.

  • Consumer surplus

    Consumer surplus is the difference between willingness to pay and price paid; graphically, it is the area below demand and above price.

  • Price elasticity of demand (PED)

    PED measures responsiveness of quantity demanded to price changes: \(PED = \frac{\% \Delta QD}{\% \Delta P}\).

  • Interpretation of PED values

    If |PED| = 0, demand is perfectly inelastic; if 0 < |PED| < 1, inelastic; if |PED| = 1, unit elastic; if |PED| > 1, elastic; if infinite, perfectly elastic.

  • Midpoint method for elasticity

    The midpoint method calculates percentage changes using averages to avoid direction bias in elasticity: \(\frac{new - old}{(new + old)/2} \times 100\).

  • Cross-price elasticity of demand

    Measures how quantity demanded of one good responds to price change of another: positive means substitutes, negative means complements, near zero means unrelated.

  • Income elasticity of demand

    Measures how quantity demanded responds to income changes: positive means normal good, negative means inferior good.