# Review for Test Two Fall 2014 - Review for Test Two Fall...

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Review for Test Two Fall 2014 Chapters: 4 thru 8 Terms to Know: Indifference (or “Utility”) Curve : A curve showing the combinations of all of the different bundles of goods that provide the consumer with the same level of utility. (The consumer finds all bundles along the curve equally attractive.) Marginal Utility : Additional utility a consumer gets from an additional unit of a good. (MU X =dU/dX). Marginal Rate of Substitution: Absolute Slope of the Indifference Curve, measuring the willingness of a consumer to give up the good on the vertical axis (Good Y) for one more unit of the good on the horizontal axis (Good X). MRS = |dY/dX| measured along a utility curve. Example: If MRS = 2, the consumer is willing to give up, at most, 2 units of Y to get one more unit of X. Perfect Substitute : A good that a consumer can trade for another good, in fixed units, and receive the same level of utility. Perfect Complement: A good whose utility level depends on its being used in a fixed proportion with another good. Budget Constraint : A curve showing all the bundles a consumer can buy when spending all of their income Income Elasticity of Demand : Percent change in quantity demanded when income goes up 1%. E D Income = % Q D /% Income where % = percent change in Normal Good : consumers buy more of the good when their income goes up E D Income >0 Types of Normal Goods: Superior (or Luxury) Good : E D Income >1, Necessity : 0< E D Income <1 Engel Curve : Curve showing how consumption of good (usually on horizontal axis) varies with income (vertical axis) Income Effect : Effect of changing utility, keeping the slope the same. Note: it is possible to have an “income” effect even when income is unchanged. What we call an income effect is really an utility effect (moving to a higher or lower curve between points that have the same slope on each curve).
Substitution Effect : Effect of changing slope, keeping utility the same Marginal Product of Labor : Increase in total output due to the addition of one unit of labor, holding capital fixed in quantity. MP L = Q/ L Variable Input : An input whose quantity can be easily increased or decreased Fixed Input : An input whose quantity is fixed in size. (in our simple model, L is a variable input in both the short and long runs while K is fixed in short run and variable in the long run) The Law of Diminishing MP : as firm increases one of its inputs (holding the other inputs fixed in quantity), its marginal product (MP) will decline (after some point)