Exam 2 Study Guide Spring 2007

# Exam 2 Study Guide - John Ware Econ 251 Exam II Review I Utility and Demand a Budget Line line describing limits to consumption possibilities given

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John Ware 3/26/2007 Econ 251 Exam II Review I. Utility and Demand a. Budget Line – line describing limits to consumption possibilities given income and prices i. Slope = relative price of item on X-axis ii. Budget Line gets flatter when a price of a good goes up b. Max Utility where Mu 1/ P1 = Mu 2/ P2 c. Consumer Equilibrium – the max utility given the budget i. MRS = Px / Py = MUx / MUy d. Indifference Curve (IC) – combinations of goods that generate some level of utility i. Slope <0 ; ΔY/ΔX = how much am I willing to change Y when X changes ii. Marginal Rate of Substitution (MRS) – amount of good Y you are willing to give up to get one more of good X iii. │Slope│ = MRS iv. Diminishing MRS as X increases v. Higher IC’s are to the northeast, all points on higher IC’s will have higher level of utility 1. *Extreme Cases a. Perfect Substitutes (MRS is constant); results in linear IC i. Trade same amount always ii. Willing to give up same amount of 1 good to get another b. Fixed Complements; results in L-Shaped IC i. Example – only have 1 right shoes or 1 left shoe ii. Max Utility given Budget = find an affordable combination of goods on highest IC possible iii. Slope = - Px / Py (X is over Y because of change is price (P) vi. Maximizing Utility – the higher the Total Utility, the better the choice 1. Marginal Utility (Mu) / \$1 spent – marginal utility of a good divided by its price 2. Increase or Decrease consumption of goods until Mu1 / P1 = Mu2 / P2 3. Marginal Analysis: if Mu1 / P1 > Mu2 / P2 do more of good 1 *(units of utility do not matter)

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vii. Marginal Utility Theory 1. When the price of a good rises (P↑), the quantity demanded
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## This note was uploaded on 05/06/2009 for the course MGMT 25100 taught by Professor Blanchard during the Spring '09 term at Purdue University-West Lafayette.

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Exam 2 Study Guide - John Ware Econ 251 Exam II Review I Utility and Demand a Budget Line line describing limits to consumption possibilities given

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