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chapter 21 vocabulary

# chapter 21 vocabulary - o budget constraint The limit on...

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o budget constraint The limit on the consumption bundles that a consumer can afford. o Giffen good A good for which an increase in the price raises the quantity demanded. o income effect The change in consumption that results when a price change moves the consumer to a higher or lower indifference curve. o indifference curve A curve that shows consumption bundles that give the consumer the same level of satisfaction. o inferior good A good for which, other things equal, an increase in income leads to a decrease in demand. o marginal rate of substitution The rate at which a consumer is willing to trade one good for another. o normal good A good for which, other things equal, an increase in income leads to an increase in demand. o perfect complements Two goods with right-angle indifference curves. o perfect substitutes Two goods with straight-line indifference curves. o substitution effect The change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution. Chapter Recap: Summary o A consumer's budget constraint shows the possible combinations of different goods he can buy given his income and the prices of the goods. The slope of the budget constraint equals the relative price of the goods. o The consumer's indifference curves represent his preferences. An indifference curve shows the various bundles of goods that make the consumer equally happy. Points on higher indifference curves are preferred to points on lower indifference curves. The slope of an indifference curve at any point is the consumer's marginal rate of substitution–the rate at which the consumer is willing to trade one good for the other. o The consumer optimizes by choosing the point on his budget constraint that lies on the highest indifference curve. At this point, the slope of the indifference curve (the marginal rate of substitution between the goods) equals the slope of the budget constraint (the relative price of the goods).

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o When the price of a good falls, the impact on the consumer's choices can be broken down into an income effect and a substitution effect. The income effect is the change in consumption that arises because a lower price makes the consumer better off. The substitution effect is the change in consumption that arises because a price change encourages greater consumption of the good that has become relatively cheaper. The income effect is reflected in the movement from a lower to a higher indifference curve, whereas the substitution effect is reflected by a movement along an indifference curve to a point with a different slope. o
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chapter 21 vocabulary - o budget constraint The limit on...

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