Ch 1 Consumer Sovereignty holds when consumers have

Ch. 1 Consumer Sovereignty holds when consumers have the power to dictate what is produced in the economy. -The individual’s preferences provide the basis for choosing between different goods and services. - Preferences drive the demand hence provide the signal in the marketplace as to what prices can be charged. - Neoclassical assumes that individuals have preferences which they use to rank the possible alternatives. - When preferences produce a ranked ordering , they can be said to be ordinal. - Neoclassicals assume that consumer rankings are consistent.

Ch. 1 Consumer Sovereignty - Indifference curve: represents all bundles of commodities which are ranked equally by the consumer. How such curve is used? Marginal Rate of Substitution: -The slope of the curve measures the rate at which a consumer is willing to give up one good in order to consume more of another. Give an Example. - What are the assumptions underlying the Indifference Curve? MRS diminshes. Indifference curves bow in towards the origin.

Ch. 1 Consumer Sovereignty Good F -Budget Constraint The Budget constraint is the frontier of the feasible consumption set. It represents the consumption bundles that can be afforded if all the consumer’s income is spent. T Y = P FF + P GG K Give an example A L Derive the Demand Curve D Good G

Ch. 1 Consumer Sovereignty Changes in price can have two main impacts on the behavior of consumers: -Substitution effect … measures the amount by which a consumer substitutes one good for another, maintaining the same level utility. -Income effect … measures the impact on the amount of the good consumed as a result of the consequent change in real income. A A’ Substitution effect, we keep the consumer in the same level of utility, the same curve. A’ B Income effect , the budget line shifts and new level of utility curve

Ch. 1 Consumer Sovereignty Giffen Goods: A good for which demand falls (rises) when its price falls (rise). Normal good: A commodity is defined as normal if its consumption increases and, conversely, its consumption falls when income is reduced. Inferior good: A commodity is defined as inferior if its consumption falls as income is increased and, conversely, its consumption increases when income is reduced.