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Chapter Review Chapter 5: The Consumption Decision

  1. The amount of one good a person must use to purchase another good is determined by the relative prices of the two goods, and is illustrated by the slope of the budget constraint.
  2. As a good becomes more expensive relative to other goods, an individual will substitute other goods for the higher-priced good.   This is the substitution effect.
  3. As the price of a good rises, a person’s buying power is reduced.  The response to this lower “real” income is the income effect.  Consumption of a normal good rises as incomes rise.  Thus, usually, when a price rises, both the substitution and income effects lead to decreased consumption of that good.
  4. When substitution is easy, demand curves tend to be elastic, or flat.  If substitution is difficult, demand curves tend to be inelastic, or steep.
  5. Economists sometimes describe the benefits of consumption by referring to the utility that people get from a combination of goods.  The extra utility of consuming one more unit of a good is referred to as the marginal utility of that good.
  6. Consumers will allocate their income so that the marginal utility per dollar spent is the same for all goods.
  7. Consumer surplus measures the difference between what a consumer would be willing to pay and what she has to pay (the market price.)
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