Question

Explain household behavior and consumer choices in economics . use economics terms like budget constraint, diminishing marginal utility, utility maximizing rule, income effect to explain your answer

Answer 1

Note that the consumer has a demand which means that the quantity of a good which a consumer wants to buy at the given prices and the given income constraint. The satisfaction which a consumer gets from consuming the goods is called utility. The curve which represents the utility of the consumer from the consumption of two goods (assumed) is called the indifference curve. This curve is the locus of a combination of two goods a consumer can consume and get the same utility at any of the combinations of goods. The slope of this curve is called the ration of the marginal utility of two goods. Note that the marginal utility is the change in the utility of a consumer when an additional unit of a good is consumed. With the additional units consumed, note that the additional utility keeps on declining and hence we have the diminishing marginal utility

On the other hand, the consumer is faced with the budget constraint which tells the combination of two goods which can be purchased from the available income at the given prices and this expenditure exhausts the income of the consumer. The budget constraint is a line which has a slope equal to the ratio of prices of two goods.

The utility-maximizing rule is where the indifference curve is tangent to the budget line which means that the slope of the indifference curve is the same as the slope of the budget line. Hence as per the utility-maximizing rule:

(MUx/MUy)=(Px/Py)

Now the income effect tells the change in the consumption of goods when the income of a consumer changes. This is because the change in the income changes the purchasing power of the consumer and hence the quantity of purchase of the two goods. Higher income would increase teh purchasing power and would make teh increase in consumption of normal and luxury goods.