Budget Constraints, Optimal Choice and Demand: every key term you need (+ practice quiz)
25 flashcard terms for Intermediate Microeconomics Topic 2, written to match the course framework. Study them here, then drill them as interactive flashcards, or test yourself with the 15-question quiz — free, no account needed.
The condition that total spending on all goods cannot exceed income. It defines the outer edge of what is affordable and converts an unlimited wish list into a well-defined constrained maximisation problem.
Budget line
The set of bundles costing exactly the consumer's income. Its slope is minus the price ratio, which is the market rate at which one good can be traded for another.
Budget set
All bundles the consumer can afford, that is the triangle bounded by the budget line and the axes. It is convex and compact, which is what guarantees an optimum exists.
Opportunity cost of a good
The amount of the other good given up to buy one more unit, measured by the price ratio. It is the market counterpart to the marginal rate of substitution the consumer feels internally.
Numeraire good
A good whose price is normalised to one so all other prices are expressed relative to it. Only relative prices and real income matter, so this normalisation loses no information.
Proportional price and income change
Scaling every price and income by the same positive factor leaves the budget set unchanged. Demand is therefore homogeneous of degree zero, which is why pure inflation alters no real choice.
Income change effect on the budget line
A rise in income shifts the budget line outward in parallel because the slope depends only on prices. The affordable set expands uniformly in every direction.
Own-price pivot
A fall in one price rotates the budget line outward around the intercept of the other good, steepening or flattening the slope while leaving the untouched intercept fixed.
Quantity tax
A fixed charge per unit purchased, which raises the effective price of the taxed good and rotates the budget line inward. The consumer faces a distorted relative price and substitutes away.
Ad valorem tax
A tax levied as a percentage of price, multiplying the effective price by one plus the rate. Like a quantity tax it distorts the relative price, but its size grows with the price itself.
Lump-sum tax
A fixed payment independent of what is bought, shifting the budget line inward without changing its slope. Because relative prices are untouched it creates no substitution distortion.
Rationing constraint
A legal ceiling on the quantity of one good, which chops the budget set with a vertical or horizontal cut. The consumer may end up at the ration limit rather than at a tangency.
Interior optimum
A best bundle with strictly positive amounts of both goods. Here the tangency condition holds: the marginal rate of substitution equals the price ratio and the budget binds.
Tangency condition
At an interior optimum the indifference curve just touches the budget line, so the rate the consumer will trade equals the rate the market offers. Any gap means a profitable rearrangement remains.
Equal marginal bang per dollar
The tangency rewritten so that marginal utility divided by price is the same for every good bought. If one good delivered more utility per dollar the consumer would shift spending toward it.
Corner solution
An optimum where the consumer buys none of some good because the tangency would require a negative quantity. The condition becomes an inequality rather than an equality at the boundary.
Lagrangian method for consumer choice
A technique that attaches a multiplier to the budget constraint and maximises the combined expression. The first-order conditions reproduce the tangency and the multiplier measures the marginal utility of income.
Marginal utility of income
The extra utility gained from one more unit of income at the optimum, given by the Lagrange multiplier. It converts money into utility units and appears throughout welfare comparisons.
Marshallian demand function
The optimal quantity of a good as a function of prices and income, obtained by solving the utility maximisation problem. It is what a demand curve plots once other prices and income are held fixed.
Individual demand curve
The graph of quantity demanded against own price with income and other prices fixed. It is a slice through the Marshallian demand function, not the whole function itself.
Market demand curve
The horizontal sum of individual demand curves at each price. Aggregation adds quantities rather than prices because every consumer faces the same price in a competitive market.
Price offer curve
The path traced by optimal bundles as one price varies with income and other prices fixed. Reading one coordinate against the changing price recovers the ordinary demand curve.
Income offer curve
The locus of optimal bundles as income varies at fixed prices, also called the income expansion path. Its shape reveals whether goods are normal or inferior over each income range.
Engel curve
The relationship between income and the quantity of one good demanded at fixed prices. Upward-sloping segments mean the good is normal and downward-sloping segments mean it is inferior there.
Indirect utility function
The maximum utility attainable given prices and income, found by plugging optimal demands back into utility. It is decreasing in prices, increasing in income and homogeneous of degree zero.