KEY TERMS

budget constraint (or budget line)  shows the possible combinations of two goods that are affordable given a consumer’s limited income

consumer equilibrium  point on the budget line where the consumer gets the most satisfaction; this occurs when the ratio of the prices of goods is equal to the ratio of the marginal utilities.

diminishing marginal utility  the common pattern that each marginal unit of a good consumed provides less of an addition to utility than the previous unit

income effect  a higher price means that, in effect, the buying power of income has been reduced, even though actual income has not changed; always happens simultaneously with a substitution effect

law of diminishing marginal utility  As we consume more of a good or service, the utility we get from additional units of the good or service tends to become smaller than what we received from earlier units

law of diminishing returns  as we add additional increments of resources to producing a good or service, the marginal benefit from those additional increments will decline

marginal utility  the additional utility provided by one additional unit of consumption

marginal utility per dollar  the additional satisfaction gained from purchasing a good given the price of the product MU/Price

substitution effect  when a price changes, consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price; always happens simultaneously with an income effect

sunk costs  costs that we make in the past that we cannot recover

total utility  satisfaction derived from consumer choices