Individual consumption decisions are made with the goal of maximizing total satisfaction from consuming various goods and services, subject to the constraint that spending on goods exactly equals the income of the individual.
Consumer theory requires that consumers can rank all consumption bundles based on the level of satisfaction they would receive from different units of consumption
Utility is the benefits consumers obtain from goods and services they consume. The Marginal utility is the utility a consumer derives from the last unit of a consumer good they consume, ceteris paribus. The indifference curve analysis is a technique for explaining how choices between two alternatives are made. The marginal rate of substitution shows the rate at which one good can be substituted for another, while keeping utility constant
A budget line describes the limits to consumption choices and depends on a consumer budget and the prices of goods and services. The budget line shows all possible commodity bundles that can be purchased at given prices with a fixed money income.
A consumer behaves rationally and would always aim to maximize utility, given money income and prices of goods in the consumption basket. Consumer equilibrium is reached at a point where the budget line is tangent to the highest attainable indifference curve by the consumer subject to budget constraint.
A fall in the price of a good has two effects:
• Consumers will tend to buy more of the good that has become cheaper and less of those goods that are now relatively more expensive
• Because one of the good is now cheaper, consumers enjoy an increase in real purchasing power
Elasticity of supply is a measure of the way suppliers respond to change in price of the goods. It is the percentage change in the quantity supplied associated with a percentage change in the price.
Factors influencing the elasticity of supply include:
• Availability of resources required to make the product
• Amount of time required to make the product
• Skill level of the worker needed to make the product
• Time period for adjustment
Depending on the elasticity of supply and demand, taxation has some impacts on the price and the quantity.
Taxation has two kinds of incidence:
• Economic incidence: the division of a tax burden according to who actually pays the tax
• Legal incidence: the division of a tax burden according to who is required under the law to pay the tax
The economic incidence of a tax is independent of its legal incidence
Government regulations, price ceiling and price floor, inevitably prevents the market system from performing its function of rationing goods and services.
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