Key Terms

behavioral economics: a branch of economics that seeks to enrich the understanding of decision-making by integrating the insights of psychology and by investigating how given dollar amounts can mean different things to individuals depending on the situation

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

fungible: the idea that units of a good, such as dollars, ounces of gold, or barrels of oil are capable of mutual substitution with each other and carry equal value to the individual

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

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

total utility: satisfaction derived from consumer choices

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