1.

Define the following terms: marginal utility, ordinal utility, marginal rate of substitution,
equal marginal principle, demand function, substitution effect, income effect, normal good,
inferior good, perfect complement, and perfect substitute. 22 points

Marginal Utility calculates the additional utility acquired by consuming one additional unit
of a good while holding all other goods constant. It is an essential concept in economic analysis
since optimizing individuals focus on the marginal (incremental) benefits and costs in making
consumption choices.

Ordinal Utility is a ranking choice by order of preference. However, it does not give the
magnitude of how much a consumer prefers a good or the exact numerical figures for the utility.

The Marginal Rate of Substitution represents the absolute value of the slope of an
indifference curve. It reflects the individual's willingness to trade at a point on an indifference
curve.

The Equal Marginal Principle asserts that the marginal utility to price ratio is equivalent to all
goods at the consumer's ideal consumption bundle. At any combination where this situation does
not hold, the consumer can be made better off by creating feasible changes in the consumption
bundle.

Demand Function articulates the mathematical relation between the quantity demanded for a
product, like how many units consumers will buy, and the factors that define consumer choices,
such as the prices and income.

Substitution Effect is the shift in the quantity demanded of good once its price changes,
resulting in a hold in other goods' prices and a constant utility.

Income Effect is the difference in the quantity demanded of a good because of a change in
purchasing power, holding prices constant.

Normal Good is the term called to the goods for which demand increases with income.

Inferior Good is the word called to define the goods with demands that vary inversely with
income.

Perfect Complement is where the indifference curve is shaped as a right angle. In this
instance, the two goods are used in fixed proportions. An individual receives no additional utility
from receiving more units of just one of the goods.

Perfect Substitute is where the indifference curve is a straight line. In this case, the Marginal
Rate of Substitution (MRS) does not change as the person receives more of one good relative to
the other

2. Alona Flores has decided to stay in a lower-paid position with a local electric company
rather than accept a much higher-paying job with a new information technology company.
Use a risk model to explain her decision. 8 points
From in risk model point of view, Alona Flores' decision to stay in a lower-paid position in
a local electric company exhibits a Risk Aversion, making her a risk-averse individual. Risk
Aversion is a concept where an individual is faced with uncertainty, then their way of reacting to
the uncertainty is by turning away from it and choosing the lower risk. Then, since Alona prefers a
lower standard deviation meaning a lower uncertainty or risk, she showcases the Risk Aversion
or calls them a Risk-averse individual. Moreover, her choice to go with the lower uncertainty also
makes her have a lower return from her decision, unlike if she chooses the higher-paying job in a
new information technology company, she would have a greater return, yet a high uncertainty or
risk. In layman's terms, Alona is playing safe in her decision to take in the lower risk position,
making her a risk-averse individual, demonstrating the risk model of Risk Aversion.

3.  What does the tangency between an indifference curve and the budget line determine?
10 points

The tangency between the indifference curve and the budget line leads to the utility
maximizing situation or optimal choice for any rational consumer. In simple terms, it is the point of
alternative where the consumers prefer the most.

It is for the reason that the tangency between the indifference curve and the budget line
indicates that the slope of the indifference curve or the Marginal Rate of Substitution(MRS) is
equal to the slope of the budget line or price ratio of the two goods in concern.

It indicates that the point of tangency illustrates that the ratio of Marginal Utility of two
goods is equivalent to the price ratio of both goods, which is the utility-maximizing condition.

In which, the tangency point is the ideal solution for the consumers as, at this point, the
marginal satisfaction gained by the consumer by purchasing a particular bundle of goods is
equivalent to the marginal cost that they are paying to buy that specific bundle.

In other terms, the willingness of the consumers to trade the two goods is equivalent to
the rate at which they are to be bought or traded in the market.

Showing, that the point of tangency between the indifference curve and the budget line
depicts that the marginal benefit of trading one good for the other is greater than the marginal
cost. Hence, making it a much favorable choice for the consumer.