11 Demand and Price Changes Flashcards
How do we find the optimal point of consumption?
What are the marginal utilities?
The MRS condition? The budget constraint?
Solve for x1 and x2.
4 steps to finding the optimal point of consumption
Define normal goods
Positive income elasticity
Define inferior goods
Negative income elasticity
Define necessities
Positive income elasticity between zero and one
Define luxury goods
Positive income elasticity greater than one
Define ordinary goods
Negative own-price elasticity
Define giffen goods
Positive own-price elasticity
Define price elastic
Own-price elasticity between -1 and -∞
Define price inelastic
Own-price elasticity between 0 and -1
Define complements
Negative cross-price elasticity
Define substitutes
Positive cross-price elasticity
When price changes, what are the two effects on the budget constraint?
- Change in relative prices of the good (change in slope) → substitution effect
- Change in the consumer’s purchasing power (area) → income effect
Suppose a relative price change of good 1, how do we show the substitution effect? + diagram
Holding utility constant, the budget constraint changes slope.
This changes the point at which the MRS = slope.
The change in quantity demanded is the substitution effect.
Train ticket to Weston-super-Mare
Suppose a change in budget, how do we show the income effect? + diagram
Holding relative prices constant at their new level, it shifts inwards/outwards.
This changes the quantity at which MRS = slope, the combination of goods does not.
The change in quantity demanded is the substitution effect.
Total effect (income + substitution) written algebraically
What is the substitution effect always?
As it shows the change in demand as its price changes (holding the utility number constant), the value is always weakly negative (or zero).
This is due to the convexity and downward-sloping characteristics of indifference curves generated by well-behaved preferences.
For a normal good, what are the signs of each effect and of total effect? Implication.
For an inferior good, what are the signs of each effect and of total effect?
What is the Slutsky equation? (own-price)
For derivative-sized changes the approximation disappears.
What is the Slutsky equation? (cross-price) + implication
What is the Slutsky equation with endowment?
Depending on whether or not the consumer is a net demander or supplier of good 1, this final term can be positive or negative.
