1.5 T1

Question 1

Draw diagrams to show x as a:
a) normal good
b) inferior good
(IC and budget)

Answer 1

See notes

Question 2

What does an income expansion (/offer) path show?

Answer 2

All optimal bundles of goods demanded, at different income levels

Question 3

See notes

Answer 3

Income path algebra

Question 4

Draw an income expansion path and then derive an Engel curve from it?

Answer 4

See notes

Question 5

What does an Engel curve show?

Answer 5

Optimal demand for good 1 for different levels of income

Question 6

2 points about Engel curves?

Answer 6

True for a GIVEN set of preferences (p1 and p2 fixed)

Each good has its own Engel curve

Question 7

How does an Engel curve look for a normal good and an inferior good?

Answer 7

Normal - UWS

Inferior - DWS

Question 8

Why might an EC be shaped like a backwards C?

Answer 8

If it is normal at low income levels and inferior at high income levels

Question 9

What is the gradient of an EC for a) perfect complements and b) perfect subs?

Answer 9

a) P(x)+P(y)

b) P(x) if x is cheaper and P(y) if y is cheaper (the income expansion path will be y=0 if p(x)<p></p>

Question 10

How do you tell the difference between a luxury good and necessary good when income increases?

Answer 10

For a luxury good, when income increases demand will go up by a greater proportion

For a necessary “” demand will go up by a lesser proportion

Question 11

See and understand

Answer 11

Quasi linear preferences example

Question 12

What is an ordinary good?

Answer 12

If price increases demand for this good decreases

Question 13

What are giffen goods?

Answer 13

Goods that if their price increases demand for them increases

Question 14

Draw diagrams for both giffen and ordinary goods (IC and budget constraints)

Answer 14

Now

Question 15

What does a price offer curve show? Draw one and show how it leads to the demand function for an ordinary good?

Answer 15

Shows the OCB of goods demanded for different levels of price

Question 16

How do you tell if 2 goods at imperfect substitutes or complements?

Answer 16

Imperfect subs:

(Δx1/Δp2)>0

Imperfect complements:

(Δx1/Δp2)<0

Question 17

See, learn and understand: POC and demand curve for perfect complements

Answer 17

Now (slide 31)

Question 18

See, learn and understand: POC and demand curve for perfect substitutes

Answer 18

Now (slides 32)

Question 19

Explain what the reservation price is?

Answer 19

Given 2 goods, a discrete good (x) and good 2 (y, money):
Between p(x)1 (price too high so Q=0) and p(x)2 (price low enough so Q=1) there is a price where the consumer is INDIFFERENT between consuming good x or not. This is the reservation price (see slide 34 on how this makes the discrete good demand curve)

Question 20

What does the inverse demand function show? What does it look like?

Answer 20

The DWS inverse demand function shows willingness to pay (more when the amount of good x is less and less as amount increases)

It is DWS with P(x) on u axis and x on x-axis (bowed towards origin)

Question 21

What is the substitution effect?

Answer 21

As prices rise, or income decreases, consumer will replace more expensive items with less costly alternatives

Question 22

What is the income effect?

Answer 22

When a consumer has relatively more REAL income so they may increase consumption of both goods

Question 23

Total effect =

Answer 23

Income + substitution

Question 24

See and learn income and substitution effect diagram

Answer 24

Now (notes)

Question 25

How do substitution and income effects work when the good is a) normal and b) inferior?

Answer 25

a) normal tf S&I work in same direction and reinforce each other
b) inferior tf S&I work in opposite directions and tf indeterminate effect

Question 26

What is the law of DWS demand?

Answer 26

For normal goods, both S&I effects lead to an increase in demand when price falls tf normal goods always have DWS demand

Question 27

Draw Slutsky effects for:

a) normal goods
b) income-inferior goods
c) giffen goods?

Answer 27

See notes

Question 28

What is the Slutsky identity?

Answer 28

Total Δdemand = Σ(subs and income effect)

Question 29

What causes giffen goods?

Answer 29

When extreme income inferiority -> income effect>substitution effect

Question 30

What are all points on an income expansion path solutions to?

Answer 30

The consumers optimisation problem