1.5 T1 Flashcards
Draw diagrams to show x as a:
a) normal good
b) inferior good
(IC and budget)
See notes
What does an income expansion (/offer) path show?
All optimal bundles of goods demanded, at different income levels
See notes
Income path algebra
Draw an income expansion path and then derive an Engel curve from it?
See notes
What does an Engel curve show?
Optimal demand for good 1 for different levels of income
2 points about Engel curves?
True for a GIVEN set of preferences (p1 and p2 fixed)
Each good has its own Engel curve
How does an Engel curve look for a normal good and an inferior good?
Normal - UWS
Inferior - DWS
Why might an EC be shaped like a backwards C?
If it is normal at low income levels and inferior at high income levels
What is the gradient of an EC for a) perfect complements and b) perfect subs?
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>
How do you tell the difference between a luxury good and necessary good when income increases?
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
See and understand
Quasi linear preferences example
What is an ordinary good?
If price increases demand for this good decreases
What are giffen goods?
Goods that if their price increases demand for them increases
Draw diagrams for both giffen and ordinary goods (IC and budget constraints)
Now
What does a price offer curve show? Draw one and show how it leads to the demand function for an ordinary good?
Shows the OCB of goods demanded for different levels of price
How do you tell if 2 goods at imperfect substitutes or complements?
Imperfect subs:
(Δx1/Δp2)>0
Imperfect complements:
(Δx1/Δp2)<0
See, learn and understand: POC and demand curve for perfect complements
Now (slide 31)
See, learn and understand: POC and demand curve for perfect substitutes
Now (slides 32)
Explain what the reservation price is?
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)
What does the inverse demand function show? What does it look like?
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)
What is the substitution effect?
As prices rise, or income decreases, consumer will replace more expensive items with less costly alternatives
What is the income effect?
When a consumer has relatively more REAL income so they may increase consumption of both goods
Total effect =
Income + substitution
See and learn income and substitution effect diagram
Now (notes)
How do substitution and income effects work when the good is a) normal and b) inferior?
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
What is the law of DWS demand?
For normal goods, both S&I effects lead to an increase in demand when price falls tf normal goods always have DWS demand
Draw Slutsky effects for:
a) normal goods
b) income-inferior goods
c) giffen goods?
See notes
What is the Slutsky identity?
Total Δdemand = Σ(subs and income effect)
What causes giffen goods?
When extreme income inferiority -> income effect>substitution effect
What are all points on an income expansion path solutions to?
The consumers optimisation problem
