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A Level Economics > 2.3. Indifference Curve Analysis > Flashcards

2.3. Indifference Curve Analysis Flashcards

1
Q

Consumer Equilibrium

A

occurs when a consumer maximises their utility (satisfaction) from the consumption of goods and services given the constraints of income and prices.

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2
Q

3 Ways to find out consumer equilibrium

A

1) Law of Diminishing Marginal Utility (one product only)
2) Equi-Marginal Principle (two or more products)
3) Budget Lines and Indifference Curves (two or more products)

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3
Q

Consumer equilibrium for DMU

A

Consumer equilibrium for one product is achieved when the marginal utility (MU) a consumer receives from consuming a product is equal to the price (P) of the product.
–> MU = P

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4
Q

Consumer equilibrium for Equi-marginal Principle

A

Consumer equilibrium is achieved when the marginal utility per money spent (MU/P) on each product is the same.(more than 1 product)
–> MUa / Pa = MUb / Pb

If: MUa / Pa > MUb / Pb
Increase in Qd for a
Decrease in D for b

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5
Q

Consumer equilibrium for BL and IC

A

Consumer equilibrium is achieved when the budget line is tangent to the indifference curve.

  • Consumer equilibrium occurs on the furthest out indifference curve a consumer is able to be on given their limited income (budget).
  • Income-consumption curve shows the consumer equilibriums at different incomes.
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6
Q

Substitution Effect

A

Substitution effect shows the impact of a price change on the demand for rival products:

1) As the price of a product falls (-), it now becomes relatively cheaper than its rivals, causing demand to rise (+).
2) As the price of a product rises (+), it now becomes relatively more expensive than its rivals, causing demand to fall (-).
- The substitution effect is always negative.

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7
Q

Income Effect

A

Income effect relates the impact of a price change on real income:

1) A fall in the price of a product causes real income to rise, resulting in:
- more demand for normal goods (positive YED)
- less demand for inferior goods (negative YED)
2) A rise in the price of a product causes real income to fall (-), resulting in:
- less (-) demand for normal goods (positive YED)
- more (+) demand for inferior goods (negative YED)

Positive income effect for normal goods
Negative income effect for inferior goods.

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8
Q

Price Effect

A

Price effect shows the overall change in demand for a product due to a change in its price.

  • Price effect is made up of the substitution effect and the income effect.
  • The overall price effect depends on the relative strength of the substitution effect and the the income effect
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9
Q

Normal Good

A

a product that has a positive income elasticity of demand (higher real income, more demand)

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10
Q

Inferior Good

A

a product that has a negative income elasticity of demand (higher real income, less demand)

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11
Q

Giffen Good

A
  • a special type of inferior good that has an upward sloping demand curve (contrary to the Law of Demand).
  • It has few/no substitutes which means its income effect is stronger than its substitution effect
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12
Q

Price Effect (Rise in Price) on Normal Goods

A
  • Substitution Effect: Decrease in quantity demanded
  • Income Effect: Decrease in quantity demanded
  • Magnitude of change: (same direction)
  • Overall Price Effect: Decrease in quantity demanded
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13
Q

Price Effect (Rise in Price) on Inferior Goods

A
  • Substitution Effect: Decrease in quantity demanded
  • Income Effect: Increase in quantity demanded
  • Magnitude of change: SE > IE
  • Overall Price Effect: Decrease in quantity demanded
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14
Q

Price Effect (Rise in Price) on GIffen Goods

A
  • Substitution Effect: Decrease in quantity demanded
  • Income Effect: Increase in quantity demanded
  • Magnitude of change: SE < IE
  • Overall Price Effect: Increase in quantity demanded
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15
Q

Rise in price: normal good (DRAW DIAGRAM)

A
  • a = original consumer equilibrium
  • Q1 = original quantity demanded for X.
  • Rise in price causes budget line to pivot shift inwards (BL1 to BL2)
  • a → b = substitution effect
  • b → c = income effect
  • Substitution effect and income effect are same direction = normal good.
  • a → c = overall price effect
  • c = new consumer equilibrium
  • Q3 = new quantity demanded for X.
  • Overall: rise in price, fall in quantity demanded.
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16
Q

Rise in price: normal good - Deriving a demand curve (DRAW DIAGRAM)

A
  • A rise in the price of good X (shown by BL1 pivot shift to BL2) results in a fall in the quantity demanded of good X from Q1 to Q3.
  • This means that price and quantity demanded have an inverse relationship. Therefore the demand curve for good X is downward sloping.
  • Since substitution effect and income effect work in the same direction, demand is relatively more price elastic.
17
Q

Rise in price: inferior good (DRAW DIAGRAM)

A
  • a = original consumer equilibrium
  • Q1 = original quantity demanded for X.
  • Rise in price causes budget line to pivot shift inwards (BL1 to BL2)
  • a → b = substitution effect
  • b → c = income effect
  • Substitution effect and income effect are different directions but S > I = inferior good.
  • a → c = overall price effect
  • c = new consumer equilibrium
  • Q3 = new quantity demanded for X.
  • Overall: rise in price, fall in quantity demanded.
18
Q

Rise in price: inferior good - Deriving a demand curve (DRAW DIAGRAM)

A
  • A rise in the price of good X (shown by BL1 pivot shift to BL2) results in a fall in the quantity demanded of good X from Q1 to Q3.
  • This means that price and quantity demanded have an inverse relationship. Therefore the demand curve for good X is downward sloping.
  • Since substitution effect and income effect work against each other, demand is relatively more price inelastic.
19
Q

Rise in price: giffen good (DRAW DIAGRAM)

A
  • a = original consumer equilibrium
  • Q1 = original quantity demanded for X.
  • Rise in price causes budget line to pivot shift inwards (BL1 to BL2)
  • a → b = substitution effect
  • b → c = income effect
  • Substitution effect and income effect are different directions but S < I = Giffen good.
  • a → c = overall price effect
  • c = new consumer equilibrium
  • Q3 = new quantity demanded for X.
  • Overall: rise in price, rise in quantity demanded.
20
Q

Rise in price: giffen good - Deriving a demand curve (DRAW DIAGRAM)

A
  • A rise in the price of good X (shown by BL1 pivot shift to BL2) results in a rise in the quantity demanded of good X from Q1 to Q3.
  • This means that price and quantity demanded have a positive relationship. Therefore the demand curve for good X is upward sloping.
21
Q

Fall in price: normal good (DRAW DIAGRAM)

A
  • a = original consumer equilibrium
  • Q1 = original quantity demanded for X.
  • Fall in price causes budget line to pivot shift outwards (BL1 to BL2)
  • a → b = substitution effect
  • b → c = income effect
  • Substitution effect and income effect are in same direction = normal good.
  • a → c = overall price effect
  • c = new consumer equilibrium
  • Q3 = new quantity demanded for X.
  • Overall: fall in price, rise in quantity demanded.
22
Q

Fall in price: normal good - Deriving a demand curve (DRAW DIAGRAM)

A
  • A fall in the price of good X (shown by BL1 pivot shift to BL2) results in a rise in the quantity demanded of good X from Q1 to Q3.
  • This means that price and quantity demanded have an inverse relationship. Therefore the demand curve for good X is downward sloping.
  • Since substitution effect and income effect work in the same direction, demand is relatively price elastic.
23
Q

Fall in price: inferior good (DRAW DIAGRAM)

A
  • a = original consumer equilibrium
  • Q1 = original quantity demanded for X.
  • Fall in price causes budget line to pivot shift outwards (BL1 to BL2)
  • a → b = substitution effect
  • b → c = income effect
  • Substitution effect and income effect are different directions but S > I = inferior good.
  • a → c = overall price effect
  • c = new consumer equilibrium
  • Q3 = new quantity demanded for X.
  • Overall: fall in price, rise in quantity demanded.
24
Q

Fall in price: inferior good - Deriving a demand curve (DRAW DIAGRAM)

A
  • A fall in the price of good X (shown by BL1 pivot shift to BL2) results in a rise in the quantity demanded of good X from Q1 to Q3.
  • This means that price and quantity demanded have an inverse relationship. Therefore the demand curve for good X is downward sloping.
  • Since substitution effect and income effect work against each other, demand is relatively price inelastic.
25
Q

Fall in price: giffen good (DRAW DIAGRAM)

A
  • a = original consumer equilibrium
  • Q1 = original quantity demanded for X.
  • Fall in price causes budget line to pivot shift outwards (BL1 to BL2)
  • a → b = substitution effect
  • b → c = income effect
  • Substitution effect and income effect are different directions but S < I = Giffen good.
  • a → c = overall price effect
  • c = new consumer equilibrium
  • Q3 = new quantity demanded for X.
  • Overall: fall in price, fall in quantity demanded.
26
Q

Fall in price: giffen good - Deriving a demand curve (DRAW DIAGRAM)

A
  • A rise in the price of good X (shown by BL1 pivot shift to BL2) results in a rise in the quantity demanded of good X from Q1 to Q3.
  • This means that price and quantity demanded have a positive relationship. Therefore the demand curve for good X is upward sloping.

A Level Economics (39 decks)

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