block 4 - consumer choice

Question 1

what does the budget line show

Answer 1

shows the various combinations of 2 goods that can be bought given their prices and consume’s’ income

Question 2

what happens to the budget line when
1. change in income
2. change in the price of one good

Answer 2

1. doesn’t change the slope of the budget line
   - budget line shifts in a parallel manner
2. pivoted shift

Question 3

what does the indifference curve show

Answer 3

the combination of 2 goods which give the consumer the same level of utility

Question 4

what is marginal rate of substitution

Answer 4

it is the rate at which the consumer is willing to trade one good for a additional unit of the other good, while keeping utility constant

utility remains constant if the loss in utility from having less of one good is fully offset by the gain in utility from consuming more of the other good

diminishing marginal rate of substitution = as more of the same good is consumed, the additional satisfaction it gives falls

• makes the indifference curve convex to the origin - MR diminishes - consumer willing to give up less and less of one for additional units of another)

Question 5

what are exceptional indifference curves

Answer 5

1. when theres perfect substitutes: MRS is constant - consumer willing to give up the same number of Y for one more X
2. when theres perfect compliments
   - 2 goods consumed in a fixed proportion
   - additional X without additional Y will not increase utility

Question 6

when is utility maximised (on the curve)

Answer 6

where the highest possible indiffference curve is tangent to the budget line

Question 7

how can utility be increased when the indifference curve is not tangent to the budget line

Answer 7

utility can be increased by substituting one good for another

Question 8

what is income consumption curve

Answer 8

the locus of the various utility maximizing bundles

Question 9

what does the engel curve show

Answer 9

the relationship between a consumer’s income and the quantity of a good he buys

tells us whether the good is a normal or inferior good

Question 10

what’s substitution effect for a good

Answer 10

the change in consumption when the relative price change (assuming no change in real income)

its always negative - the consumer buys more of a good when it is relatively cheaper

Question 11

what is the income effect

Answer 11

the change in consumption of a good due to the change in real when there is a change in real income (assuming no change in relative price)

can be negative or positive depending on whether the good is a normal or inferior good

Question 12

what is the market demand for a private good

Answer 12

a horizontal summation of the various consumers’ demnad for the good at different price