Chapter 4 - Individual and Market Demand Flashcards
What is the substitution effect?
Change in consumption of a good associated with a change in its price, with the level of utility, held constant.
A fall in the price of a good has two effects what are they?
Consumers will tend to buy more of the good that has become cheaper and less of those goods that are now relatively more expensive. This response to a change in the relative prices of goods is called the substitution effect.
Because one of the goods is now cheaper, consumers enjoy an increase in real purchasing power. The change in demand resulting from this change in real purchasing power is called the income effect.
What is income effect?
Change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant.
Total Effect Formula
Total Effect (F1F2) = Substitution Effect (F1E) + Income Effect (EF2)
What is a price-consumption curve?
Curve tracing the utility-maximizing combinations of two goods as the price of one changes.
Define a individual demand curve.
A Curve relating the quantity of a good that a single consumer will buy to its price.
Explain an income-consumption curve.
Curve tracing the utility-maximizing combinations of two goods as a consumer’s income changes.
What are two important properties of the individual demand curve?
- The level of utility that can be attained changes as we move along the curve.
- At every point on the demand curve, the consumer is maximizing utility by satisfying the condition that the marginal rate of substitution (MRS) of food for clothing equals the ratio of the prices of food and clothing.
What happens to a individual demand curve when income increases, with the
prices of all goods fixed?
It shifts outwards. (To the right) as the individual is able to afford a larger quantity of goods.
What is an inferior good?
An increase in a person’s income can lead to less consumption of one of the two goods being purchased. An inferior good is one that is purchased less of once an individual’s income increases.
Define the terms substitutes, complements, and independent in reference to different goods.
Two goods are substitutes if an increase in the price of one leads to an increase in the quantity demanded of the other.
Two goods are complements if an increase in the price of one good leads to a decrease in the quantity demanded of the other.
Two goods are independent if a change in the price of one good has no effect on the quantity demanded of the other.
