Chapter 4: Individual & Market Demand

Question 1

Total effect of a price change can be decomposed into 2 seperate effects:

Answer 1

Substitution Effect

Income Effect

Question 2

Substitution Effect

Answer 2

Change in the quantity demanded that results because the price change alters the attractiveness of substitute goods.

Question 3

Income Effect

Answer 3

Change in the quantity demanded that results from a change in purchasing power (real income) caused by price change.

Question 4

Market Demand Curve

Answer 4

Tells us how much of a good the market as a whole wants to purchase at various prices.

Question 5

Price-consumption curve (PCC)

Answer 5

Holding income and the price of Y constant, the PCC for good X is the set of optimal bundles traced on an indifference map as the price of X varies.

Question 6

ndividual Consumer’s Demand Curve

Answer 6

Tells us the quantities the consumer will buy at various prices.

Question 7

Income-Consumption Curve (ICC)

Answer 7

Holding the prices of X & Y constant, the ICC for a good X is the set of optimal bundles traced on an indifference map as income varies.

Question 8

Engel Curve

Answer 8

A curve that plots the relationship between the quantities of X consumed and income.

Question 9

Normal Good

Answer 9

One whose quantity demanded rises as income rises.

Question 10

Inferior Good

Answer 10

One whose quantity demanded falls as income rises.

Question 11

Substitution Effect

Answer 11

Component of the total effect of a price change that results from the associated change in the relative attractiveness of other goods.

Question 12

Income Effect

Answer 12

Component of the total effect of a price change that results from the associated change in real purchasing power.

Question 13

Total Effect

Answer 13

Substitution Effect + Income Effect

Question 14

Giffen Good

Answer 14

One for which the quantity demanded rises as its price rises.

Question 15

Price elasticity of demand

Answer 15

The percentage change in the quantity of a good demanded that results from a 1% change in its price.

Question 16

Properties of Price Elasticity

Answer 16

• Different at every point along the demand curve.
• Never positive
• At any point along a straight-line demand curve it will be inversely related to the slope of the demand curve.

Question 17

Determinants of price elasticity of demand

Answer 17

• Substitution possibilities
• Budget share
• Direction of income effect
• Time

Question 18

Income elasticity of demand

Answer 18

% Change in the Q(demanded) that results from a 1% change in income.

Question 19

Necessities

Answer 19

Goods for which a change in income produces a less than proportional change in the quantity demanded at any price.
Elasticity < 1.

Question 20

Luxuries

Answer 20

Elasticity > 1.

Question 21

Cross-price elasticity of demand

Answer 21

% Change in the Q(demanded) that results from a 1% change in the price of the other good.

Question 22

Network Externality

Answer 22

When one person’s demand for a good is determined by the number of other people also buying the good.

Question 23

Positive Externality

Answer 23

Leads to a typical consumer buying more of a product, as more people are buying it.

Question 24

Negative Externality

Answer 24

Leads to a typical consumer buying less of a product, as more people are buying it.

Question 25

Bandwagon Effect

Answer 25

As more people buy the good, it becomes more fashionable to buy it and more people want to buy it.

Question 26

Snop Effect

Answer 26

As more people buy the good, the consumer does not want to buy a good because too many other people already own it.

Question 27

Marginal rate of time preference (MRTP)

Answer 27

The number of units of consumption in the future a consumer would exchange for 1 unit of consumption in the present.

Question 28

Positive Time Preference

Answer 28

The consumer requires more than 1 unit of future consumption to compensate him for the loss of a unit of current consumption.

Question 29

Negative Time Preference

Answer 29

The consumer is willing to forgo 1 unit of current consumption in return for less than 1 unit of future consumption.

Question 30

Neutral Time Preference

Answer 30

The consumer has neutral time preference, present and future consumption trade off against one another at the rate of 1 to 1.

Question 31

The effects of substitution possibilities on price elasticity of demand?

Answer 31

The absolute value of price elasticity will rise with the availability of attractive substitutes.

Question 32

The effects of budget on price elasticity of demand?

Answer 32

In general, the smaller the share of total expenditure accounted for by a good, the less elastic demand will be.

Question 33

The effects of he direction of the income effect on price elasticity of demand?

Answer 33

The direction of the income effect might reinforce or offset the substitution effect.
Thus a normal good will have a higher price elasticity than an inferior good, other things being equal, because the income effect forces the substitution effect for a normal good but offsets it for an inferior good.