Chapter 5

Question 1

What is the income effect?

Answer 1

This is the change in consumers’ consumption choices because of changes in purchasing power.

Question 2

What is income elasticity?

Answer 2

This is the percentage change of Q consumed of a good as a result of percentage change in income.

Question 3

What are the elasticities for necessity goods and luxury goods?

Answer 3

Necessity goods have an income elasticity between 0 and 1

Luxury goods have income elasticities larger than 1.

Question 4

What is an income expansion path?

Answer 4

This is a curve connecting consumer’s optimal bundles at each income level. These optimal bundles are calculated using the utility function.

Question 5

What are the weaknesses of the income expansion path?

Answer 5

1. We can only look at two goods at the same time
2. Can’t see income level at which a certain quantity of goods is consumed.

Question 6

What is an Engel curve?

Answer 6

This is a curve showing the relationship between the consumed quantity and consumer income. Income is vertical and quantity consumed of a good horizontal.

Question 7

What can Engel curve indicate about type of good?

Answer 7

1. Positive slope means that it’s a normal good
2. Negative slope means it is an inferior good at that income level.

Question 8

what changes in demand curve can changes in consumer preferences create?

Answer 8

1. Demand curve will shift leftward if consumer preferences change negatively for this product.
2. Demand curve will shift to the right if consumer preferences change positively for this product.

Question 9

What is the substitution effect?

Answer 9

This is a change in consumption choises resulting from the change in relative prices of two goods.

Question 10

What is the total effect?

Answer 10

This is the total change in consumer’s optimal consumption bundle because of a price change. It is the sum of the substitute and income effect.

Question 11

What does the size of the substitution effect depend on?

Answer 11

This depends on the curvature of the indifference curves. Highly curved menas that there is a small substitution effect.

Question 12

What does the size of an income effect depend on?

Answer 12

This depends on the quantity consumed before price changes. IF he consumed a lot, the income effect will be larger because the price reduction leaves more income on the table to spend.

Question 13

What are giffen goods?

Answer 13

Goods for which a price decrease leads to consumption decrease. Demand curve slopes up. These goods must be inferior goods.