Consumer choice and demand decisions

Question 1

marginal rate of substitution (MRS)

Answer 1

MRS between two goods measures the
quantity of a good the consumer must sacrifice to increase the quantity of the
other good by one unit without changing total utility

Question 2

diminishing marginal rate of

substitution

Answer 2

The idea of preferences displaying diminishing marginal rate of
substitution captures the fact that, when a consumer has a lot of one good, she is
willing to give up a relatively large amount of it to get a good of which she has
relatively little

Question 3

indifference curve

Answer 3

indifference curveAn
indifference curve is defined as the curve representing all the combinations of
consumption bundles that provide the same level of utility for a consumer.

Question 4

Why do indifference curves slope downwards?

Answer 4

diminishing marginal rate of
substitution. With a high level of good y but few of good x, I’d be willing to give up a lot of y to gain a little x, as we go down the curve, I have a higher amount of good x, so would only give up a very little bit of y to get another x.

Question 5

Slope of indifference curve equals?

Answer 5

MRS= MUx/MUy

Question 6

equation of the budget constraint for goods x and y

Answer 6

M (income)= Px X+ Py Y

Question 7

What is the budget line? How is it derived?

Answer 7

From the budget constraint it shows how much y a consumer can consume given Px Py and consumption level of y. (rearrange budget constraint) y= M/py -Px/Py (x)

Question 8

Utility maximising point for a consumer?

Answer 8

MRS=-Px/Py

Where indifference curve sits on budget line

Question 9

income expansion path/ income–

consumption path.

Answer 9

Is the collection of the optimal choices of goods x and y, for all possible levels of income
(Draw budget line and indifference curve at utility maximising point draw a dot at each such point and connect the dots ) PG 198

Question 10

what is the optimisation point on an indifference curve, how do you find it

Answer 10

Where it sits on the budget line

MUx/MUy=Px/Py

Differentiate utility function in terms of x and y
Rearrange budget curve to get budget line in the form y= (or x2= )then rearrange to make x and y (P1 and P2) the subject

Question 11

Engel curve

Answer 11

Shows the optimal demand for a particular good (say x1) in relation to income.

Differs to income- consumption path as doesn’t show optimal demand for both x1 and x2

Question 12

substitution effect

Answer 12

The substitution effect of a price change is the adjustment of demand to the
relative price change alone (i.e. burgers have become cheaper so I substitute fries for burgers as they’re more of a bargain) PG 202

Question 13

income effect

Answer 13

The income effect of a price change is the adjustment of demand to the change in
real income alone pg 201

i.e. I buy more burgers and fries because the cheaper price of burgers means I have higher income left over (for a given purchase)

Question 14

Giffen good

Answer 14

An inferior good where the income effect is large and larger than the substitution effect (so as income increases when the price of this good falls we demand less of it, even though this good is relatively cheaper , but the sub effect is outweighed by the income effect.)

Question 15

Are inferior goods necessarily Giffen goods?

Answer 15

No, an inferior good

need not be a Giffen good, if the income effect is not sronger than the sub effect it isn’t a giffen good

Question 16

How does the substitution effect respond to a fall in price of x if the goods x and y are complements?

Answer 16

When there are more than 2 goods, the goods may not be substitutes and may be complements instead. Rather than substituting away from y to x, demand both both goods increase.

Question 17

Indifference curve Graph for perfect substitutes and what are they?

Answer 17

Straight downward sloping line (looks like a demand curve)
Perfect substitutes are goods that are viewed as equal by consumers. In that case,
the consumer always consumes the cheap one.

Question 18

Indifference curve Graph for perfect complements and what are they?

Answer 18

L shaped,

these are goods that are always consumed together in fixed proportion e.g left and right shoes

Question 19

transfer payment

Answer 19

A transfer payment is a payment, usually made by the government, for which no
corresponding service is provided by the recipient. e.g. child tax credit, universal credit

Question 20

transfer in kind

Answer 20

A transfer in kind is the gift of a good or service e.g. food stamps

Question 21

Are wages a monetary transfer

Answer 21

no, the recipient

provides labour services in exchange for wages.