Consumer Demand

Question 1

Recall consumer demand functions

Answer 1

X₁ (P₁:P₂:M) and X₂(P₁:P₂:M)

Question 2

Normal goods vs inferior goods

Answer 2

Normal goods - demand increase when income increases

Inferior- demand falls when income increases

Question 3

Graphs of normal goods/inferior goods on indifference curves following an increase in income.

Answer 3

Normal goods - demand for both goods increase

Inferior goods - the inferior good falls in demand while the other one increases. (Pg55 - x is the inferior good)

Question 4

Income expansion path definition , and formula

Answer 4

Shows all optimal bundles of goods demanded for different levels of income.

MU1/MU2 = P1/P2 (it is the tangency condition i.e MRS=price ratio)

Question 5

Engel curve

Answer 5

Shows optimal demand for good 1 for different levels of income.

m’ m’’ m’’’ shows upward sloping, as demand increases as we increase income (m)

Question 6

Engel curve for normal, inferior goods

Answer 6

Y axis - income (m)
X axis - the good

For a normal good the engel curve is upward sloping (income up consumption up)

For an inferior good the engel curve is downward sloping. (m high, demand is low)

Question 7

What would the engel curve look like for a good that behaves as a normal good at a low income and then a inferior for high levels?

Answer 7

Upward sloping then wraps back around. (Since demand falls back as income m gets to the high level)

(Like a laffer curve on the y axis)

Question 8

A) Income expansion path for perfect complements

B) Engel curve for perfect complements + what is the slope?

Answer 8

Crosses through the L shape

B) Upward sloping with a Px+Py slope.

Question 9

Income expansion path for perfect subs (assume Py>Px)

B) engel curve for perfect subs + what is the slope?

Answer 9

The path would just run along the x axis (since the optimal bundle at all levels of income is always X since perfect subs, and X is the cheaper one

B) engel curve upward sloping with a Px slope. It acts like a standard good, as income increases demand will)

Question 10

Luxury and necessary goods

Answer 10

Luxury - when income increases, demand goes up more than proportionately.

Necessary - when income increases, demand goes up by a lesser proportion

Question 11

So that was a change in income:

What about effect of CHANGE IN PRICE : for Ordinary goods vs Giffen goods

Answer 11

Ordinary - Demand increases when price decreases (vice versa)

Giffen - Demand increases when price increases (designer/status goods)

Question 12

Draw an ordinary good IC and BC, following an increase in price of good X.

(pg66)

Question 13

Draw a giffen good IC and BC, following a price increase in good X.

Question 14

Price offer curve

Answer 14

Shows all optimal consumption bundles for different levels of price

(Similar to income expansion path, but except for price changes rather than income changes)

Question 15

So IEP and POC, and Engel Curve

Answer 15

IEP shows all optimal bundles demanded for different levels of income

Engel curve shows optimal DEMAND for a SPECIFIC good at different levels of income.

POC shows all optimal bundles demanded for different price levels.

Question 16

Demand curve illustration

Answer 16

Shows the optimal demand for good X at different prices. (Downward sloping since price up demand down.

Question 17

Imperfect/gross substitutes

Answer 17

If price of good Y increases, we buy more of good X.

Question 18

Imperfect complements

Answer 18

If price of good Y increases, we will demand less of good X since they complement each other.

E.g if gin is more expensive, we will buy less tonic water

Question 19

Price offer curves and demand curves for perfect complements

Answer 19

POC through the L shape and budget line.

Demand curve is downward sloping. Price high, demand low.

Question 20

Price offer curves and demand curves for perfect substitutes

Answer 20

POC 3 parts - vertical line represents p1 being high, so demand none of it. Then downward sloping represents p1=p2, so we are indifferent and consume either one. Then horizontal part represents p1 being cheaper than p2 so now ONLY good 1 is demanded.

3 parts to the demand curve - Demand is horizontal

If then p2<p1, we consume none of good 1, shown by the vertical part of the demand curve.

Then the downward sloping part represents the case if price falls, we consume more of X (as standard)

Question 21

Discrete goods: what if price is too high.

Answer 21

Consumer consumes 0 units.

Since remember discrete goods are whole unit goods (have to be 0 or 1, can’t have 1/2 a car etc)

Question 22

So they must reduce the price.

There is a price a consumer is ready to consume one additional unit of.

What is this called?

Answer 22

Reservation price - the price a consumer will be indifferent between consuming one unit or not.

So If goes lower than this, then their prefernce will be to consume one unit of it. (Not indifferent, it will actually want to consume it).

Question 23

Discrete good optimal bundles and demand curve illustration. (Pg74)

Answer 23

2 Budget constraints to show r1 (higher price) and r2. Where they each meet different IC’s, we find optimal bundles at the specific reservation price.

Demand curve:
Collection of vertical segments. Look at annotations

Question 24

Inverse demand function; how do we find it?

Answer 24

Given our utility function 𝑈 (𝑥, 𝑦) = 𝑥^𝑐𝑦^𝑑
Demand function is…
X= c/(c+d) x m/Px

Rearrange to make px subject.

Px = mc / x(c+d)

Our inverse demand function is when px subject

Question 25

Interpretation of inverse demand function

Answer 25

Shows the willingness to pay more when we have less of X, compared to when X is already large.