Demand and Supply Analysis: Consumer Demand

Question 1

When is a consumer maximizing their utility?

Answer 1

1. When heselects his most preferred bundle (combination) of goods for consumption from all affordable bundles.
2. A given bundle of goods is preferred to all other bundles of goods that provide less utility.

Question 2

What is an indifference curve?

Answer 2

1. Shows all combinations of two goods among which a specific consumer is indifferent.
2. Ex: Consumer would be most satisfied with any combination of products along curve U3. Would be indifferent between combination Qa1, Qb1, and Qa2, Qb2.

Question 3

What is an opportunity set?

Answer 3

An opportunity set is all the combinations of goods that are affordable to a specific consumer.

Question 4

What is a budget constraint for two goods?

Answer 4

All combinations of goods that will, given the prices of the two goods, just exhaust a consumer’s income.

Question 5

How do you determine a consumer’s equilibrium bundle of goods based on utility analysis?

Answer 5

The consumer’s most preferred combination of two goods along the budget constraint is represented by the point where one of the consumer’s indifference curves is just tangent to their budget constraint.

Question 6

What is the income effect?

Answer 6

A decrease in the price of a good that a consumer purchases leaves her with unspent income (for the same combination of goods). The effect of this additional income on consumption of the good for which the price has decreased is termed the income effect.

Question 7

What is a Giffen good?

Answer 7

1. An inferior good for which the negative income effect of a price decrease outweighs the positive substitution effect, so that a decrease (increase) in the good’s price has a net result of decreasing (increasing) the quantity consumed.
2. Ex: Designer handbags

Question 8

What is a Veblen good?

Answer 8

1. One for which an increase in price results in an increase in the quantity consumed.
2. Not an inferior good.
3. The increase in consumption when the price of the good increases is due to a perception that a higher price makes consuming the good more desirable in some way, perhaps conveying higher status.
4. Ex: High-status items such as luxury cars, expensive shoes or pricey watches.