ECON 101 Chp 9 - Possibilities, Preferences and Choices

Question 1

divisible vs indivisible goods

Answer 1

divisible goods = can be bought in any quantity desired

indivisible goods = cannot be bought in any quantity

Question 2

what assumption do we hold about house choices?

Answer 2

all goods + services are divisible

Question 3

define real income

Answer 3

income expressed as a quantity of goods that the household can afford to buy

Question 4

define relative price

Answer 4

price of 1 good divided by the price of another good

Question 5

what’s the effect of a change in price on the budget line?

Answer 5

if it falls, then the slope of the budget line tilts outwards (flatter) (slope value is smaller)

if it rises, then the slope of the budget line tilts inwards (steeper) (slope value is larger)

Question 6

what’s the effect of a change in income on the budget line?

Answer 6

if it rises, the slope stays the same, the budget line shifts leftwards

if it falls, the slope stays the same, the budget line shifts rightwards

Question 7

define an indifference curve

Answer 7

curve that shows combination of goods among which a consumer is indifferent

Question 8

define a preference map

Answer 8

a series of indifference curves that resemble the contour lines on a map

Question 9

define the marginal rate of substitution (MRS)

Answer 9

the rate at which a person will give up good Y (good measured on the y-axis) to get an additional unit of good X (the good measured on the x-axis)

Question 10

what’s the effect of the slope of the indifference curve and the value of the MRS?

Answer 10

if the indifference curve is steep, the MRS is high

if the indifference curve is flat, the MRS is low

Question 11

define the diminishing marginal rate of substitution

Answer 11

general tendency for a person to be willing to give up less of good y to get 1 more unit of good x, while remaining indifferent as the quantity of x increases

Question 12

what’s the shape of indifference curves for goods that are perfect substitutes, perfect complements, and ordinary goods?

Answer 12

perfect substitutes: straight lines that slope downwards

perfect complements: 2 “L” shaped lines

ordinary goods: 2 curved lines

Question 13

what are the conditions in achieving the best affordable point?

Answer 13

1. spends all their income (a point on her budget line)
2. on the highest attainable indifference curve
3. MRS = slope of the budget line (relative prices of good X and good Y) (willingness to pay for good Y = opportunity cost of good Y)

Question 14

are all the points on the budget line on the same indifference curve?

Answer 14

no, they are on different indifference curves

Question 15

define price effect

Answer 15

the effect of a change in price of a good on the quantity of the good consumed

Question 16

what’s the price effect in terms of the budget line, indifference curve, and demand curve?

Answer 16

budget line flattens (slope change), new best affordable point, new indifference curve, (and new point on the demand curve).

Question 17

define the income effect

Answer 17

the effect of change in income on buying plans

Question 18

what’s the effect of income change on the budget line, indifference curve and demand curve?

Answer 18

1. the slope of the budget stays constant but the budget line shifts right or left depending on the change
2. the indifference curve shifts left or right depending on the change (slope stays constant)
3. demand curve shifts left or right

Question 19

what 2 effects we prove that for a normal good, a fall in its price always increases the quantity bought

Answer 19

1. substitution effect
2. income effect

Question 20

define the substitution effect

Answer 20

effect of a change in price on the quantity bought when the consumer remains indifferent between the original situation and the new one

Question 21

how is the substitution effect demonstrated on the budget line and indifference curve

Answer 21

1. price change, slope of the budget line changes
2. find new best affordable point (J) on new budget line –> new indifference curve
3. find the point where the original indifference curve and the slope of the new budget line meet (point K)
4. find the movement along the original indifference curve of the old best affordable point C) and new best affordable point (K) = substitution effect, this movement along the curve shows the new combination of good bought with a change in price (using the same income).

Question 22

how is the income effect demonstrated on the budget line and indifference curve (normal good)

Answer 22

1. price change, slope of the budget line changes
2. find new best affordable point (J) on new budget line –> new indifference curve
3. find the point (K) where the original indifference curve and the slope of the new budget line meet
4. find the magnitude of the shift from point K to new best affordable point on the new indifference curve (point J) = income effect, this shift shows the new combination of goods bought with a change in income

Question 23

for a normal good, the income effect _____ the substitution effect

Answer 23

reinforces

Question 24

what’s the substitution and income effect for inferior goods?

Answer 24

income effect for an inferior good is negative

the substitution effect of a fall in price increases the quantity demand

the negative income effect offsets the substitution effect to some degree

Question 25

to what degree does the negative income effect offset the substitution effect of an inferior good for when the negative income effect equals, is smaller than, or exceeds the positive substitution effect?

Answer 25

equals: a fall in price leads to the quantity bought stays the same, demand curve is vertical (perfectly inelastic)

smaller than: fall in price increases quantity bought and demand curve still slopes downward like a normal good, but demand for an inferior good is less elastic than that for normal good

exceeds: fall in price decreases the quantity bought, demand curve slopes upward ** never happens in real life.

Question 26

what’s the equation to income = expenditure in terms of goods?

Answer 26

y = PxQx + PyQy

Question 27

the point at which the budget line intersect the y-axis is ________?

Answer 27

the household’s real income in terms of the food measured on the y-axis

Question 28

the magnitude of the slope of the budget line is the ________?

Answer 28

relative price of the good measured on the x-axis in terms of the good measured on the y-axis

Question 29

the magnitude of the slope of an indifference curve is called ____?

Answer 29

marginal rate of substitution (MRS)