Econ Ch 7

Question 1

Fundamental of consumer choice

Answer 1

1. Limited income necessitates choice
2. Consumers make decisions purposefully
3. Often times, one good can be substituted for another
4. Consumers must make decisions without perfect information
5. The law of diminishing marginal utility applies to consumption

Question 2

marginal utility

Answer 2

the benefit derived from consuming an additional unity of the good

Question 3

Law of diminishing marginal utility

Answer 3

as the consumption of a product increase, the marginal utility derived from additional consumption will eventually decline

Question 4

Marginal benefit

Answer 4

the maximum price a consumer will be willing to pay for an additional unit of the product (the height of the demand curve)

Question 5

substitutions effect and income effect

Answer 5

People will buy more (less) of a good as the price of the good decreases (increases) for two reasons:
When the price of a good decreases, people buy more because:
1. Substitutions effect: the good has become cheaper relative other goods
2. Income effect: it is as if your real income has increased - same income but cheaper things to buy

Question 6

the market demand curve

Answer 6

on notes
The market demand curve is the horizontal sum of the individual demand curves

Question 7

price of elasticity of demand

Answer 7

Price elasticity of demand indicates how responsive consumers are to a change in the products price

Price elasticity of demand = % change in Q demanded / % change in price
Quarter pounders

Always negative, so we use the absolute value (ignore the negative sign)

If price elasticity of demand is
>1 : elastic - burgers - there are substitutes
=1 : unitary elastic
<1: inelastic - cigarettes - no substitutes

Question 8

graphs of perfectly inelastic, perfectly elastic, and unitary elastic

Answer 8

google doc

Question 9

calculating price elasticity of demand from scratch

Answer 9

Q0 - Q1/
Q0 + Q1/2
//
P0 - P1/
P0 +P1/2

Question 10

determinants of price elasticity of demand

Answer 10

1. the most important determinant of price elasticity of demand is the availability of substitutes
   good substitutes = higher elasticity
2. products share of the consumer’s budget
   - large share of budget, higher elasticity
3. time and price elasticity of demand
   second law of demand
   When the price of product increases, consumers will reduce their consumption by a larger amount in the long run than in the short run

Question 11

total revenue

Answer 11

Total revenue (or expenditures) = Price x Quantity

It depends on elasticity
Inelastic - the price effect dominates
Elastic- the quantity effect dominates
Unitary elastic- the effects are the same (no change in total revenue)

memorize picture in this section

Question 12

cross price elasticity of demand

Answer 12

Cross-price elasticity of demand measures the responsiveness of the demand for one product in response to a change in the price of a potential related product

Cross Price elasticity of demand = %∆QD of Product 1 / %∆P of Product 2

sign does matter

+ substitutes
- compliments
=0 not related

Question 13

income elasticity of demand

Answer 13

measure the responsiveness of the demand for a good to a change in income

income elasticity = percent change in quantity demanded / percent change in income

sign does matter

Question 14

income elasticity

Answer 14

Income elasticity measures the responsiveness of the demand for a good to a change in income
Income elasticity = %∆QD / %∆I
In this case, the sign does matter…

determines the type of the good

Normal good -positive income elasticity
–Necessity-income elasticity is between 0 and 1
–Luxury-income elasticity is greater than 1

Inferior good - negative income elasticity

Question 15

price elasticity of supply

Answer 15

measures how responsive suppliers are to a change in price

price elasticity of supply = percent change in quantity supplied / percent change in price

always positive

> 1 elastic
<1 inelastic
=1 unitary elastic