Income and Substitution Flashcards
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What happens to the budget constraint curve if there is an increase in income
The gradient will remain the same but the curve will shift to the right
What is the income-consumption curve and how is it made
The income-consumption curve is made through connecting all of the optimal points for the consumer at different levels of budget (therefore income) and utility
What does the income-consumption curve look like for an inferior good and why
The curve is downwards sloping as each indifference curve is shallower as people will buy less of good x as their income increases
When is it impossible to create an income-consumption curve
When both good are inferior
Where does the Engel curve come from
Taking the income-consumption curve and plotting the same quantity demanded of the chosen good against the levels of income to show the relationship
What is the slope of the Engel curve related to and why
It is linked to the income elasticity of demand as it shows how an increase in income the demand of the good
What will happen to the budget constraint if the price of good x increases
It will pivot the budget constraint closer to the origin
What is the price consumption curve and how is it plotted
It shows how the price of a good changes the quantity demanded and is plotted through connecting the optimal choices for different price points of good x
What does the market demand curve represent and how is it derived
Represents how the price of good changes the quantity demanded of the good
It derived from using the quantity demanded on the price-consumption curve and plotting that against the various price points
When the price of good x increases, the budget constraint pivots closer to the origin. What will the substitution effect do at this point
A parallel version of the new budget constraint can be drawn as a tangent to the original indifference curve which will maintain utility but change the optimal point
To ensure that prices can remain constant then what does the income effect do to the new budget constraint created by the substitution effect
Reduces it to the left by a certain amount such that a new lower utility level is reached
What happens if the price of an inferior good rises
The demand will increase which means income will fall
Why does the income effect work in the opposite way for an inferior good
Because as the price of good x goes up so does its consumption and the consumer also becomes poorer meaning that the optimal choice is a larger amount of good x irrespective of good y
