income consumption curves Flashcards
what is the analysis of income consumption curves ?
looking at a consumers optimal bundle when incomes change and everything else is equal.
how do you construct an income consumption curve ?
you draw the different indifference curves and budget lines and then connect the optimal bundles with a line that is the income consumption curve.
what is an engel curve ?
if we plot the Qx and each income level, this is the engel curve.
if the income consumption curve is + sloped, so is the engel curve
+ slope = normal good
- slope = inferior good
what happens to our consumption when prices fall ?
when prices fall 2 things happen: we change how much we consume as a consequence of price change, or as a consequence of income changing. so far we have combined these but for now we will split them into income ( affording more because you’re better off ) and substitution (affording more because its cheaper ) effects.
what is the substitution effect ?
if we keep the consumer just as well of as before ( on the same ic as before ) , as Px falls, where is consumption.
how do you calculate the substitution effect ?
B is the point on the original indifference curve that is tangent to the bL that has the same gradient as the second BL.
the movement along ic1 is the substitution effect.
SE = Xb - Xa
what is the income effect ? and how do you calculate it ?
the amount we would consume if we had the same prices as before but better off.
Xc -Xb
what are the income effects and substitution effects of a
a. normal effect
b. inferior effect
a. + iE , + SE
b. - iE , + SE
what is a giffen good ?
a good where the income effect outweighs the substitution effect ( e.g. potato famine )
what is the total effect ?
SE + iE or Xc - Xa
what is the compensating variation ?
how much income would he consumer be willing to give up after the price change in order to achieve a utility at the initial prices. this is the income difference between income needed for A and B.
ia - ib
what is the equivalent variation ?
how much income would the consumer need to be given at the initial prices in order to reach the utility level obtained at the final prices.
EV =Ie - Ia
bundle E is on ic 2 and BL that is parallel to BL1
