Indifference Curves And Budget Lines Flashcards
Q: What is an indifference curve?
A: An indifference curve is a line that links combinations of goods between which a consumer is indifferent, meaning they derive the same level of utility or satisfaction from each combination.
Q: What is a budget line?
A: A budget line shows all combinations of two goods that a consumer can afford with their given income and the prices of the goods.
Q: What causes a shift in the budget line?
A: Changes in income and changes in the prices of goods.
Q: What are the income and substitution effects?
A:
Income effect: The change in consumption resulting from a change in real income.
Substitution effect: The change in consumption resulting from a change in relative prices.
Q: How do the income and substitution effects differ for normal goods?
A: For normal goods, both the substitution effect (positive) and the income effect (positive) increase the quantity demanded when the price falls.
Q: How do the income and substitution effects differ for inferior goods?
A: For inferior goods, the substitution effect (positive) increases the quantity demanded when the price falls, but the income effect (negative) decreases the quantity demanded.
Q: How do the income and substitution effects differ for Giffen goods?
A: For Giffen goods, the substitution effect (positive) increases the quantity demanded when the price falls, but the income effect (negative and larger than the substitution effect) decreases the quantity demanded, leading to an overall decrease in quantity demanded.
Q: What are the limitations of the indifference curve model?
A:
Consumers choose from many more goods than just two.
Consumers may express preferences or rank orders instead of indifference.
Assumes consumers act rationally.
The model is theoretical and not easily observed in practice.
Asymmetric information may affect consumer satisfaction.
Q: What is the marginal rate of substitution (MRS)?
A: The rate at which a consumer is willing to substitute one good for another while maintaining the same level of utility, represented by the slope of the indifference curve.
Q: How is maximum utility achieved according to indifference curve and budget line theory?
A: Maximum utility is achieved where the budget line is tangent to the highest possible indifference curve.
Q: What happens to the budget line if there is an increase in income?
A: The budget line shifts to the right, indicating that the consumer can afford more of both goods.
Q: What happens to the budget line if the price of one good decreases?
A: The budget line pivots outward from the axis representing the good whose price has decreased, indicating that the consumer can now afford more of that good.
Q: How can indifference curves be used to derive individual demand curves?
A: By plotting the price-consumption and income-consumption curves from the indifference maps, showing the relationship between price and quantity demanded or income and quantity demanded.
Q: What is a Giffen good?
A: A Giffen good is an inferior good for which the income effect outweighs the substitution effect, resulting in a positive relationship between price and quantity demanded.
Q: Why are Giffen goods rare?
A: Because it is uncommon for the income effect to be larger than the substitution effect, which would cause the good to defy the law of demand.
