Indifferences Curves

Question 1

Budget lines

Answer 1

The combination of two products obtainable with given income and prices.

Assumption:
> maximum amount of 2 goods that can be bought with a consumer’s income

Question 2

Graph of budget lines

Answer 2

X-axis: Product B
Y-axis: Product A

Question 3

Indifference curve

Answer 3

Shows the different combinations of two goods that give a consumer equal satisfaction.

Question 4

Graph of indifference curves

Answer 4

X-axis: Good X
Y-axis: Good Y

Question 5

Marginal rate of substitution

Answer 5

The rate at which a consumer is willing to substitute one good for another.

Question 6

Income and substitution effect when there is an increase in price of a normal good

Answer 6

1. Price of good X increase
2. Consumers have less spending power
3. Loss of spending power is represented by a new budget line B2
4. Price of good Y is unchanged
5. B2 pivots downwards towards the origin, indicating that less of good X can now be consumed with the same level of income
6. This is called the income effect where the change in quantity demanded arising from a price change is attributed to changes in real income
7. Following a change in price, a consumer has higher real income and will purchase more of this product
8. As consumer has more spending power, he will consume more of both goods
9. Income effect is negative

Question 7

Income and substitution effects of a decrease in price of good X of normal good

Answer 7

1. Consumer equilibrium is at E1
2. Fall in price of good X is equivalent to a rise in real income
3. Budget line pivots to B2
4. Income effect is positive

Question 8

Income and substitution effects of a decrease in price of good X of inferior goods

Answer 8

1. Real income increases
2. Consumers will substitute more expensive, better quality goods for good X
3. Income effect is negative, not enough to outweigh the substitution effect

Question 9

Giffen gods

Answer 9

Demand falls as the price of the good falls and demand increases as the price increases.

For low income families, this could be a staple food such as rice or wheat flour.

Question 10

Income and substitution effects of a Giffen good

Answer 10

1. Substitution effect has the consumer to buy more as it is now relatively cheaper.
2. Income effect has the consumer to buy less as now having an increase in real income when price of good X decrease, less inferior good will be consumed.
   3 income effect is negative and greater than substitution effect.

Question 11

Income and substitution effects of an essential good

Question 12

Derive consumer demand curve for good X from indifference curve

Answer 12

1. Find price of good X at indifference curve 1.
   > Income ➗ Price of good X = Number of units bought
2. Repeat same step for indifference curve 2

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