Lecture 4- Consumer Demand

Question 1

What is a consumer’s demanded bundle?

Answer 1

The optimal choice of goods 1 and 2 at a given set of prices and income, representing the consumer’s optimal consumption choice

Question 2

What is a demand function?

Answer 2

A demand function shows the relationship between the quantity of any particular good
purchased and the price of that good if other factors such as consumer income and the prices of
substitute and complementary goods remain constant.

Question 3

What is a key assumption about prices in competitive markets?

Answer 3

Prices are fixed and no bargaining exists because no economic agent is big enough to affect market-determined prices

Question 4

What is a normal good?

Answer 4

A good for which demand increases as consumer income increases, while relative prices remain constant (∆Q/∆I > 0)

Question 5

What is an inferior good?

Answer 5

A good for which demand decreases as consumer income increases, while relative prices remain constant

Question 6

What is the income offer curve?

Answer 6

A locus of optimal choices demanded at various levels of income, showing how consumption changes as income changes while prices remain constant

Question 7

What is an Engel curve?

Answer 7

A graph showing the relationship between demand for a good and income while holding prices constant

Question 8

What is a Giffen good?

Answer 8

A good that violates the law of demand, where demand increases as price increases, resulting in an upward-sloping demand curve

Question 9

What is an ordinary good?

Answer 9

A good that follows the law of demand, where demand decreases as price increases and increases as price decreases

Question 10

What is the price offer curve?

Answer 10

The locus of optimal bundles that result when the price of one good changes while prices of other goods and consumer income remain fixed

Question 11

What are the two components of Slutsky partition?

Answer 11

Income effect and substitution effect

Question 12

What is the substitution effect?

Answer 12

The effect due only to relative price changes, controlling for changes in real income - always has a negative sign

Question 13

What is the income effect?

Answer 13

The effect due to changes in real income when prices change, can be either positive or negative depending on whether the good is normal or inferior

Question 14

What is consumer surplus?

Answer 14

The difference between what a consumer is willing to pay and what they actually spend on purchasing a good

Question 15

What is compensating variation?

Answer 15

The change in income necessary to restore the consumer to their original indifference curve after a price change

Question 16

What is equivalent variation?

Answer 16

The income change that is equivalent to the price change in terms of utility changes - how much money would need to be taken away before the price change to leave consumer as well off as after

Question 17

How do you calculate compensating variation?

Answer 17

CV = E[Pn, Un] – E[Po, Uo], where P represents prices (new/old) and U represents utility levels

Question 18

How do you calculate equivalent variation?

Answer 18

EV = E[Po, Un] – E[Po, Uo], where P represents prices (old) and U represents utility levels

Question 19

What happens to the budget line when a quantity tax is imposed?

Answer 19

The budget line shifts as if the price of the taxed good has increased by the amount of the tax

Question 20

What’s the key difference between quantity tax and income tax effects?

Answer 20

Under income tax, the budget line maintains the same slope as original (-P1/P2) while shifting inward; under quantity tax, the slope changes

Question 21

What are the three possible scenarios for total effect in Slutsky partition?

Answer 21

1. Negative income effect = normal good, 2. Positive but small income effect = inferior good, 3. Large positive income effect that overwhelms substitution effect = Giffen good

Question 22

Why might a good change from normal to inferior?

Answer 22

A good’s classification as normal or inferior is dynamic, not static. During income progression, goods that were once normal may become inferior at higher income levels

Question 23

What happens to the optimal choice when both goods are normal goods?

Answer 23

The income expansion path will have a positive slope, meaning consumption of both goods increases with income

Question 24

What determines if goods are substitutes or complements?

Answer 24

If demand for good 1 increases when price of good 2 increases, they are substitutes. If demand for good 1 decreases, they are complements

Question 25

When prices and income change

Answer 25

what happens to consumer behavior?