Lecture 8 - Price and Income Changes

Question 1

What is comparing two equilibrium points of a consumer an example of?

Answer 1

Comparative statics analysis

Question 2

What does a demand curve show?

Answer 2

A demand curve shows the quantity demanded at a given price

Question 3

What is the relationship between comparative statics analysis of own-price changes and a consumer’s demand curve?

Answer 3

Comparative statics analysis of own-price changes can be used to derive a consumer’s demand curve

Question 4

What can happen to demand if the price of another good changes and what types of goods does this apply to?

Answer 4

• If the price of another good changes, demand can go up or down or remain unchanged
• This applies to 3 main types of goods: Substitutes, complements and unrelated goods

Question 5

What effect do changes in the price of another good have on the demand curve?

Answer 5

Changes in the prices of another good shift the demand curve

Question 6

What is the effect on the demand curve if the price of a complement increases?

Answer 6

If the price of a complement increases, the demand curve shifts to the left

Question 7

What is the effect on the demand curve if the price of a substitute increases?

Answer 7

If the price of a substitute increases, the demand curve shifts to the right

Question 8

How do changes in a consumers income effect their optimal consumption choices?

Answer 8

Changes a consumer’s income also change his/her optimal consumption choices

Question 9

What is an Engel curve?

Answer 9

An Engel curve shows the relationship between income and the consumption of a good

Question 10

How does an income change effect the demand curve?

Answer 10

An income change leads to a shift of the demand curve

Question 11

Draw a general preferences diagram including indifference curves, engel curves and budget constraints

Answer 11

See slide 14 of lecture 8

Question 12

How can the consumption of a good change as income increases?

Answer 12

Consumption of a good can increase or decrease as income goes up

Question 13

When does the consumption of a good increase when income increases?

Answer 13

Consumption increases if the good is a normal good

Question 14

When does the consumption of a good decrease when income increases?

Answer 14

Consumption decreases if the good is an inferior good

Question 15

How do we derive the demand functions/curves for both goods given their utility function and budget constraints?

Answer 15

1- Rearrange the budget constraint to make q2 the subject
2- Substitute this q2 into the utility function to get it in terms of q1 only
3- Write the budget constraint in the form of a polynomial in q1
4- Differentiate, make it equal to zero and solve to get an equation for q1
5- Substitute this back into the budget constraint to get the equation for q2
6- These are the demand functions

Question 16

How do we get the market demand function?

Answer 16

Add all the individual consumer’s demand functions to get the market demand function