The Theory of Demand Flashcards
What is the price consumption curve?
This is the set of optimal consumption choices for a good at every possible price.
The price consumption curve shows how the demand changes, holding everything else constant.
From the price consumption curve, we can plot the individuals’s demand curve.
What three things can be said about the individual demand curve?
1) The consumer is minimising their utility at each point on the individual demand curve.
2) MRS falls as price falls along the demand curve - assuming convex IC curves and an interior solution.
3) The demand curve is just the consumer’s willingness to pay curve.
How does income effect the individual demand curve?
When income changes and the price of a good remains the same, the individual demand curve will shift.
What is an engel curve?
The engel curve plots the quantity of x consumed for each level of income.
If the income consumption curve is positively sloped, then the Engel curve will be positively sloped.
What is a normal good?
What is an inferior good?
The demand for a normal good increases as income increases.
The demand for an inferior good increases as income decreases.
Wha two things happen when the price of good x changes?
1) Substitution effect - amount of x consumed changes due to a change in the relative price.
2) Income effect - amount of x consumed changes because of a change in real income as a result of the price change.
What sort of income and substitutions effects do normal/inferior/giffen goods have?
Normal goods have positive income and substitution effects.
Inferior goods have negative income effect and a positive substitution effect.
Giffen goods are an inferior good where trhe negative income effect outweighs the positive substitution effect.
What is compensating variation?
For a price reduction will the value for CV be positive or negative?
The compensating variation is the amount of income a consumer would be willing to give up after a price change in order to achieve the same utility as before the price change.
For a price reduction, the CV will be positive - a price reduction makes the consumer better off, so thye are willing to give up a positive amount.
What is equivalent variation?
Equivalent variation is the amount of income that would be required at initial prices to achieve the same level of utility at the final prices.
What is the market demand?
The market demand is the horizontal sum of the demands of individual consumers.
