Week 4 - Household Behaviour Flashcards
If the price of good 1 is P1 and and good 2 is P2. If consumption of good 1 and 2 is C1 and C2 then what is the total consumer expenditure?
P1C1+P2C2
What is the budget constraint when a household has a fixed quantity of income Y?
P1C1+P2C2≤Y
What does a Budget constraint look like on a diagram?
What does the slope of the budget line represent?
-P1/P2 which measures the rate at which the consumer can trade one good for another.
What if the consumer only consumer good 2?
They will have C2=Y/P2 which is the Y intercept.
What happens to the budget constraint if double income but fix prices?
The slope remains unchanged as prices do not change. Intercepts on axes double so an outwards shift of the constraint.
What does an indifference curve show?
The combinations of the two goods between which the consumer is indifferent.
What is the marginal rate of substitution and how is it given?
The slope of the indifference curve gives it. Shows how much of one good the individual would accept to give up one unit of another good. This varies along the indifference curve.
What position of indifference curve would a consumer prefer to be on?
The one furthest from the origin.
What are the properties of indifference curves?
Higher indifference curves are preferred to lower ones.
They slope downwards
They do not cross
Typically bowed inwards
What would an indifference curve of perfect substitutes look like?
A straight line looking like this \
What would the indifference curve of perfect compliments look like?
Like an L
Where would the consumer want to be when combining indifference curves and budget constraints?
The individual wants to be on the highest possible indifference curve that remains within the budget constraint.
What does the marginal rate of substitution equal?
Relative price
What type of goods are one that when income rises consumption of both goods also rise?
Normal goods
What happens to the consumption of normal goods when income rises?
They both rise
What are goods where consumption falls when incomes rise?
Inferior goods
What happens to the consumption of inferior goods when incomes fall?
Consumption rises
What is the formula of income elasticity of demand?
% change in D/ % change in Income
What does a negative YED mean?
The good is inferior
What does a positive YED mean?
The good is normal
What does a YED>1 mean?
It is a luxury good
What does a YED<1 mean
It is a necessity good
What happens to a budget constraint if price of good 1 falls but good 2 and income stays the same?
Rotates the budget line from point on vertical axis. The maximum amount of good 1 that can be bought rises but amount of good 2 stays the same.
What is a giffen good?
When demand falls as price falls. This is not the usual case
What is the substitution effect?
When there is a change in relative prices but keeps the individual on the same indifference curve
What is the income effect?
When income changes and holding relative prices constant an increase in income to a new budget line.
What is the formula for cross elasticity of demand?
%change in D for G2/%change in price of G1
What are the goods called when fall in price of G1 causes demand for G2 to fall?
Substitutes - XED is positive
What does a positive XED suggest?
They are substitutes
How is XED defined when they are substitutes?
Price of G1 falls and demand for G2 falls
What are goods called when a fall in the price of G1 causes demand for G2 to increase?
They are compliments
What does a negative XED suggest?
Complimentary goods
What is the XED of perfect substitutes?
It is infinity as consumers will buy whatever is cheaper.
How can we model labour supply with budget constraints?
What does the slope of the budget constraint when modelling labour supply represent?
Real wage - how much consumption good can I get if I work one more hour.
What are the assumptions of modelling labour supply with budget constraint
I can work as much as I want - no unemployment
Will not consider leisure - non market work within home time.
How are hours of work shown on the budget constraint?
The space between the total time available and the point on the indifference curve on the x-axis (home time)
What happens if you are given a lump sum or perhaps win the lottery?
The budget constraint moves up from its original starting point.
What happens to the budget constraint if wages rise?
The slope of the budget constraint becomes more steep. Therefore, it has an income and substitution effect.
What is the substitution effect of a wage rise?
This makes the opportunity cost of leisure higher, which makes the individual work more and take less leisure
What is the income effect of a wage rise?
Now better off than before so positive income effect. If leisure is a normal good this effect tends to reduce the supply of work hours.
To help the poor should you give them a lump sum or subsidise earnings?
A subsidy would make the line steeper
A lump sum would shift the starting non-working income higher - a lump sum could make them work less
