Week 4 - Household Behaviour

Question 1

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?

Answer 1

P1C1+P2C2

Question 2

What is the budget constraint when a household has a fixed quantity of income Y?

Answer 2

P1C1+P2C2≤Y

Question 3

What does a Budget constraint look like on a diagram?

Question 4

What does the slope of the budget line represent?

Answer 4

-P1/P2 which measures the rate at which the consumer can trade one good for another.

Question 5

What if the consumer only consumer good 2?

Answer 5

They will have C2=Y/P2 which is the Y intercept.

Question 6

What happens to the budget constraint if double income but fix prices?

Answer 6

The slope remains unchanged as prices do not change. Intercepts on axes double so an outwards shift of the constraint.

Question 7

What does an indifference curve show?

Answer 7

The combinations of the two goods between which the consumer is indifferent.

Question 8

What is the marginal rate of substitution and how is it given?

Answer 8

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.

Question 9

What position of indifference curve would a consumer prefer to be on?

Answer 9

The one furthest from the origin.

Question 10

What are the properties of indifference curves?

Answer 10

Higher indifference curves are preferred to lower ones.
They slope downwards
They do not cross
Typically bowed inwards

Question 11

What would an indifference curve of perfect substitutes look like?

Answer 11

A straight line looking like this \

Question 12

What would the indifference curve of perfect compliments look like?

Answer 12

Like an L

Question 13

Where would the consumer want to be when combining indifference curves and budget constraints?

Answer 13

The individual wants to be on the highest possible indifference curve that remains within the budget constraint.

Question 14

What does the marginal rate of substitution equal?

Answer 14

Relative price

Question 15

What type of goods are one that when income rises consumption of both goods also rise?

Answer 15

Normal goods

Question 16

What happens to the consumption of normal goods when income rises?

Answer 16

They both rise

Question 17

What are goods where consumption falls when incomes rise?

Answer 17

Inferior goods

Question 18

What happens to the consumption of inferior goods when incomes fall?

Answer 18

Consumption rises

Question 19

What is the formula of income elasticity of demand?

Answer 19

% change in D/ % change in Income

Question 20

What does a negative YED mean?

Answer 20

The good is inferior

Question 21

What does a positive YED mean?

Answer 21

The good is normal

Question 22

What does a YED>1 mean?

Answer 22

It is a luxury good

Question 23

What does a YED<1 mean

Answer 23

It is a necessity good

Question 24

What happens to a budget constraint if price of good 1 falls but good 2 and income stays the same?

Answer 24

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.

Question 25

What is a giffen good?

Answer 25

When demand falls as price falls. This is not the usual case

Question 26

What is the substitution effect?

Answer 26

When there is a change in relative prices but keeps the individual on the same indifference curve

Question 27

What is the income effect?

Answer 27

When income changes and holding relative prices constant an increase in income to a new budget line.

Question 28

What is the formula for cross elasticity of demand?

Answer 28

%change in D for G2/%change in price of G1

Question 29

What are the goods called when fall in price of G1 causes demand for G2 to fall?

Answer 29

Substitutes - XED is positive

Question 30

What does a positive XED suggest?

Answer 30

They are substitutes

Question 31

How is XED defined when they are substitutes?

Answer 31

Price of G1 falls and demand for G2 falls

Question 32

What are goods called when a fall in the price of G1 causes demand for G2 to increase?

Answer 32

They are compliments

Question 33

What does a negative XED suggest?

Answer 33

Complimentary goods

Question 34

What is the XED of perfect substitutes?

Answer 34

It is infinity as consumers will buy whatever is cheaper.

Question 35

How can we model labour supply with budget constraints?

Question 36

What does the slope of the budget constraint when modelling labour supply represent?

Answer 36

Real wage - how much consumption good can I get if I work one more hour.

Question 37

What are the assumptions of modelling labour supply with budget constraint

Answer 37

I can work as much as I want - no unemployment
Will not consider leisure - non market work within home time.

Question 38

How are hours of work shown on the budget constraint?

Answer 38

The space between the total time available and the point on the indifference curve on the x-axis (home time)

Question 39

What happens if you are given a lump sum or perhaps win the lottery?

Answer 39

The budget constraint moves up from its original starting point.

Question 40

What happens to the budget constraint if wages rise?

Answer 40

The slope of the budget constraint becomes more steep. Therefore, it has an income and substitution effect.

Question 41

What is the substitution effect of a wage rise?

Answer 41

This makes the opportunity cost of leisure higher, which makes the individual work more and take less leisure

Question 42

What is the income effect of a wage rise?

Answer 42

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.

Question 43

To help the poor should you give them a lump sum or subsidise earnings?

Answer 43

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