CHAPTER 5 (test 1)

Question 1

What is the income effect? Equation for it?

Answer 1

The income effect is the change in a consumer’s consumption choices that results from a change in the consumer’s income (or purchasing power), holding relative prices constant

change in Q / change in I

Question 2

What are normal goods and inferior goods?

Answer 2

Normal - higher income is associated with rising consumption (ex. vacations and basketball tickets)

Inferior - higher income is associated with falling consumption

Question 3

What in income elasticity? Equation?

Answer 3

Income elasticity describes the response of demand to changing income > the % change in quantity consumed associated with a % change in income
> if goods are very elastic than demand will change a LOT with a change in income

Eid = (change in Q/Q) / (change in I/I)

Question 4

What’s important about the relation between income elasticity of demand and the income effect?

Answer 4

Their signs (if their positive or negative) is the same!

Question 5

How can the income effect (or Eid) tell us what type of good it is?

Answer 5

If the income effect (change in Q/change in I) is greater than 0 (positive), the good is a normal good
necessity = income elasticity between 0 and 1
luxury = income elasticity greater than 1

If the income effect (change in Q/change in I)) is less than 0 (negative), the good is an inferior good

Question 6

What are necessity goods and luxury goods?

Answer 6

necessity goods = normal goods for which income elasticity is between 0 and 1

luxury goods = normal goods for which income elasticity is greater than 1

Question 7

What is the income expansion path and 4 of its rules/characteristics

Answer 7

Curve that connects a consumer’s optimal bundles at each income level
- only two goods can be represented
- when both goods are normal goods, the path is positively sloped
- if the slope of the income path is negative, one of the goods is an inferior good
- income levels can’t be directly observed on the curve because both axes represent quantities of goods

Question 8

What is an Engel curve?

Answer 8

It is the more common way of describing the consumption-income relationship
- shows the relationship between quantity of a good consumed and a consumer’s income
- if the Engel curve has a positive slope, the good is a normal good at that income level
- if the Engel curve has a negative slope, the good is an inferior good at that income level

Question 9

What 2 things happen when the price of a good changes relative to another?

Answer 9

1. one good becomes relatively more expensive, and the other relatively less
2. the total purchasing power of a consumer’s income changes

Question 10

If the price of one good rising leads to increased consumption of a second good, what are these goods to each other?

if the price of one good rising leads to decreased consumption of a second good, what are these goods to each other?

Answer 10

they are substitutes

they are complements

Question 11

How do we find the market demand curve from the individual demand curves?

Answer 11

The market demand curve is found by summing horizontally the individual demand curves
> the market quantity demanded at each price is the sum of the individual quantities demanded at each price > the price points on the vertical y axis will not change! it’s just the quantities that we’re adding up