Lecture 4 - Demand

Question 1

Comparative Statics

Answer 1

• Process of comparing two equilibria
• Statics implies that we are not analysing the dynamics of how the consumer moves from the first to second equilibrium
• Changes in equilibrium due to: own price changes, cross price changes, income changes

Question 2

Own Price Effects

Answer 2

• Impact of change in price of a good on quantity demanded of that good
• Budget constraint rotates when price changes

Question 3

Ordinary Goods

Answer 3

• A good is called ordinary if the quantity demanded of it always increases as its own price decreases
• Most goods are ordinary goods
• Downward sloping demand curve

Question 4

Giffen Goods

Answer 4

• If for some values of its own price, the quantity demanded of a good rises as its own price increases then the good is called Giffen
• Demand curve has a positively sloped part

Question 5

Normal Goods

Answer 5

• Increase in I implies an increase in consumption
• A good for which quantity demanded rises with income is called normal
• A normal good’s Engel curve is positively sloped

Question 6

Inferior Goods

Answer 6

• Increase in I implies a decrease in consumption
• A good for which quantity demanded falls as income increases is called income inferior
• Therefore an income inferior good’s Engel curve is negatively sloped

Question 7

Engel Curve

Answer 7

A plot of quantity demanded against income is called an Engel curve

Question 8

Homotheticity

Answer 8

• The consumer’s MRS is the same anywhere on a straight line drawn from the origin
• Quasilinear preferences are an example of non-homothetic preferences

Question 9

Luxury Goods

Answer 9

Goods for which fraction of total income spent on them increases as income increases

Question 10

Necessity Goods

Answer 10

Goods for which fraction of total income spent on them decreases as income increases e.g. food, housing, utilities

Question 11

Price offer curve

Answer 11

• The curve containing all the utility maximising bundles traced out as p1 changes with p2 and income constant is the p1 price offer curve
• Also called the price consumption curve

Question 12

Ordinary demand curve

Answer 12

The plot of the x1 coordinate of the p1 price offer curve against p1 is the ordinary demand curve for commodity 1

Question 13

Inverse demand function

Answer 13

• Taking quantity demanded as given and then asking what the price must be describes the inverse demand function of a commodity
• It is the inverse demand function that you are graphing i.e. price on the y axis

Question 14

Are Engel curves always straight lines?

Answer 14

• No, Engel curves are straight lines if the consumer’s preferences are homothetic
• Consumer preferences only depend on the ratio of good 1 to good 2 not the total amount of the good

Question 15

Cross Price Effects

Answer 15

Impact of change in price of one good on quantity demanded of another good

Question 16

Gross Substitutes

Answer 16

Increases in price of good 1, increase in quantity demanded of good 2 e.g. coffee and tea

Question 17

Gross Complements

Answer 17

Increase in price of good 1, decrease in quantity demanded of good 2 e.g. tea and milk

Question 18

Unrelated goods

Answer 18

If the 2 goods are unrelated change in price of x has no impact on consumption of y

Question 19

Cross price effects for substitutes

Answer 19

Increase in price of x, increase in y

Question 20

Cross price effects for complements

Answer 20

Increase in price of x, decrease in y

Question 21

Cross price effects for unrelated goods

Answer 21

• Increase in price of x has no effect on y
• Theory alone does not tell us how x and y are related
• Must look at data, could be different for different individuals or groups