Chp 9
describe how the price effect works
-at the current price, Lisa is buying a good where her budget line intersects with her highest attainable indifference curve -when the price of a good falls (let's say on the x axis) the budget line moves outwards and intersects at a new point on an indifference curve -that new point is then plotted to show the demand curve
explain how to isolate the substitution effect
-the goal is to keep the budget line on the SAME indifference curve -show the price effect first (new budget line that intersects with a diff. indifference curve) -then REDUCE income/SHIFT the budget line so that it intersects with the OLD indifference curve
The effect of _____ on the quantity of the good consumed is called the price effect. A. a change in the price of a good B. supply C. income D. the price of a good
A. a change in the price of a good
An indifference curves slopes downward because _______. A. it shows that when a person gives up some of good x they must increase their consumption of good y to remain indifferent B. it is a demand curve without prices C. it shows that when a person gives up some of good x they can afford to increase their consumption of good y D. it shows that people are only happy when they increase consumption of all goods
A. it shows that when a person gives up some of good x they must increase their consumption of good y to remain indifferent
An indifference curve is bowed towards the origin because the more of good x that you consume the ______ . A. less you are willing to give up of good y to get more of good x and remain indifferent B. less of good y you can afford C. more you are willing to give up of good y to get more of good x and remain indifferent D. greater your income must be
A. less you are willing to give up of good y to get more of good x and remain indifferent
When the prices change next week, there is ______. A. an income effect but no substitution effect B. an income effect and a substitution effect C. a substitution effect but no income effect D. neither an income effect nor a substitution effect
B. an income effect and a substitution effect change in price = price effect which is made up of income and substitution effect
Diminishing marginal rate of substitution is the general tendency for the marginal rate of substitution to _____ as the consumer moves down along the indifference curve, _____ consumption of the good measured on the x-axis and _____ consumption of the good measured along the y-axis. A. decrease; decreasing; increasing B. decrease; increasing; decreasing .C. increase; increasing; decreasing D. increase; decreasing; increasing
B. decrease; increasing; decreasing
how do indifference curves of perfect substitutes look like
L shaped
what happens if negative income effect is larger than the positive substitution effect and there is a fall in price
a fall in price decreases quantity bought and demand curve slopes upwards <-- this does not happen in reality
what happens if negative income effect equals positive substitution effect and there is a fall in price
a fall in price will leave the quantity bought the same which means demand is perfectly inelastic
what is an inferior good
a good for which demand decreases as income rises
if the price of the good on the x axis falls what happens to the slope of the budget line, other things remaining the same
becomes flatter
what is a budget line
describes limits to a household's consumption choices
what is the substitution effect
effect of a change in price on the quantity bought when the consumer remains indifferent between original choice and new choice (shown on same indifference curve)
what happens if negative income effect is smaller than positive substitution effect and there is a fall in price
fall in price increases quantity bought and demand curve still slopes downwards like that for a normal good (but is less elastic than the demand of a normal good)
what is real income
income that is expressed in terms of goods the household can afford to buy (not $$)
explain how to isolate the income effect
isolate the substitution effect (put the new budget line on the original indifference curve) -then shift the budget line back again to a NEW indifference curve, and look at the change in the best affordable points (shift from orignal indifference curve to new one is the income effect)
does a change in income change real income or relative price
it changes real income
what is special about the marginal rate of substitution on the best affordable point on an indifference curve
it equals the relative price of the goods = opportunity costs
for an inferior good, does a lower price always lead to an increase not quantity demanded
no
how do you find relative price
price of the good you want/price of other good whereas opportunity cost is (quantity of the other good you give up/quantity of good you want)
for a normal good, does the income effect reinforce or not reinforce the substitution effect
reinforces the substitution effect
what is an indifference curve
shows combinations of goods among which a consumer is indifferent
when two goods are perfect substitutes how do their indifference curves look like
straight lines (so marginal rate of substitution is constant)
what is diminishing marginal rate of substitution
tendency to be willing to give up LESS of a good y to get one more unit of good x while still remaining indifferent
what is the income effect
the effect of a change in income on quantity bought
what is the price effect
the effect of a change in the price of a good on the quantity of the good consumed -can be divided into substitution effect and income effect
what is the marginal rate of substitution
the rate at which a consumer is willing to trade one good for another while remaining indifferent = SLOPE OF INDIFF. CURVE
how can you tell when something is a normal good
when income falls, demand falls
what is the best affordable point
where the budget line intersects with the HIGHEST indifference curve on the preference map