Economics 2150A/B Lecture Notes - Lecture 5: Emd Bl2, Demand Curve, Normal Good

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Econ 2150

Chapter 5 Notes

Oct. 7 2017

Chapter 5: The Theory of Demand

Optimal Choice and Demand

The Effects of a Change in Price

Looking at an Optimal Choice Diagram

• Vertical (or horizontal) intercept of the budget line is the same since the price of that

idiidual good/ioe has’t haged, ol the othe oe

• Slope of budget line changes as a result of Px changing

• If we draw a curve connecting all the baskets that are optimal, we get a price

consumption curve

o Generates our demand curve

The Effects of a Change in Income

• Results in a shift of the budget line since both intercepts are changing by the same amt

• If we draw a curve connecting all the baskets that are optimal, we get a income

consumption curve

Changing Income: Shifting a Demand Curve

• As income incr. we buy more of both goods

• Also generates a demand curve

Engel Curves

• A curve that relates the amount of a good consumed to the level of income, holding

prices constant

• Quantity is on horizontal axis, income is on the vertical instead of price

• Upward sloping (positive) for a normal good

o Positive elasticity of demand

• Inferior goods have backwards C-shaped curves → at some point, has a negative slope

Change in the Price of a Good: Substitution Effect and Income Effect

• Substitution effect = the change in the quantity of the good the consumer would

purchase after the price change to achieve the same level of utility

• Income effect = the change in the amount of a good that a consumer would buy as

purchasing power changes, holding prices constant

o Aouts fo the pat of the total diffeee i uatit puhased that is’t

accounted for by the substitution effect

• Work together at same time to result in an overall movement of the consumer from an

initial basket to a final basket

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The Substitution Effect

• Step 1 – find the initial basket

o At price Px1, face budget line BL1, maximizing basket is A on U1, the quantity

purchased is xA

• Step 2 – find the final basket

o Decr. in price of x rotates BL outwards (BL2), quantity purchased is now at xC,

the overall effect of a price change is xc-xa

• Step 3 – find an intermediate decomposition basket that will enable us to identify the

portion of the change in quantity due to the substitution effect

o Keep in mind:

▪ Decomposition basket reflects the price decrease, so must line on a BL

parallel to BL2

▪ The decomposition basket reflects the assumption that the consumer

achieves the initial level of utility after the price decrease, so basket must

at point where BL is tangent to indifference curve U1

o The portion of the overall effect that is attributed to substitution effect is XB-Xa

The Income Effect

• Basiall the hage i aout osued as the osue’s UTILITY hages

o Ie. We will start with the utility curves

• Shift from BLd to BL2

• Optimal basket is now on BL2

• The income effect accounts for the consue’s oeet fo asket B to fial asket

o We attribute Xc-Xb to the income effect

• Total change is substitution + income effect → (Xc-xA)

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ECON 2150A/B Full Course Notes

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If we draw a curve connecting all the baskets that are optimal, we get a price consumption curve: generates our demand curve. The effects of a change in income: results in a shift of the budget line since both intercepts are changing by the same amt. If we draw a curve connecting all the baskets that are optimal, we get a income consumption curve. Changing income: shifting a demand curve: as income incr. we buy more of both goods, also generates a demand curve. Inferior goods have backwards c-shaped curves at some point, has a negative slope. Change in the price of a good: substitution effect and income effect: substitution effect = the change in the quantity of the good the consumer would purchase after the price change to achieve the same level of utility. The income effect: basi(cid:272)all(cid:455) the (cid:272)ha(cid:374)ge i(cid:374) a(cid:373)ou(cid:374)t (cid:272)o(cid:374)su(cid:373)ed as the (cid:272)o(cid:374)su(cid:373)e(cid:396)"s utility (cid:272)ha(cid:374)ges.

Related Questions

The demand curve for a good is very unlikely to be perfectly vertical because

A) scarcity and limited income restrict the ability of consumers to afford goods as they become very expensive.
B) as the price of a good rises to high enough levels, the incentive for other suppliers to invent new substitutes for the good increases.
C) consumers generally do not care about the price of the goods they consume.
D) both a and b are true.

As the period for firms to expand output is lengthened, the elasticity of the market supply curve will

A) approach zero.
B) increase.
C) decrease.
D) remain the same since time does not affect the elasticity of market supply.

The price elasticity of demand for automobiles measures the responsiveness of

A) consumer purchases to a change in the price of automobiles.
B) consumer purchases to a change in the quality of automobiles.
C) supplier production levels to a change in the price of automobiles.
D) consumer purchases of automobiles to a change in their income.

Which of the following is true regarding the price elasticity of demand?

A) Demand is generally more elastic in the long run than in the short run.
B) Along a single demand curve, demand elasticity decreases as you move down the curve (to lower prices).
C) a flatter demand curve (has a less steep slope) is relatively more elastic than a demand curve that has a steeper slope.
D) All of the above are true.

5. (Answer ONE of the Following Question)

Economists maintain that the price of a product does not affect demand. How can this be true?
National defence is considered a public good because there appear to be no limits to the nonrivalry-in-consumption characteristic, and exclusion of nonpayers is impossible. Are there any other goods that so perfectly meet both public goods criteria?
Congressman Local stuff always votes for a balanced budget amendment to the U.S. Constitution. He also always votes for spending bills supported by the leadership of his political party. Is this rational?

carminecheetah752

budget line

marginal utility

complete property of preferences

market demand

consumption bundle

substitution effect

Giffen good

total effect

income effect

transitive property of preferences

indifference curves

utility

the marginal rate of substitution

utility function

1.	_____	The satisfaction or benefit that consumers receive from consuming goods or services.
2.	________________ _	A particular combination of specific quantities of goods or services
3.	________________ _	Consumers can rank all conceivable bundles of goods or services
4.	_____	If A is preferred to B, and B is preferred to C, then A is always preferred to C.
5.	_____	Equation showing a consumerâs perception of the total utility forthcoming from consuming each bundle of goods and services.
6.	_____	A set of consumption bundles each and every one of which provides a consumer with exactly the same level of total utility.
7.	_____	The number of units of Y that must be given up for total utility to remain the same when one more unit of X is consumed.
8.	_____	The addition to total utility attributable to consuming one more unit of a good, holding the consumption of all other goods constant.
9.	_____	The line showing all bundles of goods that can be purchased at given prices if the entire income is spent.
10.	_____	The change in the consumption of a good that would result if the consumer remained on the original indifference curve after the price of the good changes.
11.	_____	The change in consumption of goods results strictly from the change in purchasing power after the price of a good changes.
12.	________________ _	The sum of the substitution and income effects.
13.	_____	A good for which quantity demanded varies directly with price, causing an upward sloping demand curve.
14.	_____	A list of prices and the corresponding quantity consumers are willing and able to purchase at each price.

blushwildebeest943

1. Which of the following shifts aggregate demand to the right?
a. Congress reduces purchases of new weapons systems.
b. US exports increase.
c. The price level falls
d. New developments in IT increase the productivity of most manufacturing industries in the US.

2. Suppose the EPA introduces new smog regulation that makes it costlier to produce cars. As a result, aggregate supply falls (primary effect) and firms cut back on production. With less output in the economy available for consumers, consumers bid up the prices of available output. With higher prices, firms choose to produce more (secondary effect).
Which of the following best explains what the net effect on GDP?
a. The two effects should essentially cancel out, with little to no effect on GDP, but the price level clearly rises.
b. It is impossible to say what happens to GDP without being able to compare the magnitudes of the two effects.
c. Real GDP rises as the secondary effect dominates the primary effect.
d. Real GDP falls since the primary effect dominates the secondary effect.

3. A Keynesian economist who observes an output gap would conclude that
a. aggregate demand should be shifted to the right.
b. a policy of deregulation would be better than demand management policy
c. aggregate supply should be shifted to the right
d. All proposed answer options are correct

4. Monetarists believe
a. the Aggregate Supply curve is upward-sloping (but not vertical) over all time frames.
b. the Aggregate Supply curve can be treated as horizontal in the long run (over 10 years
c. the Aggregate Supply curve is vertical only in the very long run (over 20 years).
d. the Aggregate Supply curve can be treated as vertical in the short-to-medium run (1-2 years)

5. Suppose the price of oil increases due to conflict in the Middle East. How will this be illustrated in the AD-AS model?
a. The aggregate demand curve will shift to the left
b. The aggregate supply curve will shift to the left.
c. The aggregate demand curve will shift to the right
d. The aggregate supply curve will shift to the right

6. Assume a Keynesian AS curve. In the short run, when there is a large output gap
a. contractionary demand management policy is likely to be highly inflationary
b. expansionary demand management policy does not cause much inflation.
c. expansionary demand management policy is likely to be highly inflationary
d. the government should use contractionary demand management policy

7. As a result of Bush tax cuts that partially expired in January 2013, the marginal tax rates for some households increased and these households paid higher taxes. Which of the following would be the best description of the tax cut expiration?
a. Rightward shift in AS
b. Rightward shift in AD
c. Leftward shift in AD
d. Leftward shift in AS

8. Suppose that the U.S. government increases income taxes on individuals earning more than $500,000/year and uses the revenue from this tax increase to subsidize the cost of energy for businesses. How will this policy change affect the U.S. economy?
a. The effect on output is ambiguous but price level will decrease for sure
b. The effect on both output and price level is ambiguous.
c. The effect on price level is ambiguous but output will increase for sure
d. The effect on price level is ambiguous but output will decrease for sure

9. If Australia, which imports goods from the United States, went into recession, we would expect that U.S. net exports would
a. rise, making aggregate demand shift right.
b. rise, making aggregate demand shift left
c. fall, making aggregate demand shift left
d. fall, making aggregate demand shift right

10. Suppose that Greece decides to exit the European Union and the Euro Zone, causing a boost in business confidence in European markets. How would you illustrate the primary effect of Greeceâs decision in the AD-AS model for the EU economy?

Note: for this question, assume that Y in the AD-AS model represents output (GDP) of EU member countries without Greece.
a. a shift in the aggregate supply curve to the left and a shift in the aggregate demand curve to the left
b. a shift in the aggregate demand curve to the right
c. a shift in the aggregate demand curve to the left
d. movement along the aggregate demand curve to the left

11. The Austrian school of thought believes that demand management policy should not be used because
a. big government prefers deregulation, which shifts aggregate supply
b. the economy is always at full employment
c. shifting AD to the right is likely to cause deflation
d. big government has a bias towards inflationary policy

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Economics 2150A/B Lecture Notes - Lecture 5: Emd Bl2, Demand Curve, Normal Good

ECON 2150A/B Full Course Notes

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