Ejercicio Microeconomia

CHAPTER 4
INDIVIDUAL AND MARKET DEMAND

QUESTIONS FOR REVIEW

1. Explain the difference between each of the following terms:

a. a price consumption curve and a demand curve;

A price consumption curve identifies the utility maximizing combinations of two goods as the price of one of the goods changes. When the price of one of the goods declines, the budget line will pivotoutwards, and a new utility maximizing bundle will be chosen. The price consumption curve connects all such bundles. A demand curve is a graphical relationship between the price of a good and the (utility maximizing) quantity demanded of a good, all else the same. Price is plotted on the vertical axis and quantity demanded on the horizontal axis.

b. an individual demand curve and a marketdemand curve;

An individual demand curve identifies the (utility maximizing) quantity demanded by one person at any given price of the good. A market demand curve is the sum of the individual demand curves for any given product. At any given price, the market demand curve identifies the quantity demanded by all individuals, all else the same.

c. an Engel curve and a demand curve;A demand curve identifies the quantity demanded of a good for any given price, holding income and all else the same. An Engel curve identifies the quantity demanded of a good for any given income, holding prices and all else the same.

d. an income effect and a substitution effect;

The substitution effect measures the effect of a change in the price of a good on the consumption ofthe good, utility held constant. This change in price changes the slope of the budget line and causes the consumer to rotate along the current indifference curve. The income effect measures the effect of a change in purchasing power (caused by a change in the price of a good) on the consumption of the good, relative prices held constant. For example, an increase in the price of good 1 (on thehorizontal axis) will rotate the budget line down along the indifference curve as the slope of the budget line (the relative price ratio) changes. This is the substitution effect. This new budget line will then shift inwards to reflect the decline in purchasing power caused by the increase in the price of the good. This is the income effect.


2. Suppose that an individual allocates his orher entire budget between two goods, food and clothing. Can both goods be inferior? Explain.

If an individual consumes only food and clothing, then any increase in income must be spent on either food or clothing (recall, we assume there are no savings). If food is an inferior good, then, as income increases, consumption falls. With constant prices, the extra income not spent on foodmust be spent on clothing. Therefore, as income increases, more is spent on clothing, i.e. clothing is a normal good. For both types of goods, normal and inferior, we still assume that more is preferred to less.

3. Explain whether the following statements are true or false.

a. The marginal rate of substitution diminishes as an individual moves downward along the demand curve.This is true. The consumer will maximize his utility by choosing the bundle on his budget line where the price ratio is equal to the MRS. Suppose the consumer chooses the quantity of goods 1 and 2 such that [pic] As the price of good 1 falls, the price ratio becomes a smaller number and hence the MRS becomes a smaller number. This means that as the price of good 1 falls, the consumer is willing togive up fewer units of good 2 in exchange for another unit of good 1.

b. The level of utility increases as an individual moves downward along the demand curve.


This is true. As the price of a good falls, the budget line pivots outwards and the consumer is able to move to a higher indifference curve.

c. Engel curves always slope upwards.


This is false. The...