TAILIEUCHUNG - Lecture Basic microeconomics - Chapter 8 Appendix: Describing consumer preferences using indifference curves

Lecture Basic microeconomics - Chapter 8 Appendix "Describing consumer preferences using indifference curves" includes contents: Income expansion path, engel curves, price expansion path, income and substitution effects. | Describing Consumer Preferences Using Indifference Curves Chapter 8 Appendix Income expansion path Income expansion path -IEP- traces all the best (utility-maximizing) choices a consumer makes as income changes. The IEP slopes up if a good is a normal good The IEP is downward sloping if a good is inferior Income expansion path, Fig. A8-1 a and b, p 195 U1 U2 U3 U3 U2 U1 IEP IEP Good Y Good Y Good X Good X a) Normal good a) Inferior good Engel Curves An Engel curve plots all the best choices a consumer makes against INCOME. It is an income-quantity relationship If an Engel curve is upward sloping, a good is normal; downward sloping indicates an inferior good. Engel Curves, Fig. A8-2, p 195 Quantity demanded Income X1 X2 X3 Income elastic normal good (luxury) Income inelastic normal good (necessity) Inferior good Price Expansion Path Price expansion path – PEP – traces all the best choices of a consumer as the relative price changes. Price Expansion Path, Fig. A8-3, p 195 Good Y Good X B/(Px)1 B/Py B/(Px)2 PEP U1 U2 Income and substitution effects The law of demand states that there is an inverse relationship between price and quantity demanded. Two effects occur: Income effect Substitution effect Income and substitution effects Income effect reflects the purchasing power change as a result of the change in price. With a price decrease we can afford to buy more – a purchasing power increase With a price increase we can afford to buy less – a purchasing power decrease. Income and substitution effects Substitution effect reflects our willingness to switch consumption away from goods that become relatively more expensive. If relative price of a good falls, we buy more of it; At the same time, we buy less of the relatively more expensive product. Income and substitution effects For normal goods, income and substitution effects work in the same direction For inferior goods, income and substitution effects work in the opposite direction. Income and substitution effects, .

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