1 True or False, On a given indifference curve, the marginal rate of substitution is always
decreasing. (T)
2 Common fallacies Why are these statements wrong?
(a) Since consumers do not know about indifference curves or budget lines, they cannot
choose the point on the budget line tangent to the highest possible indifference curve.
Since the consumer is rational, implying that consumer chooses the
affordable bundle that maximizes his utility. He\ she can’t afford points
above the budget line and will never choose points below the budget line so
he\she will select a point on the budget line. The chosen bundle will be the
point at which an indifference curve just touches the budget line. So
indifference curves and budget lines are an attempt to explain scientifically
what people do instinctively.
(b) Inflation must reduce demand since prices are higher and goods are more expensive.
In my assumption there are situations that when demand increases it
means people are willing to pay more for the product.
if demand increases, it means the same product can be sold for more. So,
inflation sometimes DOES’NT reduce demand
3 Suppose films are normal goods but transport is an inferior good. How do the quantities
demanded for the two goods change when income increases?
For normal goods in this case (films), the higher income raises the quantity
of the demanded however, since transport is an inferior good, the quantity
demanded would fall as income rises.
4 Discuss each statement. Are they all correct?
The own-price elasticity of demand for food is negative.
demand will decrease when price increases, and demand will increase
when price decreases. That means that price elasticity of demand is
almost always negative because demand and price have an inverse
relationship. However, in some cases, demand increases when price
increases which makes the own-price elasticity of demand Positive.
I think in case of Food the price elasticity of demand is positive which
means that the statement is incorrect.
The demand for food is inelastic.
There are no substitutes for food, it’s a necessity, there will always
be demand for food. So, the statement is correct
A higher food price increases spending on food.
people will buy about the same amount of food, whether the price drops or
rises. This situation happens with things that people must have so the statement
is correct.
Higher food prices imply less is spent on all other goods. The quantity demanded of each
of these other goods falls.
1. If this other good was normal good: Since both goods are normal,
higher income raises the quantity of each good demanded especially if
the two goods are poor substitutes, Moving away from balanced
combinations of the two goods requires large extra quantities of one
good to compensate for small losses of the other good if a constant
level of utility is to be preserved.
2. If the other goods are a luxury good then it will lead to leads to a lot
fewer demanded on these goods.
The increase in the price of food decreases the real income of the
consumer since food is large part of consumer budgets. the income
effect has a negative impact on the quantity demanded of the other
good.
5 Suppose Glaswegians have a given income and like weekend trips to the Highlands, which are
a three-hour drive away. (a) If the price of petrol doubles, what is the effect on the demand for
trips to the Highlands? Discuss both income and substitution effects.
Both the income and substitution effects reduce demand.
(c) What happens to the demand for Highland hotel rooms?
There will be a decrease in the demand so the demand curve shifts down and
equilibrium price and quantity fall.
Essay question Consumer choice theory assumes that consumers are
rational but we observe a person behaving differently in apparently
similar situations. Is it realistic to think that we account for rational
behaviour in every situation?
This question involves the methodology used by economists and the
disagreements that arise from different approaches to economic subject
matter. The physical scientist is able to carry out controlled experiments
under laboratory conditions. As a result, conclusions can be arrived at
with a fair degree of certainly. By contrast the subject matter of
economics is people, and people’s behavior changes. A person
considered to be rational may save one year and dissave the following
year. A person may develop a work ethic but it may erode over time.
If taxes are increased a person may decide to work more hours in
order to maintain a target income after tax. Eventually the same person
may decide to work less because the incentive to work longer hours has
diminished. People learn from experience and so behaviour changes over
time. An atom of nitrogen will always behave like and atom of
nitrogen but people will often change their actions even when faced
with similar situations.
