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What is meant by the substitution effect in the context of Marshallian demand?
What is meant by the substitution effect in the context of Marshallian demand?
How does a change in the price of good x affect its Marshallian demand?
How does a change in the price of good x affect its Marshallian demand?
What is the significance of the Slutsky Equation in demand analysis?
What is the significance of the Slutsky Equation in demand analysis?
In the context of Marshallian demand, what does the term 'total effect' refer to?
In the context of Marshallian demand, what does the term 'total effect' refer to?
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Which of the following is true about the income effect in the context of price changes?
Which of the following is true about the income effect in the context of price changes?
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What is the optimal consumption of x and y before the price change occurs?
What is the optimal consumption of x and y before the price change occurs?
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When the price of x increases from 1 to 4, how does the slope of the budget constraint change?
When the price of x increases from 1 to 4, how does the slope of the budget constraint change?
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What point represents the least expensive way to consume while staying on the same indifference curve after the price increase?
What point represents the least expensive way to consume while staying on the same indifference curve after the price increase?
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What function is used to represent the utility in this scenario?
What function is used to represent the utility in this scenario?
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What does holding utility fixed at Ū = 4 allow for in terms of consumption changes?
What does holding utility fixed at Ū = 4 allow for in terms of consumption changes?
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What does it mean if the quantity of x increases as income increases?
What does it mean if the quantity of x increases as income increases?
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Which of the following best describes the substitution effect?
Which of the following best describes the substitution effect?
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According to the Slutsky equation, how is the total effect of a price change determined?
According to the Slutsky equation, how is the total effect of a price change determined?
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When prices increase, how can this change be interpreted regarding consumer income?
When prices increase, how can this change be interpreted regarding consumer income?
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What is the formula for the income effect according to the content?
What is the formula for the income effect according to the content?
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If the total effect of a price change equals the change in consumption, what can be inferred?
If the total effect of a price change equals the change in consumption, what can be inferred?
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What does the equation ∂x∗m/∂px represent?
What does the equation ∂x∗m/∂px represent?
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What does point C represent in the context of the income effect?
What does point C represent in the context of the income effect?
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How can the income effect be computed mathematically?
How can the income effect be computed mathematically?
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What are Marshallian and Hicksian demands equal at the initial point?
What are Marshallian and Hicksian demands equal at the initial point?
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What does the symbol Ū represent in the provided equations?
What does the symbol Ū represent in the provided equations?
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What does the change in prices indicate for consumer utility according to the content?
What does the change in prices indicate for consumer utility according to the content?
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What are the main types of demand mentioned in the content?
What are the main types of demand mentioned in the content?
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Which of the following is essential for simplifying the income effect?
Which of the following is essential for simplifying the income effect?
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When plotting the income effect on a graph, what does point B signify?
When plotting the income effect on a graph, what does point B signify?
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What component of the total effect of a price change focuses on the substitution of goods due to a shift in relative prices?
What component of the total effect of a price change focuses on the substitution of goods due to a shift in relative prices?
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What does the term 'decomposing price changes' refer to in the context of Marshallian demand?
What does the term 'decomposing price changes' refer to in the context of Marshallian demand?
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How is the total effect of a price change in Marshallian demand represented mathematically?
How is the total effect of a price change in Marshallian demand represented mathematically?
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Which of the following best describes the relationship between the income effect and changes in prices?
Which of the following best describes the relationship between the income effect and changes in prices?
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What does the symbol I represent in the formulation for Marshallian demand?
What does the symbol I represent in the formulation for Marshallian demand?
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What happens to the consumption of x and y after the price of x increases from 1 to 4?
What happens to the consumption of x and y after the price of x increases from 1 to 4?
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What does the point B on the graph represent after the price increase?
What does the point B on the graph represent after the price increase?
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What is the optimal consumption before the price change as defined in the content?
What is the optimal consumption before the price change as defined in the content?
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How does the slope of the budget constraint change when the price of x increases to 4?
How does the slope of the budget constraint change when the price of x increases to 4?
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What method is used to determine the least expensive way to achieve a set utility after a price change?
What method is used to determine the least expensive way to achieve a set utility after a price change?
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What happens to total utility when the income relative to the prices of two goods decreases?
What happens to total utility when the income relative to the prices of two goods decreases?
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How is the substitution effect mathematically expressed in the analysis?
How is the substitution effect mathematically expressed in the analysis?
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What condition must hold true for a consumer to maintain the same utility level after a price change?
What condition must hold true for a consumer to maintain the same utility level after a price change?
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In which scenario would a consumer experience a decrease in utility after a price increase?
In which scenario would a consumer experience a decrease in utility after a price increase?
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What does the equation $px x + py y = I$ represent in this context?
What does the equation $px x + py y = I$ represent in this context?
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What is the implication of calculating the substitution effect using a small price change?
What is the implication of calculating the substitution effect using a small price change?
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What occurs if a consumer cannot afford the optimal consumption after a price change?
What occurs if a consumer cannot afford the optimal consumption after a price change?
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What does the utility level drop to in optimal consumption when a price change leads to reduced income?
What does the utility level drop to in optimal consumption when a price change leads to reduced income?
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What is the primary feature of point C in relation to consumer utility after a price change?
What is the primary feature of point C in relation to consumer utility after a price change?
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How can the income effect be most simply expressed mathematically?
How can the income effect be most simply expressed mathematically?
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Which condition describes how Marshallian and Hicksian demand relate at the initial point?
Which condition describes how Marshallian and Hicksian demand relate at the initial point?
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What does the equation for calculating the income effect ultimately rely on?
What does the equation for calculating the income effect ultimately rely on?
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Why is point B significant when analyzing changes in consumer consumption?
Why is point B significant when analyzing changes in consumer consumption?
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What does the derivative represent in relation to the income effect?
What does the derivative represent in relation to the income effect?
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In the context of consumer demand changes, what effect does an increase in the price of good x have?
In the context of consumer demand changes, what effect does an increase in the price of good x have?
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Study Notes
Income and Substitution Effects
- Consumer demand is affected by price changes, and there are two concepts of demand curves that explain these effects, Marshallian and Hicksian demand curves. These curves behave differently in response to price changes.
- Both curves show a downwardsloping relationship between price and quantity.
Concepts Covered
- Effect of a price change on Marshallian demand
- Decomposing price changes
- The Slutsky equation
- Elasticity
7.1 Effect of a Price Change on Marshallian Demand
- The Marshallian demand for a good (x) can be expressed as a function of income (I) and prices (Px, Py), where x = x(Px, Py, I).
- Similarly, the Marshallian demand for good y (Ym = y(Px, Py, I)) can be determined.
- The focus is on how changes in the price of good x affect the demand for good x.
- This change in demand can be represented by the derivative of Marshallian demand with respect to the price of good x (∂xm/∂Px).
- This change is referred to as the total effect of a price change.
7.2 Decomposing Price Changes
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Two important components of total price change in demand: substitution effect and income effect
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Substitution effect: The consumer substitutes towards the cheaper good when relative prices change, holding overall utility constant. The consumer prefers a different point on the indifference curve. Demonstrated by a graph comparing two different bundles given price changes, with a fixed level of utility (U=4). The slope of the budget constraint changes with the price change.
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Income effect: The price change affects the consumer's purchasing power. If the price increases, the consumer's real income decreases. The demand shifts to a different bundle on the lowest possible indifference curve. Change in consumption due to the change in purchasing power. Demonstrated by a graph comparing how purchasing power and utility changes given price changes, given utility is adjusted.
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The substitution effect considers the response when holding the utility constant
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The income effect captures the changes in buying power.
7.3 The Slutsky Equation
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The total effect of a price change is the sum of the substitution and income effects.
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The Slutsky equation expresses this relationship mathematically: Total effect = Substitution effect + Income effect
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Used example U=x^(1/2)y^(1/2) for demonstrating relationship
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This equation shows the total effect of a price change on demand as the sum of how substitutes influence demand and the influence of the change in buying power on demand
- Total effect = ∂xm/∂Px = ∂xh/∂Px + (∂xm/∂I)*(∂I/∂Px)
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The indirect utility function (∂I/∂Px) is used to convert from utility to income.
7.4 Elasticity
- Elasticity measures the responsiveness of quantity demanded to price changes.
- Own-price elasticity is a measure of the proportional change in quantity demanded in response to a proportional change in price.
- Elasticity considers the initial price and quantity for standardization.
- Cross-price elasticity measures the responsiveness of quantity demanded of one good to a change in the price of another good.
- Income elasticity measures the responsiveness of quantity demanded to a change in income.
- Elasticity is a unit free ratio.
- Elasticity is reported as an absolute value, even though it is typically negative (quantity demanded decreases as price increases).
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Description
Explore the intricate concepts of income and substitution effects in consumer demand through the lens of Marshallian and Hicksian demand curves. This quiz covers the impact of price changes on demand, the Slutsky equation, and elasticity, essential for understanding consumer behavior. Dive into how these theories interact with price fluctuations and demand response.
