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Intermediate Microeconomics

by: Nola Williamson

Intermediate Microeconomics ECON 3010

Marketplace > University of Virginia > Economcs > ECON 3010 > Intermediate Microeconomics
Nola Williamson
GPA 3.91

William Johnson

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William Johnson
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This 2 page Class Notes was uploaded by Nola Williamson on Monday September 21, 2015. The Class Notes belongs to ECON 3010 at University of Virginia taught by William Johnson in Fall. Since its upload, it has received 53 views. For similar materials see /class/209766/econ-3010-university-of-virginia in Economcs at University of Virginia.

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Date Created: 09/21/15
Ch 7 Income and Substitution Effects Chapter Highlights 1 There are two ways in which economic circumstances typically change a change in income and a change in opportunity costs 2 When only income changes we can predict the change in behavior if we know something about how indifference curves relate to one another 7 because we jump from one indifference curve to another Whether tastes are quasilinear or homothetic whether goods are normal or inferior 7 these are statements about that relationship between indifference curves 3 When only opportunity costs change and real income remains constant we don t need to know anything about the relationship of indifference curves to one another 7 because the change in behavior occurs along a single indifference curve Thus the shape of the relevant indifference curve is all that matters 7 which is the same as saying that the degree of substitutability of the goods at the margin is all that matters 4 Substitution effects arise as we slide along indifference curves because opportunity costs have changed income effects arise as we jump between indifference curves because real income has changed I Income Effect 0 Consumption of bundle depends on tastes 0 Income effect change in income 0 Parallel shift in BC 0 No change in OCslope of BC 0 Emerge from relationship of ICs to each other Does not depend on shape of individual ICs substitutability 0 Jump from one IC to another 0 Absolute consumption 0 Normal good positive income effect Consumption and income move in same direction 0 Inferior good negative income effect Consumption and income move opposite o Quasilinear good no income effect Borderline between normal and inferior goods 0 Relative consumption consumption increase relative to income increase 0 Luxuries consumption increases by more than increase in income 0 Necessities consumption increases by less than increase in income 0 Homothetic consumption increases by same as income increase Borderline between luxury and necessity II Substitution Effect 0 Substitution effect change in pricesOC and not change in income 0 No change in indifference curves Slide along single IC 0 More consumption of relatively cheaper good and less consumption of relatively more expensive good 0 Size of SE depends on underlying tastes shape of individual IC o DOES NOT depend on whether good is normalinferior 0 Less substitutability more curvature smaller substitution effect III IE and SE Combined 0 Price change results in both IE and SE 0 Size ofIE and SE 1 Draw compensated budget parallel to new BC and tangent to original 2 Income effect difference among parallel BCs 3 Substitution effect difference among same IC Direction of SE same regardless of tastes Direction and magnitude of IE Normal good SE and IE move in same direction 0 Regular inferior good results in consumption decrease with price increase I Negative SE gt IE 0 o Giffen good results in consumption increase with price increase I Negative IE gt SE 0 Can only distinguish between regular inferiorGiffen when price of good in question changes Special cases 0 Perfect complements utility no SE TE IE 0 Quasilinear utility no IE SE TE IV Endowments 0 IE depends on if person is net buyer seller 0 Price rise 0 Net seller increases income I Normal good consume more I Inferior good consume less 0 Net buyer decreases income I Normal good consume less I Inferior good consume more V Expenditure Minimization 0 Method unconstrained optimization 0 1 Substitute constraint utility into objective function expenditure 2 Take derivative of objective function expenditure Set equal to 0 3 Solve for X1 or X2 4 Plug back into constraint utility to find optimal value for other variable Substitute optimal bundle into expenditure function for expenditure 0 Calculating substitution effect V39


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