This text discusses how to derive an individual demand curve from utility-maximizing adjustments to changes in price. It also discusses the concepts of substitution and income effects, and how they can be used to explain the demand curves for normal and inferior goods.
Summary
The marginal decision rule states that an individual should consume goods until the marginal utility of each good is equal to the price of that good.
The substitution effect of a price change refers to the change in the quantity demanded of a good due to a change in its relative price. The income effect of a price change refers to the change in the quantity demanded of a good due to a change in the consumer’s real income.
A normal good is a good whose demand increases when income increases. An inferior good is a good whose demand decreases when income increases.
Questions
- What is the marginal decision rule?
- What is the difference between the substitution and income effects of a price change?
- What is a normal good? What is an inferior good?
Answers
- The marginal decision rule states that an individual should consume goods until the marginal utility of each good is equal to the price of that good.
- The substitution effect of a price change refers to the change in the quantity demanded of a good due to a change in its relative price. The income effect of a price change refers to the change in the quantity demanded of a good due to a change in the consumer’s real income.
- A normal good is a good whose demand increases when income increases. An inferior good is a good whose demand decreases when income increases.