4 Demand, Revealed Preference, and Consumer Welfare Free Online FlashCards

What does a consumer’s budget constraint represent?

The budget constraint is $p_x x + p_y y \leq m$, where prices and quantities determine the cost of a bundle and $m$ is income.

What is a normal good?

A normal good is one whose demand rises when income rises, other things equal.

What does the substitution effect describe?

The substitution effect is the shift toward a good that has become relatively cheaper and away from goods that have become relatively more expensive.

What distinguishes movement along a demand curve from a shift?

A change in a good’s own price causes movement along its demand curve; a change in income or another determinant shifts the curve.

What is revealed preference?

Revealed preference infers a consumer’s preferences from observed choices among affordable bundles, without measuring utility directly.

What reversal does WARP rule out?

WARP says that if a consumer chooses $A$ when $B$ is affordable, they should not later choose $B$ when $A$ is affordable, unless the bundles are the same.

What does consumer surplus measure?

Consumer surplus is willingness to pay minus the amount paid; across units, it sums those differences and is the area below demand and above market price.

When might consumer surplus be an approximation rather than an exact welfare measure?

Consumer-surplus changes can approximate welfare changes when income effects matter. Compensating and equivalent variation measure welfare changes as money amounts tied to specified reference points; consumer surplus is exact in important cases such as quasilinear preferences.

What is an inferior good?

An inferior good is one whose demand falls as income rises, other things equal.

What does the income effect describe?

The income effect is the demand response to a price change altering real purchasing power, even when money income stays fixed.

What is the defining demand response of a Giffen good?

A Giffen good is an unusual inferior good for which the opposing income effect is strong enough that a price rise increases demand.

What preference does choosing $A=(3,2)$ reveal over affordable $B=(2,3)$?

At prices $(2,1)$, bundle $A=(3,2)$ costs \$8 and bundle $B=(2,3)$ costs \$7. With income of \$8, choosing $A$ reveals it as weakly preferred to affordable $B$.