Chapter 3: Comparative Statics & Demand

Short Answer Questions

1. Graphically compare the positions of the budget constraint when the price of
good Y increases and decreases respectively, assuming the price of good X and
income remain unchanged.
Answer:
Start from the first budget constraint (BL1). An increase in the price of good Y
changes the position of the budget constraint from BL1 to BL2. In contrast, an
increase in the price of good Y changes the position of the budget constraint from
BL1 to BL3.
Y
BL3
BL1

BL2
X

2. Show how to graphically derive the price consumption curve for good Y
which is a normal good.
Answer:

Price-consumption curve for

good y

3. What is the different between the price-consumption curve and the income
consumption curve?
Answer:
The price consumption curve shows the set of consumption bundles traced out as the
price of a commodity varies, ceteris paribus. The income consumption curves shows
the set of consumption bundles traced out as the level of income varies, ceteris
paribus.
4. Explain and graphically show how an increase in income affects the demand
curve when the good is normal?

Price of good X

Answer:
Since the good is normal, an increase in income increases the consumption at each
price level. As a result, the demand curve shifts outwards.

D21

D11
Quantity demand for good X

5. The income-consumption curve is also known as the Engel curve. Is this

statement true or false? Explain your answer.
Answer:
False. The income consumption curves shows the set of consumption bundles traced
out as the level of income varies, ceteris paribus. We use this curve to derive the
Engel curve which shows the relationship between the quantity demanded for a
commodity and income, holding all pieces constant.

6. Good Y is a complement for good X. Graphically show the effect of a decrease

in price of good Y on the demand curve of good X.

Price of good X

Answer:

D21
D11
Quantity demand for good X

7. If good X is inferior and good Y is normal, graphically show the effect of an

increase in income on the quantities demanded for both goods when prices are
unchanged.
Answer:

Y2
U2
Y1

BL2
U1
BL1
X2 X1

8. If both goods, X and Y, are normal, graphically show the effect of a decrease
in income on the quantities demanded for both goods when prices are
unchanged.

Answer:

Y1
Y2

U1
BL2

BL1

U2

X2 X1

9. Define what it is meant by income elasticity of demand and explain why the
income elasticity of demand for a luxury good is greater than 1.
Answer:
The income elasticity of demand is defined as the percentage change in quantity
demanded with respect to the percentage change in income. The quantity demanded
for a luxury good is very responsive to changes in income. That is, one percentage
increase in income leads to a greater percentage increase in consumption. As a result,
its income elasticity is greater than 1.
10. Why the price elasticity of demand may be greater in the long run than in the
short run? Explain.
Answer:
In the real world, it may take quite a while for a consumer to adjust their behaviour
and fully respond to changes in price. Hence, one may expect the price elasticity to
increase in the long run.
Essay Questions
1. Mr. As utility function is U ( x, y ) x 0.4 y 0.6 . Suppose that the prices of goods x
and y are 2 and 1 respectively and his income is 10. What is his budget
constraint? Find the demand function for each good. Explain your answer and
comment how a change in price affects the demand for each good.

Brief answer:
The budget constraint is px x p y y M .
To find the demand function for each good, we first set the Lagrangean equation:
L x 0.4 y 0.6 ( M px x p y y )
Using the first order conditions to solve for x and y, we will have the demand function
of each good:
0.4 M
px
0.6M
y
px
Each function shows how the quantity of each good varies with its price. As px (py)
rises (falls), the demand for x (y) decreases (increases). In short, the relationship
between price and demand is negative for both goods.
x

2. Mr. As utility function is U ( x, y ) x 0.4 y 0.6 . Suppose that the prices of goods x
and y are 2 and 1 respectively and his income is 10. What is his budget
constraint? Find the utility- maximising consumption bundle. Explain your
answer.
Brief answer:
The budget constraint is 2 x y 10 .
To find the utility- maximising consumption bundle, we first set the Lagrangean
equation:
L x 0.4 y 0.6 (10 2 x y )
Using the first order conditions to solve for x and y, the utility- maximising
consumption bundle is ( x* , y* ) (2, 6) .
3. Mr. Bs utility function is U ( x, y ) x 3 y . Suppose the price of x is 2 and the
price of y is 3 and his income is 12. What is his budget constraint? Suppose
now the price of y decreases to 2. What is the new budget constraint? Explain
and comment how such a change affects the position of the budget line and the
utility- maximising consumption bundle.
Brief answer:
The budget constraint is 2 x 3 y 12 which is drawn below (B1). Suppose now the
price of y decreases to 2. The new budget constraint is 2 x 2 y 12 which is drawn
below (B2). Hence, an increase in the price of y rotates the budget line from B1 to B2.
Y
6
B2

4
B1
X

6
Y
6
4

B2
B1

U1 6

U 2 12
6

12

U 3 18
18

From the graph, given the fist budget constraint, the utility- maximising consumption
bundle is ( x* , y* ) (0, 4) which yields a highest level of utility compared to other
feasible bundles. An increase in the price of y moves the budget line from B1 to B2 and
hence affects the utility - maximising consumption bundle which, as shown in the
graph, now becomes ( x* , y* ) (0, 6) .
4. The slope of the Engel curve is always positive. Is this statement correct?
Explain your answer.
Brief answer:
This statement is not correct. For example, if good X is inferior, then the Engel curve
showing the relationship between quantity demanded and income level have a
negative slope. To explain, the reader should define the Engel Curve and may also
show how to derive the Engel curve for good X which is income inferior.
Income

An example of the Engel curve of

an income inferior good X.

X
5. Mr. Cs utility function is U ( x, y ) min( x, y ) . What is the shape of Mr. Cs
indifference curves? Comment on the characteristic of both goods. Explain
what would happen to the demand curve for good x if the price of good y
increases?

Brief answer:
The shape of Mr. Cs indifference curves is L-shaped as shown below.
Y

U2=2

U1=1

As both goods are valuable when they are consumed together in a fixed proportion,
they are complements. An example is a consumption of left and right shoes.

Price of good X

If the price of good y increases, the demand curve for good x shifts inwards.

D11
D21
Quantity demand for good X