Economics 104-Chapter 4 Review Questions & Answers.docx

Economics 104-Chapter 4 Review Questions & Answers.docx...

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Economics 104 Chapter 4 Review Questions & Answers ANSWERS TO QUESTIONS FOR REVIEW 2 ( Law of Demand ) What is the law of demand? Give two examples of how you have observed the law of demand at work in the “real world.” How is the law of demand related to the demand curve? The law of demand states that the quantity of a product demanded during a given time period varies inversely with its price, other things constant. Real-world examples of the law of demand at work could include students buying less gasoline when the price per gallon rises or buying fewer take-out pizzas when the price of pizza rises . Along a downward-sloping demand curve, the variables, price and quantity, are inversely related. The downward-sloping demand curve is an illustration of the law of demand: as the price of the good rises, the quantity demanded decreases; as the price of the good falls, the quantity demanded increases. 2 ( Changes in Demand ) What variables influence the demand for a normal good? Explain why a reduction in the price of a normal good does not increase the demand for that good. The demand for a normal good is determined by consumer income, changes in prices of other goods, consumer expectations, the number or composition of consumers, and consumer tastes. As these variables change, the demand for normal goods will change and the demand curve will shift. A reduction in the price of a normal good causes a movement along the demand curve, an increase in quantity demanded, not an increase in demand. 3 ( Substitution and Income Effects ) Distinguish between the substitution effect and income effect of a price change. If a good’s price increases, does each effect have a positive or a negative impact on the quantity demanded? The substitution effect refers to the change in a good’s price relative to the prices of alternative goods. A price increase makes the good more expensive, so customers are more likely to buy a substitute. The income effect refers to the change in the purchasing power of the consumer’s income. A price increase reduces purchasing power. The substitution effect always creates a negative impact on the quantity demanded; the income effect has a positive impact for normal goods and a negative impact for inferior goods. 4 ( Demand ) Explain the effect of an increase in consumer income on demand for a good. Increased income leads to greater demand for normal goods and lower demand for inferior goods. For normal goods, the demand curve shifts rightward when income increases. For inferior goods, the demand curve shifts leftward when income increases.
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5 ( Income Effects ) When moving along the demand curve, income must be assumed constant. Yet one factor that can cause a change in the quantity demanded is the “income effect.” Reconcile these seemingly contradictory facts.
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