Microeconomics 06 Elasticity


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Do you use facebook?

Photo of a smartphone with the Facebook application open
Economics is greatly impacted by how well information travels through society. Today, social media giants Twitter, Facebook, and Instagram are major forces on the information super highway. (Credit: Johan Larsson/Flickr)

Decisions ... decisions in the social media age

To post or not to post? Every day we are faced with a myriad of decisions, from what to have for breakfast, to which route to take to class, to the more complex—“Should I double major and add possibly another semester of study to my education?” Our response to these choices depends on the information we have available at any given moment; information economists call “imperfect” because we rarely have all the data we need to make perfect decisions. Despite the lack of perfect information, we still make hundreds of decisions a day.

And now, we have another avenue in which to gather information—social media. Outlets like Facebook and Twitter are altering the process by which we make choices, how we spend our time, which movies we see, which products we buy, and more. How many of you chose a university without checking out its Facebook page or Twitter stream first for information and feedback?

As you will see in this course, what happens in economics is affected by how well and how fast information is disseminated through a society, such as how quickly information travels through Facebook. “Economists love nothing better than when deep and liquid markets operate under conditions of perfect information,” says Jessica Irvine, National Economics Editor for News Corp Australia.

This leads us to the topic of this chapter, an introduction to the world of making decisions, processing information, and understanding behavior in markets —the world of economics. Each chapter in this book will start with a discussion about current (or sometimes past) events and revisit it at chapter’s end—to “bring home” the concepts in play.


In this chapter, you will learn about:

  • What Is Economics, and Why Is It Important?
  • Microeconomics and Macroeconomics
  • How Economists Use Theories and Models to Understand Economic Issues
  • How Economies Can Be Organized: An Overview of Economic Systems

What is economics and why should you spend your time learning it? After all, there are other disciplines you could be studying, and other ways you could be spending your time. As the Bring it Home feature just mentioned, making choices is at the heart of what economists study, and your decision to take this course is as much as economic decision as anything else.

Economics is probably not what you think. It is not primarily about money or finance. It is not primarily about business. It is not mathematics. What is it then? It is both a subject area and a way of viewing the world.

Chapter 06: Consumer Choices Essay objective questions quiz / Critical thinking questions

6.1 Consumption Choices

6.2 How Changes in Income and Prices Affect Consumption Choices

6.3 Labor-Leisure Choices

6.4 Intertemporal Choices in Financial Capital Markets

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Microeconomics 06 Elasticity
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Sample Questions from the Microeconomics 06 Elasticity Flashcards

Question: Explain all the reasons why a decrease in the price of a product would lead to an increase in purchases of the product.


This is the opposite of the example explained in the text. A decrease in price has a substitution effect and an income effect. The substitution effect says that because the product is cheaper relative to other things the consumer purchases, he or she will tend to buy more of the product (and less of the other things). The income effect says that after the price decline, the consumer could purchase the same goods as before, and still have money left over to purchase more. For both reasons, a decrease in price causes an increase in quantity demanded.

Question: How would a decrease in expected interest rates over one's working life affect one's intertemporal budget constraint? How would it affect one's consumption/saving decision?


Lower interest rates would make lending cheaper and saving less rewarding. This would be reflected in a flatter intertemporal budget line, a rotation around the amount of current income. This would likely cause a decrease in saving and an increase in current consumption, though the results for any individual would depend on time preference.

Question: As a college student you work at a part-time job, but your parents also send you a monthly "allowance." Suppose one month your parents forgot to send the check. Show graphically how your budget constraint is affected. Assuming you only buy normal goods, what would happen to your purchases of goods?


This is a negative income effect. Because your parents' check failed to arrive, your monthly income is less than normal and your budget constraint shifts in toward the origin. If you only buy normal goods, the decrease in your income means you will buy less of every product.

Question: How would an increase in expected income over one's lifetime affect one's intertemporal budget constraint? How would it affect one's consumption/saving decision?


An increase in expected income would cause an outward shift in the intertemporal budget constraint. This would likely increase both current consumption and saving, but the answer would depend on one's time preference, that is, how much one is willing to wait to forgo current consumption. Children are notoriously bad at this, which is to say they might simply consume more, and not save any. Adults, because they think about the future, are generally better at time preference-that is, they are more willing to wait to receive a reward.

Question: In Siddhartha's problem, calculate marginal utility for income and for leisure. Now, start off at the choice with 50 hours of leisure and zero income, and a wage of $8 per hour, and explain, in terms of marginal utility how Siddhartha could reason his way to the optimal choice, using marginal thinking only.


Begin from the last table and compute marginal utility from leisure and work: Suppose Sid starts with 50 hours of leisure and 0 hours of work. As Sid moves up the table, he trades 10 hours of leisure for 10 hours of work at each step. At (40, 10), his MULeisure = 50, which is substantially less than his MUIncome of 500. This shortfall signals Sid to keep trading leisure for work/income until at (10, 40) the marginal utility of both is equal at 200. This is the sign that he should stop here, confirming the answer in question 1.

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