Practise separating income and substitution effects and applying them to normal, inferior and Giffen goods in CAIE Economics A2 questions.
Evaluate the use of indifference curve analysis to derive the demand curve for a normal good and the demand curve for an inferior good.
OR
(a)
Evaluate the use of indifference curve analysis to derive the demand curve for a normal good and the demand curve for an inferior good.
Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.
AO1 and AO2 out of 14 marks. AO3 out of 6 marks.
Indicative content Responses may include:
AO1 Knowledge and understanding and AO2 Analysis
- Assumptions of indifference curve analysis including:
- rational consumers who prefer more to less,
- a two-good world,
- the prices of the goods are (initially) constant,
- the goods can be substituted for each other,
- transitivity, if there is indifference between A and B and indifference between B and C , there is indifference between A and C
- perfect knowledge of the market.
- Definition of an indifference curve (IC), explanation of convex IC and analysis of rising levels of satisfaction and the creation of an IC map.
- Definition of a budget line (BL) and analysis of rising/falling income levels on the BL and consumption
- Explanation of the substitution effect (SE) and the income effect (YE) when the price of a good changes.
- Analysis of the effect of a positive and negative YE when combined with the SE to account for a normal and inferior good.
- The combination of the IC and BL maps to show point of tangency between IC and BL to give a combination of the 2 goods that gives the highest level of satisfaction given the level of income.
AO3 Evaluation
- Consumer rationality: indifference analysis assumes that consumers act rationally. They are of a calculating mind, carrying numerous combinations of different commodities in their heads, can substitute one for the other, compare their total utilities and make a rational choice between various combinations of goods.
2(a)
- As the effect of a reduction in price is an increase in demand for both a normal and inferior good (except in the case of Giffen good) it is not possible to know whether a good is normal or inferior.
- It is difficult to apply the concept of substitutability to goods such as consumable durables, which are one-off indivisible purchases and the choice is between, for example, 1 fridge and 4 weeks' food.
- A consumer is faced with a much more complex world than the two-good world of the model because a consumer buys not just two but a large number of commodities to satisfy their innumerable wants.
- IC analysis is a static analysis and consumer preferences may change over time.
- Accept all valid responses.
AO1 Knowledge and understanding and AO2Analysis
AO3 Evaluation
OR