(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