Microeconomics - Assignment Example

A good graphical representation of functional utility is shown below. Marginal rate of substitution represents the rate at which customers are ready to give up one commodity in order to exchange while ensuring a same level of utility. MRS varies with points along the indifference hence it is vital to keep locally in the definition. In addition, MRS of a commodity X is equivalent to the marginal utility of X over the marginal utility of Y. a. An increase in the price of a normal good: This had direct effect of changes in income on consumption choice.

In this case, consumers buy more goods when their income rises as the prices remain fixed in the market. In this case, a change in the income of the buyer causes the demand curve to shift. This is evident through a negatively sloped demand curve to counter the space in the exhibit. Therefore, the increase in demand causes an increase in demand and a shift to the right of the demand curve for living space. b. A decrease in the price of an inferior good: In the market, a decrease in the prices of such goods leads to increase in the equilibrium quantity demanded.

Therefore, the substitution effect would force the consumer to buy more of the good. c. An increase in the price of a Giffen good: In economics, an increase in the prices of Giffen good increases the quantity of the good that is demanded in the market. This results to an upward sloping demand curve due to interactions of the income and substitution effects. The income effect can be positive or negative when the price of these goods