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MicroS05-I.10

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Question from Past Microeconomics Qualifying ExamEdit

Spring 2005 - Section I, Question ten, George Mason University

T,F,U. State first whether the following statements are true, false or uncertain. Then briefly explain your resaoning in four or five sentences. You may sue a graph if it helps clairify your answer.

An income-compensated demand curve is everywhere more elastic than an ordinary demand curve.

AnswerEdit

False, an income-compensated, demand curve is usually less elastic than an ordinary demand curve because it doesn't account for the income effect.

However, for inferior goods, the usual elasticity result is reversed. The ordinary demand curve is less elastic for price decreases because the income effect counteracts the substitution effect whereas on the compensated demand curve only the substitution effect is operative. The demand curve is less elastic for price increases for the same reason: the compensated curve shows only the negative substitution effect whereas the ordinary demand curves quantity adjustment is lessened due to the income effect. So compensated demand curves for inferior goods are always more elastic. They are to the right of the ordinary demand curve for price decreases and to the left for price increases.

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