1(a) Explain why products may have different income elasticities of demand. [10]
Answers may include:
• Terminology: income elasticity of demand (YED)• Explanation: that a positive YED is where an increase in income leads to an increase in demand/a decrease in income leads to a decrease in demand and that this is associated with normal goods; that a negative YED is where an increase in income leads to a decrease in demand/a decrease in income leads to an increase in demand and that is associated with inferior goods; that some goods may have a high income elasticity of demand (ie income elastic) and some may have a low income elasticity of demand (ie income inelastic).
• Diagram: demand and supply diagram showing relevant shifts of demand, Engel curve.
2(b) Using real-world examples, discuss the assumption that consumers always seek
to maximize their utility.
Answers may include:
• Terminology: utility.
• Explanation: of the assumption in terms of consumer rationality, perfect
information and the maximization of total utility.
• Diagram: not needed for this question.
• Synthesis (discuss): a challenge to the assumption in terms of the limitations to rational consumer choice such as imperfect information, bounded rationality, bounded selfishness, biases – rule of thumb, anchoring and framing, availability; consideration of the word “always”.
• Examples: real-world examples of consumers acting rationally or where there are limitations to their ability to do so.