1 Chapters 4: Individual and Market Demand. 2 Price-Consumption Curve 1020 32 P=$2P=$3 P=$7 7 3 2...
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Transcript of 1 Chapters 4: Individual and Market Demand. 2 Price-Consumption Curve 1020 32 P=$2P=$3 P=$7 7 3 2...
1
Chapters 4: Individual and Market Demand
2
Price-Consumption Curve
10 20
32
P=$2P=$3P=$7
7
3
2
10 20
Price
Quantity of butter
butter
margarine
Demand for butter
32
Price-Consumptioncurve
3
Link Between Indifference Curve Budget Constraint Model and Demand Curve
• The utility-maximizing quantities at each price level trace out the individual’s demand curve
P=$5P=$10P=$15
$5
$10
$15
9 12 15 9 12
15Q Q
P
4
From Individual to Market Demand
• Market demand is made up of the sum of individual demands
D1 D2 D3
D4
Total Demand
15 30 25 1080
p p p p p
Q Q Q Q Q
5
Income-Consumption and Engel Curves
apples
OrangesIncome
apples
I = 75I = 100
I = 50
1000 2000 2900
50
75
100
1000 2000 2900
Income-ConsumptionCurve
Engel Curve
6
Normal and Inferior Goods
• Normal good - one whose quantity demanded rises as income rises
• Inferior good - one whose quantity demanded falls as income rises
Normal good
Inferior goodNormal good
Normal good
7
Effect of a Price Change on Utility
• Compensating Variation: The minimum change in income at the new prices that would make the consumer as well off as they were before the price change
• Equivalent Variation: The minimum change in income at the old prices that would make the consumer as well off as they are after the price change
8
Compensating Variation
Compensating Variation
9
Equivalent Variation
Equivalent Variation
10
Income and Substitution Effects
• The total impact of a price change on the demand for a product can be broken into the income and substitution effects– Income effect - the component of the total effect of a price change that results from the associated change in real purchasing power (quasi income)
– Substitution effect - the component of the total effect of a price change that results from the associated change in the relative attractiveness (relative price) of the good in question
• Giffen good is one for which the total effect of a price increase/decrease is to increase/decrease the demand for that good (counter intuitive effect)– Substitution effect is always in the same direction so a Giffen good is a strongly inferior good, so strongly inferior that the income effect is larger than the substitution effect
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Effect of a Price Change: Normal Good
apples
All other goods
Income effect
Substitution effect
12
Effect of a Price Change: Inferior Good
Spam
All other goods
Income effectSubstitution
effect
13
Effect of a Price Change: Giffen Good
Potatoes
All other goods
Income effect
Substitution effect
14
Price Elasticity
• Price elasticity of demand - the percentage change in the quantity demanded that results from a 1 percent change in its price
• Always less than zero by Law of Demand
• The value of price elasticity tells whether demand is elastic, inelastic, or unitary elastic– Elastic– Inelastic– Unitary Elastic
%Q%P
QP
P
Q
1
slope
P
Q 0
1
1
1
15
Graphical Depiction of Price Elasticity
10
9
2
1
1 2 9 10
1 QP
P
Q(2 1)(9 10)
9
29
2
2 QP
P
Q(10 9)(1 2)
2
92
9
Elastic
Inelastic
Price
Quantity
demand
16
Elasticity Along a Demand Curve
Elastic
Inelastic
Price
Quantity
demand
Unitary Elastic
17
Other Elasticities
• Income elasticity of demand - the percentage change in the quantity demanded that results from a 1 percent change in income (Y)
• Cross-price elasticity - the percentage change in the demand for good X that results from a 1 percent change in the price of good Y
%Q%Y
QYY
Q
xy %Qx%Py
QxPy
PyQx
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What Determines Price Elasticities
• Substitution possibilities - greater number of substitutes makes goods more elastic
• Budget share - greater share of expenditures accounted for by the product, the more elastic
• Direction of income effect - normal goods will have higher price elasticities than inferior goods b/c the income effect reinforces the substitution effect
• Time - the longer the time period in question, the greater the price elasticity
19
Price Elasticity and Total Revenue(Elastic)
Price
Quantity
Gains in total revenue from lowering the price
Losses in total revenue from lowering the price
20
Price Elasticity and Total Revenue
(Inelastic)Price
Quantity
Gains in total revenue from lowering the price
Losses in total revenue from lowering the price