Income consumption curve,price consumption curve, engles law
Price Consumption Curve
-
Upload
night-seem -
Category
Technology
-
view
3.190 -
download
6
description
Transcript of Price Consumption Curve
![Page 1: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/1.jpg)
Ch 4. Consumers in the Marketplace
• Consumption choices change as a function of price and/or income
• Price increases– Lead to decreases in quantity demanded– Lead to pivoting budget line and consumers
choosing new consumption point
![Page 2: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/2.jpg)
Contents
1. Income Changea. Income-Consumption Curveb. Normal/Inferior good
2. Price Change a. Price-Consumption Curveb. Substitution Effect / Income Effectc. Normal/Inferior/Giffen Good
3. Elasticitya. Point/Arc Elasticityb. Elasticity and Total Revenue
![Page 3: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/3.jpg)
Changes in Income
• Composite good convention• Income changes
– Result in a parallel shift of the budget line
• Increase in income– Cause consumption increase if normal good – Cause consumption decrease if inferior good
![Page 4: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/4.jpg)
Suppose the price of X is $2 and the price of Y is $3. Given the following indifference curve mapping, draw an Engel curve graph for X.
Y 6 4 2 1 3 4 6 9
![Page 5: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/5.jpg)
EXHIBIT 4.3 Normal and Inferior Goods
![Page 6: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/6.jpg)
Income-Consumption Curve• Assumption that prices fixed• Relationship between income and quantity of good
consumed– prices of goods consuming and indifference curves are
constant• Shape of Income-Consumption Curve
– Upward-sloping if good X is normal• If consumer income rises, consumes more of good X
– Downward-sloping if good X is inferior• If consumer income rises, consumes less of good X
• From this, we can get an Engel Curve – showing the relationship between Income and quantity demanded
![Page 7: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/7.jpg)
EXHIBIT 4.4 Constructing the Engel Curve
![Page 8: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/8.jpg)
Changes in Price
• Income and price of good Y remain fixed• Y-intercept of budget line unchanged by
change in price of X• Budget line pivots around y-intercept
– Pivots inward if rise in price of X– Pivots outward if fall in price of X
• Changes in optimum point– Located anywhere along new budget line
![Page 9: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/9.jpg)
Suppose the price of Y is $4 and your income is $30. Given the following indifference curve mapping, generate a demand curve for X.
Y 4 6 7 9 10 15 X
![Page 10: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/10.jpg)
Price-Consumption Curve• Locus of optimal
bundles when the price of the good on the x-axis changes.
• This is not a demand curve but the information for a demand curve is here
![Page 11: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/11.jpg)
The Demand Curve
• Engel curve vs demand curve– Engel curve: relationship between income and
consumption• Plots income on horizontal axis and consumption on
the vertical axis
– Demand curve: relationship between price and consumption
• Plots price on the vertical axis and consumption on the horizontal axis
![Page 12: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/12.jpg)
Constructing the Demand Curve
• Derived from indifference curves– Find price of X– Draw budget line given income and prices– Find tangency between budget line and
indifference curve– Read off quantity of X– Plot point on demand curve relating price to
quantity– Repeat the process for additional points on the
demand curve
![Page 13: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/13.jpg)
Constructing the Demand Curve (P falls)
• From this we can get a demand schedule and curve.
• Assuming Income is constant.
Price Qd
250 C1
200 C2
150 C3
![Page 14: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/14.jpg)
Shape of Demand Curve
• Slopes downward• If Giffen good, slopes upward• Demand and indifference curves cannot be
drawn on same graph– Require different axes
![Page 15: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/15.jpg)
Giffen Goods• If price of X increases, quantity demanded decreases
– Follows law of demand– Then, non-Giffen goods
• If price of X increases, quantity demanded increases– Violates law of demand– Then, Giffen goods
• Giffen goods rare or nonexistent– Using theory of indifference curves indicates exception to
law of demand
![Page 16: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/16.jpg)
Non-Giffen Goods and Giffen Goods
![Page 17: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/17.jpg)
Income and Substitution Effects
• When the price of a good changes, consumers choose a new bundle.
• Economists decompose this shift from one bundle to another into two parts: the substitution effect and the income effect.– Substitution effect
• Price rises• Adjust consumption of goods whose price above marginal value
– Income effect• Price rises• Can no longer afford previous basket• Decrease (increase) consumption if normal (inferior) good
![Page 18: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/18.jpg)
Income and Substitution Effects
• Substitution Effect: The change in Qd resulting from a change in the relative price of a good, and assuming the original level of utility is maintained.– Substitution effects are always the opposite (negative) of
the price change.
• Income Effect: The effect on the quantity demanded that results from the change in the purchasing power of a given income when the price of a good changes.– Income effects can go either way.
![Page 19: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/19.jpg)
Y 6 3 U1 2 U0 8 9 10 14 15 20 X
Suppose Jane has an income of $40 and the price of Y is $4. (1) Price of X = $2: She consumes 14 X & 3 Y. What is her MV of X? (2) Price of X = $4: She decides to consume 8 X & 2 Y. What is her MV of X?(3) With (9X, 6Y), her MV of X = 1 & she will be as happy as with (14X, 3Y)
![Page 20: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/20.jpg)
Income and Substitution Effects
• The substitution effect is the change in “X” caused by the move from A to C (XA to XC).
• The income effect is the change in “X” caused by the move from C to B (XB to XC).
A: original bundle (with X = XA)C: compensated bundle (with X = XC)B: new optimal bundle (with X = XB)
![Page 21: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/21.jpg)
Isolating the Substitution Effect
• Suppose given just enough money to offset income effect (Compensated: same indifference curve originally on)– If Px increases, the compensated budget constraint must
always be steeper than the original budget constraint. (a negative effect on the consumption of X)
– If Px were to decrease, the compensated budget constraint must always be flatter than the original budget constraint. (a positive effect on the consumption of X)
![Page 22: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/22.jpg)
the Income Effects• If know how substitution effect changes consumption
– Can deduce impact of income effect• Substitution effects are always the opposite (negative) of the price
change.• Income effects can go either way.
• Ordinary Inferior/ Giffen Inferior can be determined by the relative size of Income effect to Substitution effect
Price change Income Effect Therefore…
Price increase Negative income effect Normal Good
Price increase Positive income effect Inferior Good
Price decrease Negative income effect Inferior Good
Price decrease Positive income effect Normal Good
![Page 23: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/23.jpg)
Inferior Good (Ordinary & Giffen) Ordinary: Substitution Effect > Income Effect Giffen: Substitution Effect < Income Effect
![Page 24: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/24.jpg)
Total effect
Income and Substitution Effects of a Fall in Price of Good X (Normal Good)
0 Quantity of X per week
Quantity of Y per week
Old budget constraint
U1
XA
YANew budget constraint after lower price of X
U2
XB
YB
XC
A
Substitution effect
Income effect
B
C
Compensated Budget after subtracting income to put consumer on original indifference curve
Created by Dr. Michael Nieswiadomy
YC
![Page 25: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/25.jpg)
Total effect
Income and Substitution Effects of a Fall in Price of Good X (Inferior Good)
0 Quantity of X per week
Quantity of Y per week
Old budget constraint
U1
XA
YANew budget constraint after lower price of X
U2
XB
YB
XC
A
Substitution effect
Income effect
B
C
Compensated Budget after subtracting income to put consumer on original indifference curve
Created by Dr. Michael Nieswiadomy
YC
![Page 26: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/26.jpg)
Total effect
Income and Substitution Effects of a Fall in Price of Good X (Giffen Good)
0 Quantity of X per week
Quantity of Y per week
Old budget constraint
U1
XA
YANew budget constraint after lower price of X
U2
XB
YB
XC
A
Substitution effect
Income effect
B
C
Compensated Budget after subtracting income to put consumer on original indifference curve
Created by Dr. Michael Nieswiadomy
YC
![Page 27: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/27.jpg)
Total effect
Income and Substitution Effects of a Rise in Price of Good X (Normal Good)
0 Quantity of X per week
Quantity of Y per week
Old budget constraintU2
XB
YB
New budget constraint after higher price of X
U1
XA
YA
XC
A
Substitution effect
Income effect
B
C
Compensated Budget after adding income to put consumer on original indifference curve
Created by Dr. Michael Nieswiadomy
YC
![Page 28: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/28.jpg)
Total effect
Income and Substitution Effects of a Rise in Price of Good X (Inferior Good)
0 Quantity of X per week
Quantity of Y per week
Old budget constraint
U2
XB
YB
New budget constraint after higher price of X
U1
XA
YA
XC
A
Substitution effect
Income effect
B
C
Compensated Budget after adding income to put consumer on original indifference curve
Created by Dr. Michael Nieswiadomy
YC
![Page 29: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/29.jpg)
Total effect
Income and Substitution Effects of a Rise in Price of Good X (Giffen Good)
0 Quantity of X per week
Quantity of Y per week
Old budget constraint
U2
XB
YB
New budget constraint after higher price of X
U1
XA
YA
XC
A
Substitution effect
Income effect
B
C
Compensated Budget after adding income to put consumer on original indifference curve
Created by Dr. Michael Nieswiadomy
YC
![Page 30: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/30.jpg)
the relative size of Income effect to Substitution effect for a good on X axis
Price of X rises
Normal B C A
Inferior (Ordinary) C B A
Inferior (Giffen) C A B
Price of X falls
Income EffectSubstitution Effect
Normal A C B
Inferior (Ordinary) A B C
Inferior (Giffen)B A C
I.E.
S.E.
S.E.
I.E.
S.E. I.E.
S.E.
S.E.I.E.
I.E.
![Page 31: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/31.jpg)
the relative size of Income effect to Substitution effect for a good on Y axis
Price of X rises
Normal C B A
Inferior (Ordinary)BCA
Price of X falls
I. E.S.
E.
I. E.
S. E.
NormalABC
Inferior (Ordinary)ACB
S. E.
S. E.
I. E.
I. E.
![Page 32: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/32.jpg)
Why Demand Curves Slope Downward: Normal Goods
• Geometric Observations– Increases in price, substitution effect means less
consumption– Move from compensated line to new line, income
falls, consume less of good if normal
• Demand curve for normal good– Both effects move consumer leftward– Normal goods are not Giffen goods
![Page 33: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/33.jpg)
Why Demand Curves Slope Downward: Inferior Goods
• Demand curve for inferior goods– Effects move in opposite directions and not as easily analyzed as
normal good– Inferior good non-Giffen is substitution effect exceeds income effect– Inferior good Giffen if income effect exceeds substitution effect
• Size of income effect– Income effect of price change large if good large fraction of consumer
expenditures• Giffen goods revisited
– Giffen goods are inferior– Giffen goods account for a large portion of consumer expenditures– However, goods that make up a large portion of your budget are
generally normal.– Conditions above explain why so rare (or nonexistent)
![Page 34: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/34.jpg)
Example)Beatrice has a monthly income of $100 and buys gasoline (Pg = $2) and a composite commodity Y (Py = $2). Say Beatrice consumes 20 gallons of gas and 30 units of Y each month (let’s call that bundle “A”). In order to reduce our use of foreign oil, the government places a tax on gasoline resulting in a new price for gas of Pg = $4. But to eliminate the hardship of extra taxes, the government decides to give citizens like Beatrice $40 per month. They call this the Gas Tax and Gift Policy (GaTGiP). Will Beatrice be better or worse off after the GaTGiP, Tax and Gift policy? Verbally and using the above graph, explain how you know. Will the tax raise enough revenue to pay for the $40 gift? Explain.
![Page 35: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/35.jpg)
Substitutes/Complements
When PX↑QY↓(Complements),
1.True/False: Y could not possibly be an inferior good for you.
2.True/False: X could not possibly be an inferior good for you.
![Page 36: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/36.jpg)
Compensated Demand Curve
• Curve showing, for each price, what the quantity demanded would be if the consumer were income-compensated for all price changes (if there were no income effect.)
• Allows for isolation of substitution effect• Confirms that compensated demand curve
downward sloping
![Page 37: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/37.jpg)
EXHIBIT 4.12 Compensated and Uncompensated Demand Curve
Price Qd
P1=$1 7
P2=$3 1
![Page 38: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/38.jpg)
Summing Individual Demands to Obtain Market Demand
![Page 39: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/39.jpg)
Elasticity• Anticipate changes in consumer buying habits• Prediction about direction of change
– If income increases or price falls, consumer buys more• No predictions about magnitude of change
– Consumption and expenditures change by how much• An elasticity can be calculated for any
relationships between two variables– the price elasticity of demand– the income elasticity of demand– the cross-price elasticity.
![Page 40: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/40.jpg)
Price Elasticity
• If price of the good decreased by one dollar, by how many units would you increase your consumption of X?
• If price of the good decreased by 1%, by what percent would you increase your consumption of X?
• Slope = =%
%
Q
P
Q
P
![Page 41: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/41.jpg)
Price Elasticity of DemandArc Price elasticity:
Point Price elasticity:
2 1
2 1
2 1
2 1
( )( )
% 100 / 2( )% 100 /
( )2
Q QQ QQ
Q Q Q QP P PP P P
P P P
Q
P
P
Q
PP
P
Q
/100
/100
%
%
The coefficient on Price of demand function. Ex) Q=22-2P: 2
P
Q
![Page 42: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/42.jpg)
More about Price Elasticity
• Demand highly elastic when price elasticity of demand has large absolute value
• Why one good is more elastic?– Availability of substitutes
![Page 43: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/43.jpg)
More about Price Elasticity
Elasticity Demand is considered…
If P increases, then total expenditure...
e = 0 perfectly inelastic Qd completely insensitive to in P
increases
0 < e < 1 inelastic Qd highly insensitive to in P
increases
e = 1 unit elastic % in Qd exactly the same as the % in P
does not change
1 < e < elastic Qd highly sensitive to in P
decreases
e = perfectly elastic Qd extremely sensitive to in P
decreases
![Page 44: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/44.jpg)
REVENUE/EXPENDITURE AND ELASTICITYDemand Curve: Qd = 22-2P (or P = 11-.5Qd)
Price Quantity Point Elasticity
Total Revenue
Elastic?
10 2 20
9 4 36
8 6 48
7 8 56
6 10 60
5 12 60
4 14 56
3 16 48
2 18 36
1 20 20
![Page 45: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/45.jpg)
Income Elasticity
Income elasticity =
Q
I
I
Q
QI
IQ
II
I
Q
/100
/100
%
%
Elasticity Goods are considered…
eY Inferior good
0 ≤ eY ≤1 Normal, Necessity
eY 1 Normal, Luxury
The coefficient on INCOME of demand function. Ex) Q=1200-16*P+0.2*I :
2.0
I
Q
![Page 46: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/46.jpg)
Relationship between Income and Price Elasticity of Demand
• Determinants of value of price elasticity of demand – Size of substitution effect– Size and direction of income effect
• Larger for goods that take up large fraction of income • Larger for goods with high income elasticity of demand• Income effect depends on whether good normal or inferior
– Normal: larger income effect means larger price elasticity of demand– Inferior: larger income effect means smaller price elasticity of
demand
![Page 47: Price Consumption Curve](https://reader031.fdocuments.in/reader031/viewer/2022020709/54bebdd94a795929458b46b9/html5/thumbnails/47.jpg)
Cross Elasticity of Demand• Demand for good X affected by change in price of some other
good Y– Use cross elasticity of demand to measure size of effect – Percent change in consumption of good X divided by the percent
change in the price of good Y
• Used to determine level and amount of monopoly power held by certain firms in antitrust cases
Elasticity Goods are considered…
eQa,Pb > 0 Substitutes
eQa,Pb = 0 Independent goods
eQa,Pb < 0 Complements