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...
![Page 1: 1 Chapters 4: Individual and Market Demand. 2 Price-Consumption Curve 1020 32 P=$2P=$3 P=$7 7 3 2 1020 Price Quantity of butter butter margarine Demand.](https://reader036.fdocuments.us/reader036/viewer/2022082820/56649e735503460f94b72940/html5/thumbnails/1.jpg)
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Chapters 4: Individual and Market Demand
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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
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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
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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
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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
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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
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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
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Compensating Variation
Compensating Variation
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Equivalent Variation
Equivalent Variation
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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
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Effect of a Price Change: Inferior Good
Spam
All other goods
Income effectSubstitution
effect
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Effect of a Price Change: Giffen Good
Potatoes
All other goods
Income effect
Substitution effect
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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
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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
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Elasticity Along a Demand Curve
Elastic
Inelastic
Price
Quantity
demand
Unitary Elastic
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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
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Price Elasticity and Total Revenue(Elastic)
Price
Quantity
Gains in total revenue from lowering the price
Losses in total revenue from lowering the price
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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