2. The Demand Curve Flashcards
What would happen to this curve if the price of beer goes down from 12 to 6?
New optimal consumption bundle is now at point e2
–> you calculate the new budget line by changing the price of b in the equation!
Where do you plot the price-consumption curve?
Price-consumption curve shows the curves of different optimal consumption bundles as the price changes
How do you plot the demand curve?
What does demand show?
Demand shows how much you will buy at different prices your willingness to pay for one additional unit of the good at any given quantity
What is the definition of “consumer surplus”?
“The difference between what a buyer is willing to pay for a good and what the buyer actually pays”
If a consumer was willing to purchase 1 unit at $100, but they bought 1 unit at $50, what is the consumer surplus
–> If a consumer was willing to purchase at 1 unit at $100, but they bought at a price of $50, the difference is the consumer SURPLUS == $50
Where is market-wide consumer surplus shown on a graph?
Above the equilibrium (market) price, below the demand curve.
If the market price increases from $50 to $75, what are on the graph is lost consumer surplus?
area that was previously between $50 and $75
What happens to the demand curves as income increases?
Allowing income to increase, the budget constraint (budget line) shifts out and shows how the optimal quantity of the horizontal axis good purchased increases. Correspondingly, the demand curve shifts outwards equally.
(You can see how price remains the SAME, and demand just SHIFTS outwards only because of the increase in INCOME)
What is an “Engel Curve”?
an Engel curve describes how household expenditure on a particular good or service varies with household income.
What is the definition of “elasticity”?
the percentage change in one variable in response to a given percentage change in another variable.
What is the definition of “price elasticity of demand (PED)”?
the percentage change in the quantity demanded in response to a given percentage change in the price, at a particular point on the demand curve.
What is the equation to measure PED?
–> Easier to remember as:
PED = % change in Q / % change in P
How does the PED change along the demand curve?
–> Unit elastic where PED is 1
The PED varies ALONG a sloped line. It only stays the same on straight (either vertical OR horizontal lines)
What are the 2 constant elasticities?
1) Perfectly Elastic Demand
2) Perfectly Inelastic Demand
What is “perfectly elastic demand”?
Perfectly elastic demand, demand only exists at one price
What is “perfectly inelastic demand”?
Perfectly inelastic demand, whatever the price, demand stays the same (eg. a particular drug that you need to stay alive)
What are the different classifications of PED?
What are the determinants of PED?
- Closeness of substitutes. The closer the substitutes, the more price elastic demand will be.
- The budget share spent on the good. The greater the share spent on a good, the more price elastic demand will be.
- Time. In the long run, we have ample opportunity to adapt, we respond much more to price changes than we do in the short run.
What is the “Income Elasticity of Demand (YED)”?
YED = % change in Qd / % change in Y
eg. if a 1% increase in income results in a 3% increase in Quantity Demanded, the income elasticity of demand is 3% / 1% = 3
How do we classify goods according to YED?
Normal good - a commodity of which as much or more is demanded as income rises. Positive income elasticity.
- Luxury goods = are normal goods with an income elasticity greater than 1. (price elastic)
- Necessity goods = are normal goods with an income elasticity between 0 and 1. (price inelastic)
Inferior good - a commodity of which less is demanded as income rises. Negative income elasticity.
–> Eg. cheap steak
How does the price consumption curve tell the income elasticity?
Point A = Even though your income increases you spend LESS on food, which means that the food must be inferior good
Point C = Even though your income increases you spend less on housing, which means that the housing must be an inferior good
Can you have a point where both goods are inferior even though income increases?
You can NOT have a point where BOTH goods are inferior even though income increases. As it means that the point would have to be smaller than point E –> which simply means you are not allocating it to an optimal consumption bundle
What does this graph show?
When the consumer was poor and their income increased they purhcased a greater quantity of fast food meals.
But as she became wealthier, and her income rose, she purchased less fast food meals.
This shows that fast food meals can be an inferior good
