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?
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
What is the “cross price elasticity of demand”?
measures how the quantity demanded of one good responds to a change in the price of another related good. It helps to understand the relationship between two products—whether they are substitutes or complements.
What is the equation of “cross price elasticity of demand”?
High positive value: Strong substitutes (e.g., Coke and Pepsi).
Low positive value: Weak substitutes.
Low negative value: Weak complements.
High negative value: Strong complements (e.g., smartphones and apps).
What is this L* curve?
This is complex for many students because it is abstract, it is not relatable to something complete. Just used for explanation!
–> L* has the same slope as the line L2 (they are parallel) - L* is an artificial budget we make up to explain something
What is the L* curve USED for?
To examine the substitution effect
(from e1 to e*)
–> when you change the relative price fo the two goods, you can remain with the same utility, but you choose to change the quantities of the goods in your consumption bundle. You reduce the quantity of the good that became more expensive (music tracks), and you purchase MORE of the live music. HENCE why they are on the same indifference curve.
What is the real quantity of goods you buy after the price change?
the REAL quantity of goods you buy is at point e2. This move from E* to E2 is called the INCOME EFFECT.
Both curves have the SAME slope (hence same combination of goods), so the change from e* to e2 is down to the income, e* costs “too much”
What is the substitution effect, income effect, and total effect?
If the good is inferior and the price increases, what is the income effect?
Price of rice has gone down, so the marginal utility per rice is GREATER, hence it makes sense to purchase more, which is why quantity increases from e1 to e* according to substitution effect
But does this happen? No.
Rice is only consumed at a quantity of e2 which is lower than e1. Meaning consumers choose to buy LESS rice even though their income increases and they CAN buy more. Hence why we can consider rice an INFERIOR good == the income effect is NEGATIVE.
(a negative income effect does not always have to be larger than the substitution effect)
What is a “giffen good”?
the good is inferior (income effect of a price increase is positive) and the income effect is larger in absolute value than the substitution effect.
