Chapter 4: Individual & Market Demand Flashcards
Total effect of a price change can be decomposed into 2 seperate effects:
Substitution Effect
Income Effect
Substitution Effect
Change in the quantity demanded that results because the price change alters the attractiveness of substitute goods.
Income Effect
Change in the quantity demanded that results from a change in purchasing power (real income) caused by price change.
Market Demand Curve
Tells us how much of a good the market as a whole wants to purchase at various prices.
Price-consumption curve (PCC)
Holding income and the price of Y constant, the PCC for good X is the set of optimal bundles traced on an indifference map as the price of X varies.
ndividual Consumer’s Demand Curve
Tells us the quantities the consumer will buy at various prices.
Income-Consumption Curve (ICC)
Holding the prices of X & Y constant, the ICC for a good X is the set of optimal bundles traced on an indifference map as income varies.
Engel Curve
A curve that plots the relationship between the quantities of X consumed and income.
Normal Good
One whose quantity demanded rises as income rises.
Inferior Good
One whose quantity demanded falls as income rises.
Substitution Effect
Component of the total effect of a price change that results from the associated change in the relative attractiveness of other goods.
Income Effect
Component of the total effect of a price change that results from the associated change in real purchasing power.
Total Effect
Substitution Effect + Income Effect
Giffen Good
One for which the quantity demanded rises as its price rises.
Price elasticity of demand
The percentage change in the quantity of a good demanded that results from a 1% change in its price.
Properties of Price Elasticity
- Different at every point along the demand curve.
- Never positive
- At any point along a straight-line demand curve it will be inversely related to the slope of the demand curve.
Determinants of price elasticity of demand
- Substitution possibilities
- Budget share
- Direction of income effect
- Time
Income elasticity of demand
% Change in the Q(demanded) that results from a 1% change in income.
Necessities
Goods for which a change in income produces a less than proportional change in the quantity demanded at any price.
Elasticity < 1.
Luxuries
Elasticity > 1.
Cross-price elasticity of demand
% Change in the Q(demanded) that results from a 1% change in the price of the other good.
Network Externality
When one person’s demand for a good is determined by the number of other people also buying the good.
Positive Externality
Leads to a typical consumer buying more of a product, as more people are buying it.
Negative Externality
Leads to a typical consumer buying less of a product, as more people are buying it.
Bandwagon Effect
As more people buy the good, it becomes more fashionable to buy it and more people want to buy it.
Snop Effect
As more people buy the good, the consumer does not want to buy a good because too many other people already own it.
Marginal rate of time preference (MRTP)
The number of units of consumption in the future a consumer would exchange for 1 unit of consumption in the present.
Positive Time Preference
The consumer requires more than 1 unit of future consumption to compensate him for the loss of a unit of current consumption.
Negative Time Preference
The consumer is willing to forgo 1 unit of current consumption in return for less than 1 unit of future consumption.
Neutral Time Preference
The consumer has neutral time preference, present and future consumption trade off against one another at the rate of 1 to 1.
The effects of substitution possibilities on price elasticity of demand?
The absolute value of price elasticity will rise with the availability of attractive substitutes.
The effects of budget on price elasticity of demand?
In general, the smaller the share of total expenditure accounted for by a good, the less elastic demand will be.
The effects of he direction of the income effect on price elasticity of demand?
The direction of the income effect might reinforce or offset the substitution effect.
Thus a normal good will have a higher price elasticity than an inferior good, other things being equal, because the income effect forces the substitution effect for a normal good but offsets it for an inferior good.
