Consumer Theory - Demand and Elasticities Flashcards
What are some practical applications to the derivation of Demand and Elasticities?
For businesses and marketing companies:
-Identify and understand nature of rival products, understand effects of income changes on demand, and predict effects of changes in business environment
on demand.
For governments:
-Understand effects of economy on demand for different products and activity in different sectors, and predict the effects of tax changes or other regulation.
How do you construct a Demand Function?
Following the Lagrangian method done previously while considering the Budget Constraint (both prices equalling to income(M)) i.e. (PhH + PgG = M)
Step 1: Find First Order derivatives
Step 2: Rearrange to find optimal ratio
Step 3 : Insert Optimal Ratio into budget constraint
EXAMPLE IN NOTES
What can the term Comparative Statics refer to as?
Used to refer to the analysis of changes in
equilibrium that occur due to some specified change in environment.
Why is Comparative Statics used in Government and Business Scenarios?
Governments need to know this in making taxation, spending, regulation and all sorts of other policy decisions.
Firms need to know this in making their pricing, marketing, research and
investment decisions.
How can we define Normal and Inferior goods mathematically?
If ∂H*/∂M > 0 Good H is a normal good.
If ∂H*/∂M < 0 Good H is an inferior good.
For exams how do we define Normal and Inferior Goods therefore?
NORMAL GOOD:If the derivative of Income in respect to the demand of a good is positive
INFERIOR GOOD: If the derivative of income in respect to the demand of a good is negative
(legit same definition as before but lecture says to use these definitions) - Could still use previous explanations
How can we identify if a good is normal or inferior?
Identify the the Demand function
- Could solve by looking at it
or - Trial and Error by inputting numbers into the demand function
How can we identify if two goods are substitutes, complements or independent goods?
If ∂H/∂pG > 0 Good G and good H are substitutes (coke and pepsi)
If ∂H/∂pG < 0 Good G and good H are complements (cars + petrol)
If ∂H*/∂pG = 0 Good G and good H are independent goods (choc + hats)
How can we identify if a good is a giffen or an ordinary good?
If ∂H*/∂pH < 0 Good H is an ordinary good.
If ∂H*/∂pH > 0 Good H is a Giffen good.
What is an ordinary good?
A good with a downward sloping demand curve
Different to a normal good
How do we calculate the IED?
𝜼 =% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑯∗/% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑴 = (𝝏𝑯∗/𝑯∗)x𝟏𝟎𝟎/ (𝝏𝑴/𝑴)x𝟏𝟎𝟎 = (𝝏𝑯∗/𝑯∗)/ (𝝏𝑴/𝑴) = 𝝏𝑯∗x 𝑴/ 𝝏𝑴 x 𝑯∗ = (𝝏𝑯∗/𝝏𝑴) x 𝑴/𝑯∗
SEE NOTES FOR BETTER VIEW OF EQUATION
How do we define IED?
the income elasticity of demand is defined as the % change in demand for good H that follows from a 1% increase in income.
What do the definitions of the IED suggest?
Indicate that a good is a normal good if ∂H/∂M > 0. Hence, we can also suggest that a normal good will have a positive income elasticity, 𝜼>0
(because (M/H)>0).
How do we define the cross price elasticity of demand?
The cross-price elasticity of demand for good H (with respect to good G) is defined as the % change in demand for good H that follows from a 1%
increase in the price of good G.
goods G and H will have a positive cross price elasticity if they
are substitutes and a negative cross price elasticity if they are complements.
How do we calculate the Cross Price Elasticity of Demand?
𝜺𝑯𝑮 = % 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑯∗/ % 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝑮 = 𝝏𝑯∗/ 𝝏𝒑𝑮 ∙ 𝒑𝑮/ 𝑯∗
SEE NOTES FOR BETTER VIEW OF EQUATION
