individual and market demand Flashcards
if the price of a good falls , what will be the normal response of quanity demanded?
the quantity demanded will rise when the price falls, there is an inverse relationship
what are the reasons for the demand curve to be downward sloping?
The law of diminishing marginal utility.
The income effect.
The substitution effect
how can you derive the demand curve from the indifference curve and budget constraints?
we start off at the original equillbrium between the indifference curve and the budget constraint at Q1 of the original good. if the price of good x falls then the budget constraint becomes stretched along the good X axis whilst pivoting along other good point. this therefore shifts to a new indifference curve at a higher level moving the quantity of good X up to Q2. the demand curve is the combination of all price changes of good X with all quantities of good X
what is the market demand curve?
it is the horizontal addition of all the individual demand curves. it is simply the sum of the individual demand curves
what is the substitution effect?
This is the change in consumption brought about by the change in the relative prices of good X and Good Y. as one good becomes more expensive, consumers consume less of it and more of the other good. the affect is always negatiev
what is the income effect?
this is the change in the consumption caused by the effect that the price change has on a consumers income. as the price of a good falls, consumers buying power rises. this effect can be negative or positive for an individual good
what is the total effect on the demand?
it is the additon of the substitution effect plus the income effect. it can be positive or negative
what is the formula for the income effect?
it is the change in quantity consumed given a change in income. the formula is equal to change in quantity / change in income and the sign depends on income elasticity .
what is the formula for the income elasticity of demand?
(change in quantity demand x income) / ( change in income x quantity demanded)
when is the good a giffen good?
when the income effect is negative and more then offsets the substitution effect then the consumer views the commodity as a giffen good
what is the hicks method?
it is a method to decompose the total effect into income and substitution effects
you start off at the equillibrium between the original budget constraint and indifference curve. a decrease in the price of the good X will cause a stretch of the budget constraint along the good X axis. this will shift the budget constraint onto a new higher indifference curve. you then draw a line that is parralel to the new budget constraint and tangential to the old indifference curve. the difference between the quantity at which the parrelel line and the old indifference curve crosses and the old equillibrium quantity is the subsitution effect and the rest of the quantity is the income effect. substitution is from Q to Q1 and income is from Q1 to Q2. total effect is Q to Q2.
