Individual and market demand Flashcards
Price-consumption curve (PCC)
Holding income and the price of Y constant, the PCC for a good X is the set of optimal bundles traced on an indifference map as the price of X varies
Moving from the PCC to the individual’s demand curve
Table and then plot the different price-quantity combinations from the PPC
Income-consumption curve (ICC)
Holding the prices of X and 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 quantity of X consumed and income
- Plots the quantities of X on the ICC against the corresponding values of income
- Can be backward bending when changing from a normal good to an inferior good as income rises
Normal good
A good whose quantity demanded rises as income rises (positive sloping Engel-curve)
Inferior good
A good whose quantity demanded falls as income rises (negative sloping Engel curve)
Substitution effect
That component of the total effect of a price change that results from the associated change in the relative attractiveness of other goods
Income effect
The component of the total effect of a price change that results from the associated change in the real purchasing power
Graphs p 99
Graphs p 99
Giffen good
- A good whose quantity demanded rises as its price rises
- Inferior good whose income effect is stronger than its substitution effect
- Has to account for a large part of the consumers’ budget
- Has to have a relatively small substitution effects
Price insensitive good
- Eg salt
- No close substitutes (represented by indifference curves with a nearly right-angled shape)
- Negligible budget share (intersect between indifference curves and budget line near Y-intersect of budget line
Income and substitution effects of a price sensitive good
- Eg housing
- Close substitutes available (Smooth convex shaped indifference curve)
- Large budget share
Aggregation of individual demand curves
Horizontal summation to get the market demand
Price elasticity of demand
The percentage change in the quantity of a good demanded that results from a 1 percent change in its price
Elasticity of demand formula
E = dQ/Q / dP/P
E = dQ/dP * P/Q
E = P/Q * 1/slope
Elastic demand
E > 1
Inelastic demand
0 < E < 1
Unit elastic demand
E = 1
Perfect elastic demand
E = infinity
Perfect inelastic demand
E = 0
How to increase total revenue
Elastic demand - decrease prise
Inelastic demand - increase price
Unit Elastic demand - keep price the same
Elasticity and tax income
- It make more sense to levy a tax on a product with an inelastic demand because
- the consumers pay the burden of the tax more
- the government collects more tax income
- the deadweight loss is smaller
Determinants of price elasticity of demand
- Availability of substitutes (substitute effect is smaller if less substitutes are available)
- Budget share (Income effect is bigger if the good forms a bigger part of the budget)
- Direction of income-effect (normal or inferior good)
- Time (eg fuel price inelastic over short term and more elastic over long term as driver switch to other modes of transport)
Constant elasticity demand curve
P = k / Q^(1/E)
Segment ratio method
abs(Ec) = EC/AC
Income elasticity of demand
The percentage change in the quantity of a good demanded that results from a 1 percent change in income
Income elasticity of demand formula
n = dQ/Q / dY/Y
n = dQ/dY * Y/Q
n = P/Q * 1/slope of Engel curve
Luxury good
n > 1
Necessity
0 < n < 1
Inferior good (income elasticity)
n < 0
Cross price elasticity of demand
The percentage change in the quantity of one good demanded that results from a 1 percent change in the price of the other good
Cross price elasticity of demand formula
Exz = dQx/Qx / dPz/Pz
Positive = substitutes
Negative = compliments
Slide 38 & 39
Look at
Bandwagon effect
The desire to have a good because almost everybody else has it
Makes the demand curve more elastic
Snob effect
The desire to have a good because not a lot of people own it
Makes the demand curve less elastic
Intertemporal consumption bundles
Consumers choose between their current and future consumption
Max future consumption
= M1(1+r) + M2 (y-intersect)
Max current consumption
= M1 + PV(M2) (X-intersect)
Slope = -(1+r)
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
Slope of the intertemporal indifference curves
MRTP = dFuture/dCurrent
Positive time preference
MRTP > 1
Negative time preference
MRTP < 1
Neutral time preference
MRTP = 1
Patient and impatient consumer
Patience - postpone consumption
Impatience - Consume much now
Network externality
A network externality exists when a person’s demand for a specific good does not only depend on their own demand for that good, but also on their perception of how many other people own that good
