INDIVIDUAL AND MARKET DEMAND

Drawing on Chapter 4 Graphics copyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Overview Individual Demand Market Demand ∆P  ∆QD ∆M  ∆QD Income & Substitution Effects of ∆P Responsiveness to ∆P Market Demand QD(P,…) = ∑i QiD(P,…) Price Elasticity Dependence on Income, Income Elasticity Cross-price Elasticities 4-3

Individual Demand ∆P  ∆QD For good X, the price-consumption curve (PCC) traces the set of optimal bundles on an indifference curve map as PX varies (holding income and other prices constant). 4-4

A Price-Consumption Curve 4-5

The Matching Individual Demand Curve 4-6

The Effects of Changes in Income ∆M  ∆QD For goods X and Y, the income-consumption curve (ICC) traces the set of optimal bundles on an indifference curve map as income (M) varies (holding all prices constant). For good X, the Engel curve plots the relationship between QD and M. 4-7

Distinguish Two Types of Goods Normal: ∆QD is same direction as ∆M Inferior: ∆QD is opposite direction from ∆M 4-8

Figure 4.3: An Income-Consumption Curve 4-9

Figure 4.4: An Individual Consumer’s Engel Curve 4-10

Figure 4.5: The Engel Curve for Normal and Inferior Goods 4-11

Income and Substitution Effects Substitution effect: the part of ∆QD  ∆P that would result from ∆P with utility, as well as other prices, held constant. Income effect: the part of ∆QD  ∆P that would result from the associated change in real purchasing power, with relative prices held constant. Total effect: the sum of the substitution and income effects. 4-12

Figure 4.6: The Total Effect of a Price Increase 4-13

Figure 4.7: The Substitution and Income Effects of a Price Change 4-14

Figure 4.8: Income and Substitution Effects for an Inferior Good 4-15

Figure 4.9: The Demand Curve for a Giffen Good 4-16

Figure 4.10: Income and Substitution Effects for Perfect Complements 4-17

Figure 4.11: Income and Substitution Effects for Perfect Substitutes 4-18

Responsiveness to ∆P: Substitutability and Income Share Figure 4.12: … Effects of a Price Increase for Salt 4-19

Responsiveness to ∆P (cont.) Figure 4.13: … Effects for a Price-Sensitive Good 4-20

Market Demand: QD(P,…) = ∑i QiD(P,…) Figure 4.16. Linear Individual Demands over Varying Price Ranges 4-21

Market Demand: QD(P,…) = ∑i QiD(P,…) Figure 4.17. Linear Individual Demands over Identical Price Ranges 4-22

Market Demand: QD(P,…) = ∑i QiD(P,…) Figure 4.18. Identical Linear Individual Demands 4-23

Elasticities of Demand: Definitions Ratio of proportional (%) change in quantity demanded to proportional (%) change in a determinant (call it X) of demand Proportional rate of change of quantity demanded relative to that of a determinant of demand The percentage change in the quantity of a good demanded that results from a 1% change in a determinant of demand %∆QD/%∆X = (∆QD/QD)/(∆X/X)

Calculating Price Elasticity of Demand Point-slope method Arc method Compare at 04 Examples - Elasticities.xlsx.

Ranges of Price Elasticity of Demand ε = -1 unit elastic -1 < ε < 0 inelastic

Figure A4.1: A Constant Elasticity Demand Curve 4-27