CDAE Class 11 Oct. 2 Last class: 3. Individual demand curves Today: 3. Individual demand curves 4. Market demand and elasticities Quiz 3 (Chapter 3) Next class: 4. Market demand and elasticities Important dates: Problem set 3: due Thursday, Oct. 4 Midterm exam: Tuesday, Oct. 16

Problem set 3 -- Due at the beginning of class on Thursday, Oct Please use graphical paper to draw graphs -- Please staple all pages together before you turn them in -- Scores on problem sets that do not meet the requirements Problems 3.1., 3.2., 3.3. and 3.4. from the textbook Two more problems: A. Suppose an individual’s demand function is Q = 20 – 0.5P (a) Calculate the consumer surplus (CS) when P = 10 (b) Calculate the change in CS when P increased from 10 to 13 B. Draw a graph and use the graph to explain why many individuals with low income prefer income subsidy over price subsidy. Then explain why many governments use price subsidies rather than income subsidies.

3. Individual demand curves 3.1. Basic concepts 3.2. Demand functions 3.3. Changes in income 3.4. Change in a good’s price 3.5. Change in the price of another good 3.6. Construction of individual demand curves 3.7. Consumer surplus 3.8. Applications

3.7. Consumer surplus and welfare analysis (1) What is consumer surplus (CS)? The extra value individuals receive from consuming a particular amount of a good over what they pay for that. CS = Amount of willingness to pay – actual cost (2) A graphical analysis (Fig. 3.10) (3) Change in CS (4) Applications

Class Exercise (Tuesday, Oct. 2) For demand function Q = P, (a) What is the consumer surplus when the price (P) is equal to $6 per unit? (b) What is the change in consumer surplus when the price increased from $6 to $8

3.8. Applications (1) Income tax vs sales tax (2) Income subsidy vs. price subsidy (3) Change in consumer surplus – a measure of the impacts on consumer welfare due to change in price

4. Market demand and elasticity 4.1. Market demand curves 4.2. A general definition of elasticity 4.3. Price elasticity of demand 4.4. Income elasticity of demand 4.5. Cross-price elasticity of demand 4.6. Empirical studies of demand 4.7. Applications

4.1. Market demand curves (1) Basic concepts Market demand: The total quantity of a good or service demanded by all potential buyers in a market. Market demand curve: A curve that represents the relationship between the total quantity demanded for a good or service and its price, holding all other factors constant.

4.1. Market demand curves (2) Construction of a market demand curve -- A graphical analysis (Fig. 4.1) -- Another definition of a market demand curve: A market demand curve is the horizontal sum of individual demand curves.

4.1. Market demand curves (3) General notations regarding a market: Q = Quantity demanded in a market P = Market price Other factors are held constant

4.1. Market demand curves (4) Shifts in the market demand curve -- A change in individuals’ income -- A change in population -- A change in the price of another good ……

4.2. A general definition of elasticity (1) How to measure the response of demand to a change price? e.g., what will be the change in quantity demanded for a good when its price changes by $1? e.g., what will be the percentage change in quantity demanded for a good when its price changes by 1%?

4.2. A general definition of elasticity (2) Definition of elasticity: The percentage change in one variable (Y) brought about by a 1% change in another variable (X). (3) A mathematical notation: Elasticity of Y with respect to X =

4.2. A general definition of elasticity (4) How to calculate a percentage change? e.g., If X increased from 10 to 12, what is the percentage change in X? Percentage change in X If X decreased from 12 to 10, what is the percentage change in X?

4.2. A general definition of elasticity (5) How to calculate an elasticity? e.g., when X increased from 10 to 12, Y increased from 100 to 110, what is the elasticity of Y with respect to X? Elasticity of Y with respect to X e Y, X = =