2. Task: Read Ch. 5

3. Ch 5. Demand Theory

4. The Effects Of Change In The Price Of A Good On Consumption Price Consumption Curve (PCC): The set of utility maximizing baskets as the price of one good varies (holding constant income and the prices of other goods). The set of utility maximizing baskets as the price of one good varies (holding constant income and the prices of other goods).

5. The Effects Of Change In The Price Of A Good On Consumption (continued) Figure 5.1. Page 137 I = 40 I = 40 Py = 4 Py = 4 Px = 4 Px = 4 Px = 2 Px = 2 Px = 1 Px = 1

6. The Effect Of A Change In Income Income Consumption Curve (ICC): The set of utility maximizing baskets as income varies (and prices are held constant). The set of utility maximizing baskets as income varies (and prices are held constant).

7. The Effect Of A Change In Income (continued) Figure 5.2. Px = 2 Px = 2 Py = 4 Py = 4 I = 40 I = 40 I = 68 I = 68 I = 92 I = 92

8. Engel Curve Engel curve: A curve that relates the amount of commodity purchased to the level of income, holding constant the prices of all goods. A curve that relates the amount of commodity purchased to the level of income, holding constant the prices of all goods. Figure 5.3. Page 141 Figure 5.3. Page 141 Px = 2 Px = 2 Py = 4 Py = 4 I = 40 I = 40 I = 68 I = 68 I = 92 I = 92

9. Note: - Normal good: - Normal good: a good that a consumer purchases more a good that a consumer purchases more of as income rises. of as income rises. - Inferior good: - Inferior good: A good that a consumer purchases less of as A good that a consumer purchases less of as income rises. income rises.

10. Finding A Demand Curve A consumer purchase two goods (food and clothing). U(x,y) = XY; Px; Py; I U(x,y) = XY; Px; Py; I - find the demand curve? - find the demand curve? - Is the food a normal good? - Is the food a normal good?

11. Substitution Effect And Income Effect Substitution effect: the change in the amount of a good that would be consumed as the price of that good changes, holding constant all other prices and the level utility. the change in the amount of a good that would be consumed as the price of that good changes, holding constant all other prices and the level utility. Income effect: the change in the amount of a good that a consumer would buy as purchasing power changes, holding all prices constant. the change in the amount of a good that a consumer would buy as purchasing power changes, holding all prices constant.

12. Substitution Effect And Income Effect (continued) Figure 5.6 Page 148 Price of food drops from Px1 to Px2. Price of clothing is constant.

13. Consumer Surplus Consumer surplus: The difference between the maximum amount a consumer is willing to pay for a good and the amount he or she must actually pay when purchasing. The difference between the maximum amount a consumer is willing to pay for a good and the amount he or she must actually pay when purchasing. Figure 5.13. Page 159 Figure 5.13. Page 159

14. Consumer Surplus (continued) Suppose the equation Q = 40-4P Represents a consumer’s monthly demand curve for milk, where Q is the number of gallons of milk purchased when the price is P dollars per gallon. 1.What is the consumer surplus per month if the price of milk is $ 3 per gallon? 2.What is the increase in consumer surplus if the price falls to $ 2 per gallon

15. Market Demand Market demand curve: the horizontal sum of demand of the individual consumers. the horizontal sum of demand of the individual consumers. Qb(P) = 15 – 3P, when P < 5 Qb(P) = 15 – 3P, when P < 5 = 0, when P = 5 or P > 5 = 0, when P = 5 or P > 5 Qc(P) = 6 – 2P, when P > 3 Qc(P) = 6 – 2P, when P > 3 = 0, when P = 3 or P > 3 = 0, when P = 3 or P > 3 Q market (P) = ? Q market (P) = ?

16. Homework: 5.7. Page 180