1. Zaher Charara B200 AOU1 CHAPTER 3 Reader 2 HOUSEHOLDS Jane Wheelock

2. Zaher Charara B200 AOU2 Introduction Introduction The household is a very important economic institution The household is a very important economic institution It links significant economic activities: consumption, production, distribution, decisions about spending It links significant economic activities: consumption, production, distribution, decisions about spending Households are crucial agents in the circular flow process of the national economy Households are crucial agents in the circular flow process of the national economy People in households make decisions about People in households make decisions about  Paid work, or:  Work in the home (bringing up children to reproduce labor force) Decision about buying a specific product is a micro level behavior Decision about buying a specific product is a micro level behavior How household behavior affects the activity in the economy in general is a macro level (how much money spent or saved) How household behavior affects the activity in the economy in general is a macro level (how much money spent or saved)

3. Zaher Charara B200 AOU3 Households have different structures Households have different structures  Single person household  Family with one or two parents  Group of unrelated people Different social characteristics: class, race, gender, generation to which they belong Different social characteristics: class, race, gender, generation to which they belong Levels of income: relationship between spending and demand. Consumption is a socio-economic process (advertising encourages consumption) Levels of income: relationship between spending and demand. Consumption is a socio-economic process (advertising encourages consumption) Economic characteristics: rich, poor, employed, retired, unemployed Economic characteristics: rich, poor, employed, retired, unemployed

4. 4 Households Firms Consumption goods & services Factors Of production Consumption expenditure Income Circular flow of income

5. Zaher Charara B200 AOU5 Relationship Between Income, Expenditure and Savings (Macro) 1. The personal sector (households):  Households in the personal sector must have income before they can spend it  Members of households sell productive services in the market  Some receive wages & salaries from selling their labor services  Others gain income from self employment, from rent, dividends or interest  Some are paid by government as part of welfare state: ‘unrequited’ (not in return for a service rendered)

6. Zaher Charara B200 AOU6  There is an income and expenditure account, as well as a capital account in households. Consumption of goods & services comes from the expenditure account  The capital account allows households to save and buy assets (adding to wealth)

7. Zaher Charara B200 AOU7 2. Personal sector expenditure Consumer expenditure Food and housing (the largest part) Food and housing (the largest part) Poor households spend a greater proportion of their income on basic items like food Poor households spend a greater proportion of their income on basic items like food Consumption, or investment in people People need good nutrition in order to be productive in their working life (minimum income is needed) People need good nutrition in order to be productive in their working life (minimum income is needed) Consuming the environment While consuming, households pollute the environment While consuming, households pollute the environment In summary, the personal sector accounts show how households divide their income between expenditure and savings

8. Zaher Charara B200 AOU8 Household Demand for Particular Commodities (Micro) 1. Demand & Income  Households behave as economic agents in the micro economy (buying individual commodities)  Income is unequally distributed between households  Unequal distribution of purchasing power therefore affects the market for individual products  Those with higher incomes will purchase more of most commodities  If a country’s national income goes up:  Its households in the aggregate have more purchasing power  More commodities of most types will be bought

9. Zaher Charara B200 AOU9  When less of commodities is purchased as income goes up they are called inferior goods.  The rich and the poor may buy different sorts of things. In the case of so-called inferior goods, those with higher incomes actually buy less of them. Rice, black & white TVs are examples of inferior goods.  What we buy is inevitably influenced by what is available for purchase.

10. Zaher Charara B200 AOU10 2. Influence of Technology on Demand: Technology mediates our psychological need and economic demand: with innovations, the way of satisfying a need changes. Examples: microwave ovens, DVDs, cars 3. Social Influences on Demand: Advertising gives a ‘demonstration effect’ where people feel social pressure to buy what others have. Sales people also persuade us to buy. Two sorts of consumption: a) Instrumental, which includes buying what’s necessary for livelihood; and b) Ceremonial, which includes wasteful unnecessary products.

11. Zaher Charara B200 AOU11 Demand in Product Markets Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price. Quantity demanded is the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price. The most important relationship in individual markets is that between market price and quantity demanded. The most important relationship in individual markets is that between market price and quantity demanded.

12. Zaher Charara B200 AOU12 Changes in Quantity Demanded Versus Changes in Demand We use the ceteris paribus or “all else equal” device, to examine the relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant. We use the ceteris paribus or “all else equal” device, to examine the relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant. Changes in price affect the quantity demanded per period. Changes in price affect the quantity demanded per period. Changes in income, wealth, other prices, tastes, or expectations affect demand. Changes in income, wealth, other prices, tastes, or expectations affect demand.

13. Zaher Charara B200 AOU13 Price and Quantity Demanded: The Law of Demand A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices. A demand schedule is a table showing how much of a given product a household would be willing to buy at different prices. Demand curves are usually derived from demand schedules. Demand curves are usually derived from demand schedules.

14. Zaher Charara B200 AOU14 Price and Quantity Demanded: The Law of Demand The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices. The demand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.

15. Zaher Charara B200 AOU15 Price and Quantity Demanded: The Law of Demand The law of demand states that there is an inverse relationship between price and the quantity of a good demanded. The law of demand states that there is an inverse relationship between price and the quantity of a good demanded. This means that demand curves slope downward. If price goes up, quantity demanded goes down.

16. Zaher Charara B200 AOU16 Other Determinants of Household Demand Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure. Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.

17. Zaher Charara B200 AOU17 Other Determinants of Household Demand Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower. They follow the law of demand. Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower. They follow the law of demand. Inferior Goods are goods for which demand falls when income rises. These goods are also called Giffen goods. These are exceptions to the law of demand Inferior Goods are goods for which demand falls when income rises. These goods are also called Giffen goods. These are exceptions to the law of demand Luxury items (Veblen goods) are also exceptions to the law of demand: demand is greater at higher prices. Luxury items (Veblen goods) are also exceptions to the law of demand: demand is greater at higher prices.

18. Zaher Charara B200 AOU18 Other Determinants of Household Demand Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products. Perfect substitutes are identical products. Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa. Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

19. Zaher Charara B200 AOU19 Shift of Demand Versus Movement Along a Demand Curve A change in demand is not the same as a change in quantity demanded. A higher price causes lower quantity demanded and a move along the demand curve DA. Changes in determinants of demand (income, wealth, substitutes), other than price, cause a change in demand, or a shift of the entire demand curve, from DA to DB.

20. Zaher Charara B200 AOU20 A Change in Demand Versus a Change in Quantity Demanded To summarize: Change in price of a good or service leads to Change in quantity demanded (Movement along the curve). Change in income, preferences, or prices of other goods or services leads to Change in demand (Shift of curve).

21. Zaher Charara B200 AOU21 The Impact of a Change in Income Higher income decreases the demand for an inferior good

22. Zaher Charara B200 AOU22 The Impact of a Change in Income Higher income increases the demand for a normal good

23. Zaher Charara B200 AOU23 The Impact of a Change in the Price of Related Goods If Price of hamburger rises: Quantity of hamburger demanded per month falls; Demand for complement good (ketchup) shifts left: less quantity demanded; Demand for substitute good (chicken) shifts right: more quantity demanded.

24. Zaher Charara B200 AOU24 In strawberry season, the quantity of strawberries will be high and the price is low. Few months later, strawberries are scarce, and people buy imported ones at higher price (we move up along the demand curve). A shift in the “strawberry” demand curve to the right can happen when demand increases: if there is increase in incomes, or increase in price of substitutes like raspberry… A shift in demand curve to the left (decrease in demand for strawberry) can happen if: price of complementary goods go up for example, or national income falls…

25. Zaher Charara B200 AOU25 From Household Demand to Market Demand Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

26. Zaher Charara B200 AOU26 From Household Demand to Market Demand Assuming there are only two households in the market, market demand is derived as follows: Assuming there are only two households in the market, market demand is derived as follows: