1. Chapters 4: Individual and Market Demand

2. Price-Consumption Curve
margarine
Price-Consumption
curve
P=$7
P=$3
P=$2 10 20 32
butter
Price 7 3
Demand for butter 2 10 20 32
Quantity of butter

3. Link Between Indifference Curve Budget Constraint Model and Demand Curve
The utility-maximizing quantities at each price level trace out the individual’s demand curve P
$15
$10 $5
P=$15
P=$10
P=$5 Q Q 9 12 15 9 12 15

4. From Individual to Market Demand
Market demand is made up of the sum of individual demands
Total Demand p p p p p D3 D1 D2 D4 15 Q 30 Q 25 Q 10 Q Q 80

5. Income-Consumption and Engel Curves
Oranges
Income
Engel Curve
Income-Consumption
Curve
100 75
The Engel curve looks just like the income-consumption curve except that it has income on the vertical axis. 50
I = 100
I = 50
I = 75
1000
2000
2900
apples
1000
2000
2900
apples

6. Normal and Inferior Goods
Normal good - one whose quantity demanded rises as income rises
Inferior good - one whose quantity demanded falls as income rises
Normal
good
Normal
good
Normal good
Inferior good

7. Effect of a Price Change on Utility
Compensating Variation: The minimum change in income at the new prices that would make the consumer as well off as they were before the price change
Equivalent Variation: The minimum change in income at the old prices that would make the consumer as well off as they are after the price change

8. Compensating Variation

9. Equivalent Variation
Equivalent Variation

10. Income and Substitution Effects
The total impact of a price change on the demand for a product can be broken into the income and substitution effects
Income effect - the component of the total effect of a price change that results from the associated change in real purchasing power (quasi income)
Substitution effect - the component of the total effect of a price change that results from the associated change in the relative attractiveness (relative price) of the good in question
Giffen good is one for which the total effect of a price increase/decrease is to increase/decrease the demand for that good (counter intuitive effect)
Substitution effect is always in the same direction so a Giffen good is a strongly inferior good, so strongly inferior that the income effect is larger than the substitution effect

11. Effect of a Price Change: Normal Good
All other goods
apples
Substitution
effect
Income
effect

12. Effect of a Price Change: Inferior Good
All other goods
Income
effect
Spam
Substitution
effect

13. Effect of a Price Change: Giffen Good
All other goods
Income
effect
Potatoes
Substitution
effect

14. Price Elasticity
Price elasticity of demand - the percentage change in the quantity demanded that results from a 1 percent change in its price
Always less than zero by Law of Demand
The value of price elasticity tells whether demand is elastic, inelastic, or unitary elastic
Elastic
Inelastic
Unitary Elastic

15. Graphical Depiction of Price Elasticity10 9
Inelastic 2 1
demand 1 2 9 10
Quantity

16. Elasticity Along a Demand Curve
Price
Elastic
Unitary Elastic
Inelastic
demand
Quantity

17. Other Elasticities
Income elasticity of demand - the percentage change in the quantity demanded that results from a 1 percent change in income (Y)
Cross-price elasticity - the percentage change in the demand for good X that results from a 1 percent change in the price of good Y

18. What Determines Price Elasticities
Substitution possibilities - greater number of substitutes makes goods more elastic
Budget share - greater share of expenditures accounted for by the product, the more elastic
Direction of income effect - normal goods will have higher price elasticities than inferior goods b/c the income effect reinforces the substitution effect
Time - the longer the time period in question, the greater the price elasticity

19. Price Elasticity and Total Revenue (Elastic)
Losses in total revenue
from lowering the price
Price
Note that the area of the gains exceeds the area of the losses, implying that the firm has greater total revenue after the price is lowered than before.
Gains in total revenue
from lowering the price
Quantity

20. Price Elasticity and Total Revenue (Inelastic)
Losses in total revenue
from lowering the price
Note that the area of the losses exceeds the area of the gains, implying that the firm has less total revenue after the price is lowered than before.
Gains in total revenue
from lowering the price
Quantity