4 main topics related to Individual & Market Demand
1. Use the Rational Choice model
Derive an individual’s demand curve
Construct a relationship that summarizes how individual demands vary with income
Individual & Market Demand
2. The total effects of a price change can be broken down into two effects:
1. Substitution Effect
2. Income Effect
Individual & Market Demand
3. Individual demand curves can be added to yield the demand curve for the whole market
Individual & Market Demand
4. Price elasticity of demand is a responsiveness measure for changes in price
Income elasticity of demand measures the individual’s purchase responsiveness to small changes in income
Individual & Market Demand
Cross-elasticity of demand measures the responsiveness of the quantity demanded of one good to the small price changes of another
Effects of Changes in Price: Price-Consumption Curve (PCC)
Holding money, income and the prices of all other goods constant, the PCC of good X is the set of optimal bundles traced on an indifference map as the price of X varies
The Individual Consumer’s Demand Curve
The PCC contains all the information needed to construct an individual demand curve
Effects of Changes in Income: The Income-Consumption Curve (ICC)
Holding the prices of all goods constant, the ICC is the set of optimal bundles traced on an indifference map as money income varies
The Engel Curve
A curve that plots the relationship between the quantity of a good consumed and income
Normal & Inferior Goods
Normal goods have an upward sloping demand curve
For inferior goods, an increase in income leads to a reduction in quantity demanded
Substitution Effects of a Price Change
Component of the total effect
Results from the associated change in the relative attractiveness of other goods
Income Effect of a Price Change
Results from the associated change in real purchasing power
The total effect of a price change is the sum of the income and substitution effects
Price Elasticity of Demand
The percentage change in the quantity of a good demanded that results from a 1% change in its price
Price Elasticity of Demand
If the price elasticity is less than -1, demand is said to be elastic
If the price elasticity is between -1 and zero the good is inelastic
If the price elasticity is equal to -1 the good is unit elastic
Price Elasticity of Demand: Three Properties
Price elasticity is different at each point along a linear demand curve
Price Elasticity of Demand
Perfectly elastic demand has infinitely high price elasticity at all points
Perfectly inelastic demand is vertical, meaning that price elasticity is equal to zero at all points
Elasticity & Total Expenditure
“If the price of a product changes, how will the total amount spent on the product be affected?”
“Will more be spent on the product if we sell more units at a lower price or fewer units at a higher price?”
Determinants of Price Elasticity of Demand
Substitution Possibilities
Budget Share
Direction of Income effect
Time
The Dependence of Market Demand on Income
Government policies that redistribute income from the rich to the poor:
Increases demand for goods like food
Decreases demand for luxury items like jewellery
The Dependence of Market Demand on Income
Engel curves, at the market level, relate the quantity demanded to the average income level in the market
Income Elasticity of Demand
A formal measure of the responsiveness of purchase decisions to variations in the average market income
If a good has a stable Engel curve we can define its income elasticity of demand
Income Elasticity of Demand
Income elasticities for necessities must take on a value of ε<1
Luxuries are those goods for which ε >1