individual and market demand. outcomes derive individual demand curve effect of change in price and...
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CHAPTER 4Individual and market demand
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OutcomesDerive individual demand curveEffect of change in price and income on the
demand curveMarket demand curveConsumer surplusEffects of network externalities
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CHANGES IN EQUILIBRIUMHow does the equilibrium position change if:
1. Consumer’s income changeOR
2. Price of one of the goods change
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Income Effect on Consumer Equilibrium Change in income, all prices remaining constant.
If prices of goods, tastes and preferences of the consumer remain constant and there is a change in income, it will directly affect consumer’s equilibrium.
A rise in the income of a consumer shifts the Budget line to the right upward on higher IC.
A fall in the income shifts the Budget line to the left side on lower IC.
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Income Effect on Consumer Equilibrium A rise in the Income: Consumer can buy
more of both commodities = Higher level of satisfaction and increase in equilibrium.
A fall in the Income = Consumer buy less of both the commodities = Lower level of satisfaction and decrease in equilibrium.
The line which touches all the consumer equilibrium points = Income Consumption Curve (ICC).
ICC = The consumption of two goods is affected by change in income when prices are constant.
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Income Effect on Consumer
Equilibrium
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Price Effect on Consumer Equilibrium Price Effect = A result of change in the price of
one commodity while price of other good and income of the consumer remain constant.
The change in demand in response to a change in price of a commodity, other things remaining the same (Ceteris Paribus), is called Price effect.
If we draw a line which touches all the consumer equilibrium points so we will get Price Consumption Curve (PCC).
PCC = The consumption of good X changes, as its price changes, remaining constant the price of good Y and the income of the consumer.
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Price Effect on Consumer Equilibrium
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NORMAL AND INFERIOR GOODSNormal goods = Willing and able to buy
anything with an income increases or the price decreases Example: NEW clothing, NEW car, NEW computer.
Inferior goods = Comparable to the normal good. More willing to purchase as income decreases or the price increases Example: USED clothing, USED car, USED computer i.e. income and quantity.
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Effect on an inferior good
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Engel CurvesCurve relating the quantity of a good
consumed to income.
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Income and substitution effects Price:
Consumer will buy more of cheaper good and less of relatively more expensive good.
One good cheaper Consumer enjoy increase in real purchasing power.
Two effects occur simultaneously
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Income and substitution effects: Normal Good
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Substitution effectChange in consumption of a good with a
change in its price, with the level of utility held constant.
Income effectChange in consumption of a good resulting from
an increase in purchasing power, with relative prices held constant.
Total effectTotal Effect (F1F2) = Substitution effect
(F1E) + Income Effect (EF2)
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Income and substitution effects: Inferior Goods
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Special Case: GIFFEN GOODSTheoretically
possible (but doubted): Good whose
demand curve slopes upward because the negative income effect is larger than the substitution effect.
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Market demand curveDiscussed in Chapter 2
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ELASTICITY: RecapInelastic demand: Quantity demanded is
relatively unresponsive to changes in price, e.g.. Gasoline
Elastic demand: Expenditure on the product decreases as the price goes up, e.g.. Beef
Isoelastic demand: Demand curve with constant price elasticity.Special isoelastic demand curve: unit-elastic
demand curve -1.
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Consumer SurplusDefinition: Difference between
Willing to pay for a good, and;Amount actually paid
Calculate from the demand curve
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Network externalitiesAssumption: Demand for a good are
independent of one another.However, for some goods demand depends on
the demand of other people.Network externalities exist.
Definition: Situation in which each individual’s demand,depends on the purchases of other individuals
Positive or negativePositive = Quantity of good demand by
consumer increase in response to the growth in purchases of other consumers.
Negative = Vice versa, demand decreases
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Network externalities- The bandwagon effectPositive network externalityDefinition: Consumer wishes to possess a
good in part because others do, e.g.. Toys: Playstation, Xbox
Exploited by marketers
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Network externalities- Snob effectNegative externality.Definition:
Consumer wishes to own an exclusive or unique good e.g.. Works of art, sports car
Prestige, status and exclusivity
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