Download Why review demand relationships? • Demand Review EconS 451: Lecture # 6

Why review demand relationships?
EconS 451: Lecture # 6
• Helps us understand market behavior!
Demand Review
•
Understand the definition of Demand.
•
Explain the difference between Marshallian and Hicksian Demand.
• Explains price fluctuations!
•
Be able to describe and explain the substitution and income effect in
product space from a change in price.
• Provides a foundation for empirical research
•
Understand how proportion of expenditure allocated to a specific good
impacts the substitution and income effect.
•
Understand the difference between demand shifts and structural change.
•
Calculate Own-Price, Income and Cross-Price Elasticity of Demand.
and analysis!
• Equips you with necessary analytical capability
to evaluate market dynamics!
Demand Review
Demand Review
• Demand Defined:
• Begins at the individual level……then summed
across all individuals to the market level.
• The various quantities of a particular commodity that
an individual consumer is willing and able to buy as
the price varies, all other factors held constant.
Individual Attempting to Solve
Max U(x x ) s.t.
1,
• Marshallian Demand
1,
2
px + p x = I
1
1
2
2
Individual Demand
Demand Review
Max U(x x ) s.t.
2
Price
px + p x = I
1
1
2
2
10
• Hicksian (or Compensated) Demand
5
Min Expenditures E(p, U) s.t. U(x x ) = U
1,
2
F
Demand
25
45
Quantity X
1
Observations
Product Space
Y
• If the commodity in questions represents a
large proportion of expenditures, then the
income effect from a change in the price will be
relatively large.
100
r
• Both Income and Substitution effect usually
s
inversely related to price changes.
U2
t
U1
X
25
u
37 45 50
v
100
w
Static and Dynamic Demand
Graphical Changes in Demand
• Static :
Price
• Quantity movements or responses to price while all
other factors are assumed constant.
Parallel Shift
• Movements along a demand curve.
• Dynamic:
• Shifts and changes in demand that happen with the
passage of time to account for changes in income,
population, taste and preferences, etc.
Shift and Structural Change
• Structural Change
• Change in the shape of the demand curve due to
changes in technology or information.
Quantity
Short Run……….Long Run
Demand Changes
• Short Run :
• Shift
• Parallel shifts from
changes such as
income, population.
• Time period too short for complete quantity
adjustment from a price change (a snapshot).
Q = α − β P + γY
• Long Run:
• Structural Change
Q = α − βP + γY
• Changes in the
parameters or functional
form.
2
• The time required for a complete quantity adjustment
to occur in response to a “once-and-for-all” price
change.
2
Distributed Lag Models
• Refers to a delayed
Speculative Demand
• Consumer demand for current consumption
adjustment in quantity as
a result of a price change.
• Speculative demand
• Anticipated demand and uses
• Future cost > current cost + all storage costs
• And the adjustment may
be spread over a period
of time.
Qdt = f (Yt , Pt , Pt − 1 )
• Commodity market financial investment
• “open interest”
• Current market price impacted by current and
expected events.
Primary and Derived Demand
Price
Own-Price Elasticity of Demand
• Relates changes in the
price of the commodity
back to the changes in
quantity demanded.
Pr
• Defined at a point along
Pd
Ep =
the demand curve.
Primary Demand
dQ P
×
dP Q
• At the average
• Arc formula
Derived Demand
Quantity
• Assuming Q = f(P)
Own-Price Elasticity of Demand
Income Elasticity of Demand
• Relates changes in
Range
• Elastic
Ep > 1
• Unitary Elasticity
E
• Inelastic
Ep < 1
p
= 1
income back to the
changes in quantity
demanded.
• Defined at a point along
EY =
dQ Y
×
dY Q
the demand curve.
• Revenue and elasticity
• TR = P(Q)
3
Income Elasticity of Demand
Cross-Price Elasticity of Demand
• Relates changes in the
Range
• Inferior
EY < 0
price of the jth product
back to the changes in
the quantity demanded
for the ith product.
• Normal
EY > 0
• Defined at a point along
Eij =
∂Qi Pj
×
∂ Pj Qi
the demand curve.
Cross-Price Elasticity of Demand
Range
Summary Questions
• Explain the difference between individual and market demand.
• Independent
E ij = 0
• Describe the difference between the short and long run as it relates
• Substitute
E ij > 0
• What is meant by a distributed-lag……as it relates to demand?
• Complement
Eij < 0
to market demand.
• Explain what the own-price, income, and cross-price elasticity of
demand are each measuring.
• Generalizations because of the “income and
substitution effects” of a price change of inferior
goods.
4