Download Chapter 4 – Individual and Market Demand.

Chapter 4 – Individual and
Market Demand.
Goals:
• Generate an individual consumer’s demand curve.
* Substitution and Income Effect of a Change
in Price.
* How a change in Income affects the demand
curve.
• Generate the market demand curve from (many)
individual consumer’s demand curve.
* Price Elasticity of Demand.
Individual Consumer’s Demand
Curve.

The Effect of Changes in Price.
◦ Price-Consumption Curve (PCC): Holding
everything else constant, the PCC for a good
X is the set of optimal bundles traced on an
indifference map as the price of X varies.
◦ Consider the case when the price of the good
X goes down.
Individual Consumer’s Demand
Curve.

The Effect of Changes in Price.
◦ The Substitution Effect: When price of one
good increases, consumer will substitute away
from the now more expensive good.
◦ The Income Effect : When price of one good
increases, the real income that a consumer has
is also reduced.
◦ Total Effect: The sum of Substitution Effect and
Income Effect.
Income and Substitution Effect
of a Normal Good.
Income and Substitution Effects
of an Inferior Good.
Individual Consumer’s Demand
Curve.
An Increase In Price of Good X
Effects
Normal Good
Inferior Good
Substitution Effect
-
-
Income Effect
-
+
Total Effect
-
-/+
Individual Consumer’s Demand
Curve.

The Effects of Changes in Income (holding
prices constant).
◦ The income consumption curve (ICC):
Ceteris paribus, in good X,Y domain, the ICC
is the set of optimal bundles traced on an
indifference map as money income varies.
◦ In Income and Quantity domain, the ICC is
referred to as the Engel Curve.
 Normal Good: Upward sloping Engel Curve.
 Inferior Good: Downward sloping Engel Curve.
Market Demand.

Aggregating individual demand curves.
◦ Consider the case where we have 2 individuals
in the market. Each individual has his/her own
demand for good X. Suppose
 (D1): P = 10 – X1 => X1 = 10 – P.
 (D2):P = 10 – 2X2 => X2 = 5 – 1/2P.
 XAgg = X1 + X = 15 – 3/2P. => (D): P = 10 – 2/3 XAgg
2
Market Demand
(D1)
D
(D2)
12
12
12.0
10
10
10.0
8
8
8.0
6
6
6.0
4
4
4.0
2
2
2.0
0
0
0.0
0 2 4 6 8 10
0 1 2 3 4 5
0
2
4
6
8 10 12 14
Market Demand

Price Elasticity of Demand.
◦ A percentage change in the quantity of a good
demanded that results from a 1% change in its
own price.
◦
or
Market Demand.

Elasticity of Demand.
Cases
Elasticity
Implication
η=0
Perfectly Inelastic Any change in price will leave the
quantity demanded unchanged.
0<η<1
Inelastic
Less sensitive to a change in price  an
increase in price will increase total
expenditure.
η=1
Unit Elastic
A 1% change in price will result in 1%
change in quantity.
1 < η < Infinity
Elastic
More sensitive to a change in price  a
decrease in price will increase total
expenditure.
η = Infinity
Perfectly Elastic
A small change in price results in 0
quantity demanded.
Market Demand.

Concept of Income Elasticity of Demand.
◦ A percentage change in the quantity of a good
demanded that results from a 1% change in
one’s income.
Q I

I Q
Market Demand

Concept of Cross Price Elasticity of
Demand.
◦ A percentage change in the quantity of a good
demanded that results from a 1% change in
another good’s price.
QX PY
X 
PY QX
◦
◦
> 0 => Good X and Y are substitute.
X < 0 => Good X and Y are complement.
X
Market Demand

Exercise:
◦ A hot dog vendor faces a market consisting of
30 identical individuals, each has a demand for
1
q

60

P
hot dog as:
2
i
 Derive the agg. Market demand for hotdog?
 If the vendor has been selling 300 hot dogs/day, how
much revenue has he been collecting?
 What is the price elasticity of demand at this level
of sales?
 If the vendor wants to increase his daily revenue,
should he raise or lower the price?
 At what price would he max. total revenue?