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Unit 6 The Demand Curve Economics - 6th year EURSC 2007/2008 Economics - 6th year (EURSC) Unit 6 2007/2008 1 / 19 Unit 6 2007/2008 2 / 19 Contents 1 Demand and Price 2 Factors affecting Demand 3 The consumer surplus Economics - 6th year (EURSC) Demand and Price In most cases (except for Giffen goods), the quantity demanded of that good increases as price decreases. Demand for books per year Say X=books, Y=other goods Books are normal goods for the individual considered Starting price and income: Px = 10, Py = 20, M = 100 Price changes to Px = 15 (ceteris paribus) Economics - 6th year (EURSC) Unit 6 2007/2008 3 / 19 Other 12 20 16 12 A 8 B 4 0 2 4 6 8 10 Books Price 30 The Demand Curve 25 20 B 15 A 10 5 0 2 4 6 8 10 Books Demand and Price The Demand Function Consider the space price of books versus books demanded. For each price we plot the corresponding optima (A,B) The result is the INDIVIDUAL DEMAND CURVE (or FUNCTION) Read horizontally: the demand curve shows how much would the individual would consume at each price (given her resources). Economics - 6th year (EURSC) Unit 6 2007/2008 6 / 19 Individual and Market Demand The Market Demand is the sum of the individual demands at each price for a group of agents. How to obtain Market Demand for Oranges Price 0.50 1.00 1.50 2.00 2.50 A 3.50 2.00 1.50 0.80 0.20 B 2.00 1.60 1.30 0.60 0.00 Economics - 6th year (EURSC) C 4.25 4.00 3.20 2.70 1.90 Market Demand 9.75 7.60 6.00 4.10 2.10 Unit 6 2007/2008 7 / 19 Factors affecting Demand Demand and Income Income affects demand Normal good: higher income, higher demand. Individual is ready to pay more for the same consumption. Inferior good: higher income, lower demand. Individual wants to pay less for the same consumption. Income induces SHIFTS the demand curve Normal good: higher income, DC shifts northeast Inferior good: higher income, DC shifts southwest Economics - 6th year (EURSC) Unit 6 2007/2008 8 / 19 Other 12 20 16 12 A 8 B 4 0 2 4 6 8 10 Books 8 10 Books Price 30 25 20 15 A 10 B 5 0 2 4 6 Factors affecting Demand Demand and Price of Other Goods Markets of different goods are related each other. Changes in one market Y may affect another market X. X,Y can be: Complements: ↑ Py → demand of X falls (shifts southwest) Substitutes: ↑ Py → demand of X increases (shifts northeast) Independent: ↑ Py → demand of X is not affected (does not move) Economics - 6th year (EURSC) Unit 6 2007/2008 11 / 19 Factors affecting Demand Demand and Price of Other Goods Milk, Corn Flakes and Porridge Milk and corn flakes are complements. An increase in the price of milk will likely reduce the demand of milk, and thus, the demand of corn flakes (will move southwest). But corn flakes and porridge are substitutes. An increase in the price of corn will shift the demand for porridge northeast. Economics - 6th year (EURSC) Unit 6 2007/2008 12 / 19 Factors affecting Demand Demand and Other Factors Changes in preferences: changes in tastes of people A preference for the good: demand shifts northeast A dislike for the good: demand shifts southwest Changes in legislation: ex. law against drunk drivers and alcoholimeters. Finally, population grotwh always increases market demand. Economics - 6th year (EURSC) Unit 6 2007/2008 13 / 19 Factors affecting Demand Summary Quantity demanded (Qx ) changes with own price (Px ). Also, we have seen that shifts in the demand curve can be caused by: Changes in income (M) Changes in cross-prices (Py ) Changes in tastes or legislation (T ) Population growth (only for market demand) (T ) Demand curve can be expressed as a function. Qx = f (Px ; M, Py , T ) Example: Qx = Economics - 6th year (EURSC) M+T Py − 3Px Unit 6 2007/2008 14 / 19 The Consumer Surplus Let’s read the demand function “vertically” For each quantity the demand curve shows the maximum the individual would pay for the last unit (recall principle #3) Demand of Big Brother TV show First minute of BB TV show is worth 50 cents. Having seen 59 minutes, minute 60 of BB TV show is worth 20 cents. Having seen one hour and a half of BB TV show, this BB TV fan would pay nothing for minute 100. Economics - 6th year (EURSC) Unit 6 2007/2008 Price 60 Demand of BB TV show in minutes 50 40 30 20 10 0 20 40 60 80 100 15 / 19 The Consumer Surplus Assume the BB TV fan contracts an hour of BB TV show per 12 EUR (i.e., 20 cents per min). Benefit is the difference between “willingness to pay” and real payment. For the first minute, his benefit is 50-20=30 cents. For the 20th. minute, benefit is 40-20=20 cents. Total benefit is the CS area: called the CONSUMER SURPLUS. Economics - 6th year (EURSC) Unit 6 2007/2008 Price 60 Demand of BB TV show in minutes 50 40 30 CS 20 10 0 20 40 60 80 100 17 / 19 The Consumer Surplus The Paradox of Value Why diamonds have such a big price despite being so useless? They are scarce: thus, people is willing to pay a high price for them (left part of demand function for diamonds) Why water has a low price despite being so useful? Water is more abundant, thus people pays a low price for the last unit (right part of the demand function for water) Thus, consumer surplus in the diamonds market is small but very big in the water market. Economics - 6th year (EURSC) Unit 6 2007/2008 19 / 19