Download Chapter 4

Chapter 4
Individual and Market Demand
Question:
 Why is the Demand Curve downward
sloping?
 Stupid question?
 Needs explanation?
©2005 Pearson Education, Inc.
Chapter 4
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Effect of a Price Change
Clothing
Assume:
•I = $20
•PC = $2
•PF = $2, $1, $0.50
10
A
6
U1
5
Each price leads to
different amounts of
food purchased
D
B
4
U3
U2
4
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Chapter 4
Food (units
per month)
3
Effect of a Price Change
 By changing prices
and showing what
the consumer will
purchase, we can
create a demand
schedule and
demand curve for the
individual
©2005 Pearson Education, Inc.
Chapter 4
Demand Schedule
P
Q
$2.00
4
$1.00
12
$0.50
20
4
Effect of a Price Change
Price
of Food
Individual Demand relates
the quantity of a good that
a consumer will buy to the
price of that good.
E
$2.00
G
$1.00
Demand Curve
$.50
H
4
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Chapter 4
Food (units
per month)
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Demand Curves – Important
Properties
 The level of utility that can be attained
changes as we move along the curve.
 At every point on the demand curve, the
consumer is maximizing utility by
satisfying the condition that the MRS of
food for clothing equals the ratio of the
prices of food and clothing.
©2005 Pearson Education, Inc.
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Effect of a Price Change
Price
of Food
When the price falls:
Pf/Pc & MRS also fall
E
$2.00
•E: Pf/Pc = 2/2 = 1 = MRS
•G: Pf/Pc = 1/2 = .5 = MRS
•H:Pf/Pc = .5/2 = .25 = MRS
G
$1.00
$.50
H
4
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Demand Curve
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Chapter 4
Food (units
per month)
7
Effects of Income Changes
Clothing
(units per
month)
Assume: Pf = $1, Pc = $2
I = $10, $20, $30
7
D
5
U3
An increase in income,
with the prices fixed,
causes consumers to alter
their choice of
market basket.
U2
B
3
U1
A
4
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Chapter 4
Food (units
per month)
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Effects of Income Changes
Price
of
food
An increase in income, from
$10 to $20 to $30, with the
prices fixed, shifts the
consumer’s demand curve
to the right as well.
E
$1.00
G
H
D3
D2
D1
4
©2005 Pearson Education, Inc.
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Chapter 4
Food (units
per month)
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Individual Demand
 Engel Curves
 Engel
curves relate the quantity of good
consumed to income.
 If the good is a normal good, the Engel curve
is upward sloping.
 If the good is an inferior good, the Engel
curve is downward sloping.
©2005 Pearson Education, Inc.
Chapter 4
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Engel Curves
Income 30
($ per
month)
Engel curves slope
upward for
normal goods.
20
10
4
©2005 Pearson Education, Inc.
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Chapter 4
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Food (units
per month)
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Income and Substitution Effects
 A change in the price of a good has two
effects:
Substitution Effect
Income Effect
©2005 Pearson Education, Inc.
Chapter 4
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Income and Substitution Effects
 Substitution Effect
Relative price of a good changes when price
changes
Consumers will tend to buy more of the good
that has become relatively cheaper, and less
of the good that is relatively more expensive.
©2005 Pearson Education, Inc.
Chapter 4
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Income and Substitution Effects
 Income Effect
Consumers experience an increase in real
purchasing power when the price of one
good falls.
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Income and Substitution Effects
 Substitution Effect
The substitution effect is the change in an
item’s consumption associated with a change
in the price of the item, with the level of
utility held constant.
When the price of an item declines, the
substitution effect always leads to an
increase in the quantity demanded of the
good.
©2005 Pearson Education, Inc.
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Income and Substitution Effects
 Income Effect
The income effect is the change in an item’s
consumption brought about by the increase
in purchasing power, with the price of the
item held constant.
When a person’s income increases, the
quantity demanded for the product may
increase or decrease.
©2005 Pearson Education, Inc.
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Income and Substitution Effects
 Income Effect
Even with inferior goods, the income effect is
rarely large enough to outweigh the
substitution effect.
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Income and Substitution
Effects: Normal Good
Clothing
(units per
month) R
When the price of food falls,
consumption increases by F1F2
as the consumer moves from A
to B.
The substitution effect,F1E,
(from point A to D), changes the
A
relative prices but keeps real income
(satisfaction) constant.
C1
D
B
C2
U2
Substitution
Effect
O
F1
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Total Effect
The income effect, EF2,
( from D to B) keeps relative
prices constant but
increases purchasing power.
U1
E S
Chapter 4
F2
T
Income Effect
Food (units
per month)
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Income and Substitution
Effects: Inferior Good
Clothing
(units per
month) R
Since food is an
inferior good, the
income effect is
negative. However,
the substitution effect
is larger than the
income effect.
A
B
U2
D
Substitution
Effect
O
F1
Total Effect
©2005 Pearson Education, Inc.
U1
E S
F2
Chapter
4
Income
Effect
T
Food (units
per month)
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Income and Substitution Effects
 A Special Case--The Giffen Good
The income effect may theoretically be large
enough to cause the demand curve for a
good to slope upward.
This rarely occurs and is of little practical
interest.
©2005 Pearson Education, Inc.
Chapter 4
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Market Demand
 Market Demand Curves
A curve that relates the quantity of a good
that all consumers in a market buy to the
price of that good.
The sum of all the individual demand curves
in the market
©2005 Pearson Education, Inc.
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Determining the Market Demand
Curve
Price
A
B
C
Market
Demand
1
6
10
16
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2
4
8
13
25
3
2
6
10
18
4
0
4
7
11
5
0
2
4
6
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Summing to Obtain a
Market Demand Curve
Price
5
The market demand
curve is obtained by
summing the consumer’s
demand curves
4
3
Market Demand
2
1
0
DA
5
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10
DC
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Chapter 4
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25
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Quantity
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Market Demand
 From this analysis one can see two
important points
The market demand will shift to the right as
more consumers enter the market.
Factors that influence the demands of many
consumers will also affect the market
demand.
©2005 Pearson Education, Inc.
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Consumer Surplus
 Why do consumers exchange 1,000 Won
for an apple?
Consumers buy goods because it makes
them better off
Consumer Surplus measures how much
better off they are
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Consumer Surplus
 The difference between the maximum
amount a consumer is willing to pay for a
good and the amount actually paid.
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Consumer Surplus - Example
 Student wants to buy concert tickets
 Demand curve tells us willingness to pay
for each concert ticket
1st ticket worth $20 but price is $14 so
student generates $6 worth of surplus
Can measure this for each ticket
Total surplus is addition of surplus for each
ticket purchased
©2005 Pearson Education, Inc.
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Consumer Surplus - Example
Price
($ per
ticket)
The consumer surplus
of purchasing 6 concert
tickets is the sum of the
surplus derived from
each one individually.
20
19
18
17
16
15
Consumer Surplus
6 + 5 + 4 + 3 + 2 + 1 = 21
Market Price
14
13
0
Will not buy more than 7
because surplus is
negative
1
©2005 Pearson Education, Inc.
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Rock Concert Tickets
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Consumer Surplus
Price
($ per
ticket)
Consumer Surplus
for the Market Demand
20
19
CS = ½ ($20 - $14)*(1600)
= $19,500
18
17
16
15
Consumer
Surplus
Market Price
14
13
Demand Curve
Actual
Expenditure
0
1
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Rock Concert Tickets
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Network Externalities
 Up to this point we have assumed that
people’s demands for a good are
independent of one another.
 For some goods, one person’s demand
also depends on the demands of other
people
©2005 Pearson Education, Inc.
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Network Externalities
 A positive network externality exists if the
quantity of a good demanded by a
consumer increases in response to an
increase in purchases by other
consumers.
 Negative network externalities are just
the opposite.
©2005 Pearson Education, Inc.
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Network Externalities
 The Bandwagon Effect
This is the desire to be in style, to have a
good because almost everyone else has it,
or to indulge in a fad.
This is the major objective of marketing and
advertising campaigns (e.g. toys, clothing).
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Positive Network
Externality: Bandwagon Effect
Price
($ per
unit)
D20
D40 D60 D80 D100
When consumers believe more
people have purchased the
product, the demand curve shifts
further to the the right .
Quantity
20
©2005 Pearson Education, Inc.
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Chapter 4
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100
(thousands per month)
33
Positive Network
Externality: Bandwagon Effect
Price
($ per
unit)
D20
D40 D60 D80 D100
The market demand
curve is found by joining
the points on the individual
demand curves. It is relatively
more elastic.
Demand
Quantity
20
©2005 Pearson Education, Inc.
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Chapter 4
80
100
(thousands per month)
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Positive Network
Externality: Bandwagon Effect
Price
($ per
unit)
D20
D40 D60 D80 D100
$30
Suppose
the price
fallsbuy
But as more
people
fromthe
$30
to $20.
If there
good,
it becomes
werestylish
no bandwagon
effect,
to own it and
quantity
demanded
would
the quantity
demanded
only increase
tofurther.
48,000
increases
Demand
$20
Bandwagon
Effect
Pure Price
Effect
Quantity
20
©2005 Pearson Education, Inc.
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Chapter 4
80
100
(thousands per month)
35
Network Externalities
 The Snob Effect
If the network externality is negative, a snob
effect exists.
 The snob effect refers to the desire to
own exclusive or unique goods.
 The quantity demanded of a “snob” good
is higher the fewer the people who own it.
©2005 Pearson Education, Inc.
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Network Externality: Snob Effect
Price
($ per
unit)
Demand
$30,000
Originally demand is D2,
when consumers think 2000
people have bought a good.
However, if consumers think 4,000
people have bought the good,
demand shifts from D2 to D6 and its
snob value has been reduced.
$15,000
D2
Pure Price Effect
D4
D8
2
©2005 Pearson Education, Inc.
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Chapter 4
D6
Quantity
14
(thousands
per month)
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Network Externality: Snob Effect
Price
($ per
unit)
The demand is less elastic and
as a snob good its value is greatly
reduced if more people own
it. Sales decrease as a result.
Examples: Rolex watches and long
lines at the ski lift.
Demand
$30,000
Net Effect
Snob Effect
$15,000
D2
Pure Price Effect
D4
D8
2
©2005 Pearson Education, Inc.
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6
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Chapter 4
D6
Quantity
14
(thousands
per month)
38