Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Topics to be Discussed Individual Demand Income and Substitution Effects Market Demand Consumer Surplus Empirical Estimation of Demand Lecture 4 Slide 1 Effect of a Price Change Clothing (units per month) Assume: •I = $20 •PC = $2 •PF = $2, $1, $.50 10 A 6 U1 5 D B U3 4 Three separate indifference curves are tangent to each budget line. U2 4 Lecture 4 12 20 Food (units per month) Slide 2 Effect of a Price Change The price-consumption curve traces out the utility maximizing market basket for the various prices for food. Clothing (units per month) A 6 Price-Consumption Curve U1 5 D B U3 4 U2 4 Lecture 4 12 20 Food (units per month) Slide 3 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 Lecture 4 12 20 Food (units per month) Slide 4 Effects of Income Changes Clothing (units per month) Assume: Pf = $1 Pc = $2 I = $10, $20, $30 Income-Consumption Curve 7 D 5 U2 B 3 An increase in income, with the prices fixed, causes consumers to alter their choice of market basket. U1 A 4 Lecture 4 U3 10 16 Food (units per month) Slide 5 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. E $1.00 G H D3 D2 D1 4 Lecture 4 10 16 Food (units per month) Slide 6 Individual Demand Normal Good vs. Inferior Good Income Changes Lecture 4 When the income-consumption curve has a positive slope: The quantity demanded increases with income. The income elasticity of demand is positive. The good is a normal good. Slide 7 Individual Demand Normal Good vs. Inferior Good Income Changes Lecture 4 When the income-consumption curve has a negative slope: The quantity demanded decreases with income. The income elasticity of demand is negative. The good is an inferior good. Slide 8 An Inferior Good Steak 15 (units per month) Income-Consumption Curve C 10 Both hamburger and steak behave as a normal good, between A and B... U3 B 5 U2 …but hamburger becomes an inferior good when the income consumption curve bends backward between B and C. A U1 5 Lecture 4 10 20 Hamburger 30 (units per month) Slide 9 Consumer Expenditures in the United States Income Group (1997 $) Expenditure ($) on: Less than 1,000$10,000 19,000 Entertainment 20,00029,000 30,000- 40,00039,000 49,000 50,000- 70,00069,000 and above 700 947 1274 1514 2054 2654 4300 Owned Dwellings 1116 1725 2253 3243 4454 5793 9898 Rented Dwellings1957 2170 2371 2536 2137 1540 1266 Health Care 1031 1697 1918 1820 2052 2214 2642 Food 2656 3385 4109 4888 5429 6220 8279 859 978 1363 1772 1778 2614 3442 Clothing Individual Demand Substitutes and Complements 1) Two goods are considered substitutes if an increase (decrease) in the price of one leads to an increase (decrease) in the quantity demanded of the other. Lecture 4 e.g. movie tickets and video rentals Slide 11 Individual Demand Substitutes and Complements 2) Two goods are considered complements if an increase (decrease) in the price of one leads to a decrease (increase) in the quantity demanded of the other. Lecture 4 e.g. gasoline and motor oil Slide 12 Individual Demand Substitutes and Complements 3) Two goods are independent when a change in the price of one good has no effect on the quantity demanded of the other Lecture 4 Slide 13 Income and Substitution Effects A fall in the price of a good has two effects: Substitution & Income Substitution Effect Lecture 4 Consumers will tend to buy more of the good that has become relatively cheaper, and less of the good that is now relatively more expensive. Slide 14 Income and Substitution Effects A fall in the price of a good has two effects: Substitution & Income Income Effect Consumers experience an increase in real purchasing power when the price of one good falls. Lecture 4 Slide 15 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 of the item demanded. Lecture 4 Slide 16 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. Lecture 4 Slide 17 Income and Substitution Effects Income Effect Lecture 4 Even with inferior goods, the income effect is rarely large enough to outweigh the substitution effect. Slide 18 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 Lecture 4 F1 Total Effect The income effect, EF2, ( from D to B) keeps relative prices constant but increases purchasing power. U1 E S F2 T Income Effect Food (units per month) Slide 19 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 E Total Effect Lecture 4 U1 S F2 T Food (units per month) Income Effect Slide 20 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. Lecture 4 Slide 21 Market Demand From Individual to 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. Lecture 4 Slide 22 Determining the Market Demand Curve Price Individual A Individual B Individual C Market ($) (units) (units) (units) (units) 1 6 10 16 32 2 4 8 13 25 3 2 6 10 18 4 0 4 7 11 5 0 2 4 6 Lecture 4 Slide 23 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 Lecture 4 DA 5 DB 10 DC 15 20 25 30 Quantity Slide 24 Market Demand Point Elasticity of Demand Point elasticity measures elasticity at a point on the demand curve. Its formula is: EP (P/Q)(1/sl ope) Lecture 4 Slide 25 Market Demand Problems Using Point Elasticity We may need to calculate price elasticity over portion of the demand curve rather than at a single point. The price and quantity used as the base will alter the price elasticity of demand. Lecture 4 Slide 26 Market Demand Point Elasticity of Demand (An Example) Assume Price increases from 8$ to $10 quantity demanded falls from 6 to 4 Percent change in price equals: $2/$8 = 25% or $2/$10 = 20% Percent change in quantity equals: -2/6 = -33.33% or -2/4 = -50% Lecture 4 Slide 27 Market Demand Point Elasticity of Demand (An Example) Elasticity equals: -33.33/.25 = -1.33 or -.50/.20 = -2.54 Which one is correct? Lecture 4 Slide 28 Market Demand Arc Elasticity of Demand Arc elasticity calculates elasticity over a range of prices Its formula is: EP ( Q/P)( P / Q) P the average price Q the average quantity Lecture 4 Slide 29 Market Demand Arc Elasticity of Demand (An Example) EP ( Q/ P)( P / Q) P 8, P 10, Q 6, Q 4 P 18 / 2 9 & Q 10 / 2 5 E (2 / $2)($9 / 5) 1.8 1 2 1 2 p Lecture 4 Slide 30 An Example: The Aggregate Demand For Wheat The demand for U.S. wheat is comprised of domestic demand and export demand. Lecture 4 Slide 31 The Aggregate Demand For Wheat The domestic demand for wheat is given by the equation: QDD = 1700 - 107P The export demand for wheat is given by the equation: Lecture 4 QDE = 1544 - 176P Slide 32 The Aggregate Demand For Wheat Domestic demand is relatively price inelastic (-0.2), while export demand is more price elastic (-0.4). Lecture 4 Slide 33 The Aggregate Demand For Wheat Price ($/bushel) 20 18 16 Total world demand is the horizontal sum of the domestic demand AB and export demand CD. A 14 12 10 C E 8 Total Demand 6 4 Export Demand 2 0 Lecture 4 Domestic Demand D 1000 F B 2000 3000 Wheat(million bushels/yr.) 4000 Slide 34 Consumer Surplus Consumer Surplus The difference between the maximum amount a consumer is willing to pay for a good and the amount actually paid. Lecture 4 Slide 35 Consumer Surplus 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 Lecture 4 1 2 3 4 5 6 Rock Concert Tickets Slide 36 Consumer Surplus Price ($ per ticket) Consumer Surplus for the Market Demand 20 19 18 17 16 15 Consumer Surplus 1/2x(20 14)x6,500 $19,500 Market Price 14 13 Demand Curve Actual Expenditure 0 Lecture 4 1 2 3 4 5 6 Rock Concert Tickets Slide 37 Consumer Surplus Combining consumer surplus with the aggregate profits that producers obtain we can evaluate: 1) Costs and benefits of different market structures 2) Public policies that alter the behavior of consumers and firms Lecture 4 Slide 38 An Example: The Value of Clean Air Air is free in the sense that we don’t pay to breathe it. The Clean Air Act was amended in 1970. Question: Were the benefits of cleaning up the air worth the costs? Lecture 4 Slide 39 The Value of Clean Air People pay more to buy houses where the air is clean. Data for house prices among neighborhoods of Boston and Los Angeles were compared with the various air pollutants. Lecture 4 Slide 40 Valuing Cleaner Air Value ($ per pphm of reduction) 2000 A 1000 0 Lecture 4 5 The shaded area gives the consumer surplus generated when air pollution is reduced by 5 parts per 100 million of nitrous oxide at a cost of $1000 per part reduced. 10 NOX (pphm) Pollution Reduction Slide 41 Empirical Estimation of Demand The most direct way to obtain information about demand is through interviews where consumers are asked how much of a product they would be willing to buy at a given price. Problem. Consumers may lack information or interest, or be mislead by the interviewer. Lecture 4 Slide 42 Empirical Estimation of Demand In direct marketing experiments, actual sales offers are posed to potential customers and the responses of customers are observed. Lecture 4 Slide 43 Empirical Estimation of Demand The Statistical Approach to Demand Estimation Properly applied, the statistical approach to demand estimation can enable one to sort out the effects of variables on the quantity demanded of a product. “Least-squares” regression is one approach. Lecture 4 Slide 44 Demand Data for Raspberries Year Quantity (Q) 1988 1989 1990 1991 1992 1993 1994 1995 1996 Lecture 4 4 7 8 13 16 15 19 20 22 Price (P) 24 20 17 17 10 15 12 9 5 Income(I) 10 10 10 17 17 17 20 20 20 Slide 45 Estimating Demand Price 25 D represents demand if only P determines demand and then from the data: Q=28.2-1.00P 20 15 d1 10 d2 5 D d3 0 Lecture 4 5 10 15 20 25 Quantity Slide 46 Estimating Demand Adjusting for changes in income Price 25 d1, d2, d3 represent the demand for each income level. Including income in the demand equation: Q = a - bP + cI or Q = 8.08 - .49P + .81I 20 15 d1 10 d2 5 D d3 0 Lecture 4 5 10 15 20 25 Quantity Slide 47 Empirical Estimation of Demand Estimating Elasticities Assuming: Price & income elasticity are constant The isoelastic demand = log(Q) a b log( P) c log( I ) The slope, -b = price elasticity of demand Constant, Lecture 4 c = income elasticity Slide 48 Empirical Estimation of Demand Estimating Elasticities Using the Raspberry data: log(Q) 0.81 2.4 log( P) 1.46 log( I ) Price elasticity = -0.24 (Inelastic) Income Lecture 4 elasticity = 1.46 Slide 49 Empirical Estimation of Demand Estimating Complements and Substitutes log(Q) a b log( P) b2 log P2 c log( I ) Substitutes: b2 is positive Complements: b2 is negative Lecture 4 Slide 50 Summary Individual consumers’ demand curves for a commodity can be derived from information about their tastes for all goods and services and from their budget constraints. Engel curves describe the relationship between the quantity of a good consumed and income. Lecture 4 Slide 51 Summary Two goods are substitutes if an increase in the price of one good leads to an increase in the quantity demanded of the other. They are complements if the quantity demanded of the other declines. The market demand curve is the horizontal summation of the individual demand curves for all consumers. Lecture 4 Slide 52