Transcript File
Individual and market demand
Outcomes
Derive individual demand curve
Effect of change in price and income on the demand
curve
Market demand curve
Consumer surplus
Effects of network externalities
CHANGES IN EQUILIBRIUM
How does the equilibrium position change if:
1. Consumer’s income change
OR
2. Price of one of the goods change
Income Effect on Consumer Equilibrium
Change in income, all prices remaining constant.
If prices of goods, tastes and preferences of the consumer
remain constant and there is a change in income, it will
directly affect consumer’s equilibrium.
A rise in the income of a consumer shifts the Budget line
to the right upward on higher IC.
A fall in the income shifts the Budget line to the left side
on lower IC.
Income Effect on Consumer Equilibrium
A rise in the Income: Consumer can buy more of
both commodities = Higher level of satisfaction and
increase in equilibrium.
A fall in the Income = Consumer buy less of both
the commodities = Lower level of satisfaction and
decrease in equilibrium.
The line which touches all the consumer equilibrium
points = Income Consumption Curve (ICC).
ICC = The consumption of two goods is affected by
change in income when prices are constant.
Income Effect on
Consumer
Equilibrium
Price Effect on Consumer Equilibrium
Price Effect = A result of change in the price of one
commodity while price of other good and income of the
consumer remain constant.
The change in demand in response to a change in price of a
commodity, other things remaining the same (Ceteris
Paribus), is called Price effect.
If we draw a line which touches all the consumer equilibrium
points so we will get Price Consumption Curve (PCC).
PCC = The consumption of good X changes, as its price
changes, remaining constant the price of good Y and the
income of the consumer.
Price Effect
on Consumer
Equilibrium
NORMAL AND INFERIOR GOODS
Normal goods = Willing and able to buy anything
with an income increases or the price decreases
Example: NEW clothing, NEW car, NEW
computer.
Inferior goods = Comparable to the normal good.
More willing to purchase as income decreases or
the price increases
Example: USED clothing, USED car, USED
computer i.e. income and quantity.
Effect on an inferior good
Engel Curves
Curve relating the quantity of a good consumed to
income.
Income and substitution effects
Price:
Consumer will buy more of cheaper good and less of
relatively more expensive good.
One good cheaper Consumer enjoy increase in real
purchasing power.
Two effects occur simultaneously
Income and
substitution
effects:
Normal Good
Substitution effect
Change in consumption of a good with a change in its
price, with the level of utility held constant.
Income effect
Change in consumption of a good resulting from an
increase in purchasing power, with relative prices held
constant.
Total effect
Total Effect (F1F2) = Substitution effect (F1E) + Income
Effect (EF2)
Income and
substitution
effects:
Inferior Goods
Special Case:
GIFFEN GOODS
Theoretically possible
(but doubted):
Good whose demand
curve slopes upward
because the negative
income effect is larger
than the substitution
effect.
Market demand curve
Discussed in Chapter 2
ELASTICITY: Recap
Inelastic demand: Quantity demanded is relatively
unresponsive to changes in price, e.g.. Gasoline
Elastic demand: Expenditure on the product decreases
as the price goes up, e.g.. Beef
Isoelastic demand: Demand curve with constant price
elasticity.
Special isoelastic demand curve: unit-elastic demand
curve -1.
Consumer Surplus
Definition: Difference between
Willing to pay for a good, and;
Amount actually paid
Calculate from the demand curve
Network externalities
Assumption: Demand for a good are independent of
one another.
However, for some goods demand depends on the
demand of other people.
Network externalities exist.
Definition:
Situation in which each individual’s demand,
depends on the purchases of other individuals
Positive or negative
Positive = Quantity of good demand by consumer
increase in response to the growth in purchases of other
consumers.
Negative = Vice versa, demand decreases
Network externalities
- The bandwagon effect
Positive network externality
Definition: Consumer wishes to possess a good in
part because others do, e.g.. Toys: Playstation, Xbox
Exploited by marketers
Network externalities
- Snob effect
Negative externality.
Definition:
Consumer wishes to own an exclusive or unique good
e.g.. Works of art, sports car
Prestige, status and exclusivity