Transcript Individual Demand Curves

Chapter 3
Individual
Demand
Curves
Individual Demand Curves
2

This chapter studies how people change their choices when
conditions such as income or changes in the prices of goods
affect the amount that people choose to consume.

This chapter then compares the new choices with those that were
made before conditions changed

The main result of this approach is to construct an individual’s
demand curve
Demand Functions
3

If we knew a person’s preferences and all the economic forces
that affect his or her choices, we could predict how much of each
good would be chosen.

This summarizes this information in a demand function: a
representation of how quantity demanded depends on prices,
income, and preferences.
Demand Function
Quantityof X demanded d x ( PX , PY , I ; preferences)
4

The three elements that determine the quantity demanded are the
prices of X and Y, the person’s income (I), and the person’s
preferences for X and Y.

Preferences appear to the right of the semicolon because we
assume that preferences do not change during the analysis.
Homogeneous Demand Function
5

Individual demand functions are homogeneous since
quantity demanded does not change when prices and
income increase in the same proportion.

The budget constraint PXX + PYY = I is identical to the
budget constraint 2PXX + 2PYY = 2I.

Graphically the lines are the same.
Changes in Income
6

When a person’s income increase, while prices remain the same,
the quantity purchased of each good might increase.

This situation is shown in Figure 3.1 where the increase in income
is shown as the budget line shifts out from I1 to I2 to I3.

The slope of the budget lines are the same since the prices have
not changed .
FIGURE 3.1: Effect of Increasing Income on
Quantities of X and Y Chosen
Quantity of Y
per week
Y1
U1
I1
7
0
X1
Quantity of X
per week
FIGURE 3.1: Effect of Increasing Income on
Quantities of X and Y Chosen
Quantity of Y
per week
Y2
U2
Y1
U1
I1
8
0
X1 X2
I2
Quantity of X
per week
FIGURE 3.1: Effect of Increasing Income on
Quantities of X and Y Chosen
Quantity of Y
per week
Y3
Y2
U3
U2
Y1
U1
I1
9
0
X1 X2 X3
I2
I3
Quantity of X
per week
Changes in Income
10

In response to the increase in income the quantity of X purchased
increases from X1 to X2 and X3 while the quantity purchased of Y
also increases from Y1 to Y2 to Y3.

Increases in income make it possible for a person to consume
more reflected in the outward shift in the budget constraint that
allows an increase in overall utility.
Normal Goods
11

A normal good is one that is bought in greater quantities as
income increases.

If the quantity increases more rapidly than income the good is
called a luxury good as with good Y in Figure 3.1.

If the quantity increases less rapidly than income the good is
called a necessity good as with good X in Figure 3.1.
APPLICATION 3.1: Engel’s Law
12

One important generalization about consumer behavior is that the
fraction of income spent on food tends to decline as income
increases.

This finding was discovered by Prussian economists Ernst Engel
(1821-1896).

Table 1 show Engel’s data with Table 2 showing recent data for
U.S. consumers.
TABLE 1: Percentage of Total Expenditures of
Various Items in Belgian Families in 1853
Expenditure Item
Food
Clothing
Lodging, light, and fuel
Services (education, legal, health)
Comfort and recreation
Total
13
Annual Income
$225-$300 $450-$600 $750-$1000
62.0%
16.0
17.0
4.0
1.0
100.0
55.0%
18.0
17.0
7.5
2.5
100.0
50.0%
18.0
17.0
11.5
3.5
100.0
TABLE 2: Percentage of Total Expenditures
by U.S. Consumers on Various Items, 2000
Item
Food
Clothing
Housing
Other Items
Total
14
Annual Income (000)
$15 - 20
$40 - 50
$70+
15.4%
4.8
32.9
46.9
100.0
14.7%
4.7
30.4
50.2
100.0
11.4%
5.3
30.2
53.1
100.0
Inferior Goods
15

An inferior good is one that is bought in smaller quantities as
income increases.

In Figure 3.2 as income increases from I1 to I2 to I3, the
consumption of inferior good Z decreases.

Goods such as “rotgut” whiskey, potatoes, and secondhand
clothing are examples of inferior goods.
FIGURE 3.2: Indifference Curve Map
Showing Inferiority
Quantity of Y
per week
Y1
0
16
U1
Z1
I1
Quantity of Z
per week
FIGURE 3.2: Indifference Curve Map
Showing Inferiority
Quantity of Y
per week
Y2
U2
Y1
17
0
Z2 Z1
U1
I1
I2
Quantity of Z
per week
FIGURE 3.2: Indifference Curve Map
Showing Inferiority
Quantity of Y
per week
Y3
U3
Y2
U2
Y1
18
0
Z3 Z2 Z1
U1
I1
I2
I3
Quantity of Z
per week
Changes in a Good’s Price
19

A change in the price of one good causes both the slope and an
intercept of the budget line to change.

The change also involves moving to a new utility-maximizing
choice on another indifference curve with a different MRS.

The quantity demanded of the good whose price has changed
changes.
Substitution Effect
20

The part of the change in quantity demanded that is caused by
substitution of one good for another is called the substitution
effect.

This results in a movement along an indifference curve.

Consumption has to be changed to equate MRS to the new price
ratio of the two goods.
Income Effect
21

The part of the change in quantity demanded that is caused by a
change in real income is called the income effect.

The price change also changes “real” purchasing power and
consumers will move to a new indifference curve that is consistent
with this new purchasing power.
Substitution and Income Effects
from a Fall in Price
22

As shown in Figure 3.3, when the price of good X falls, the budget
line rotates out from the unchanged Y axis so that the X intercept
lies father out because the consumer can now buy more X with
the lower price.

The flatter slope means that the relative price of X to Y (PX/PY) has
fallen.
Substitution Effect from a Fall in
Price
23

The consumer was originally maximizing utility at X*, Y* in Figure
3.3.

After the fall in the price of good X, the new utility maximizing
choice is X**, Y**.

The substitution effect is the movement on the original indifference
curve to point B.
FIGURE 3.3: Income and Substitution
Effects of a Fall in Price
Quantity of Y
per week
Y*
U1
0
24
X*
Quantity of X
per week
FIGURE 3.3: Income and Substitution
Effects of a Fall in Price
Quantity of Y
per week
Old budget constraint
Y*
B
New budget constraint
U1
0
25
X*
XB
Substitution
effect
Quantity of X
per week
FIGURE 3.3: Income and Substitution
Effects of a Fall in Price
Quantity of Y
per week
Old budget constraint
Y**
Y*
U2
B
New budget constraint
U1
0
26
X*
XB X**
Substitution Income
effect
effect
Total increase in X
Quantity of X
per week
Substitution Effect from a Fall in
Price
27

If the individual had to stay on the U1 with the new price ratio, the
consumer would choose B since that is the point where the MRS
is equal to the slope of the new budget line (shown by the dashed
line).

Staying on the same indifference curve is the same as holding
“real” income constant.

The consumer buys more good X.
Income Effect
28

The movement from point B to X**, Y** results from the increase in
purchasing power.

Because PX falls but nominal income (I) remains the same, the
individual’s “real” income increases so that he or she can be on
utility level U3.

The consumer buys more good X.
The Effects Combined
29

Using the hamburger-soft drink example from Chapter 2, suppose
the price of soft drinks falls from $.50 to $.25.

Previously the consumer could purchase up to 20 soft drinks, but
now he or she can purchase up to 40.

This price decrease shifts the budget line outward and increases
utility.
The Effects Combined
30

If the consumer bought his or her previous choice it would now
cost $7.50 so that $2.50 would be unspent.

If the individual stayed on the old indifference curve he or she
would equate MRS to the new price ratio (consuming 1 hamburger
and 4 soft drinks).

This move is the substitution effect.
The Effects Combined
31

Even with constant real income the consumer will buy more soft
drinks since the opportunity cost of eating a burger in terms of the
soft drinks forgone is now higher.

Since real income has increased the person will choose to buy
more soft drinks so long as soft drinks are a normal good.
Substitution and Income Effects
from an Increase in Price
32

An increase in PX will shift the budget line in as shown in Figure
3.4.

The substitution effect, holding “real” income constant, is the move
on U2 from X*, Y* to point B.

Because the higher price causes purchasing power to decrease,
the movement from B to X**, Y** is the income effect.
FIGURE 3.4: Income and Substitution
Effects of an Increase in Price
Quantity of Y
per week
U2
New budget constraint
Y*
Old budget constraint
0
33
X*
Quantity of X
per week
FIGURE 3.4: Income and Substitution
Effects of an Increase in Price
Quantity of Y
per week
U2
U1
B
New budget constraint
Y*
Old budget constraint
0
34
XB
X*
Quantity of X
Substitution per week
effect
FIGURE 3.4: Income and Substitution
Effects of an Increase in Price
Quantity of Y
per week
U2
U1
B
Y**
New budget constraint
Y*
Old budget constraint
0
35
X** XB
X*
Income Substitution
effect
effect
Total reduction
in X
Quantity of X
per week
Substitution and Income Effects
from an Increase in Price

36
In Figure 3.4, both the substitution and income effects cause the
individual to purchase less soft drinks do to the higher price of soft
drinks.
Substitution and Income Effects for
a Normal Good: Summary
37

As shown in Figures 3.3 and 3.4, the substitution and income
effects work in the same direction with a normal good.

When the price falls, both the substitution and income effects
result in more purchased.

When the price increases, both the substitution and income
effects result in less purchased.
Substitution and Income Effects for
a Normal Good: Summary
38

This provides the rational for drawing downward sloping demand
curves.

This also helps to determine the steepness of the demand curve.

If either the substitution or income effects are large, the change in
quantity demanded will be large with a given price change.
Substitution and Income Effects for
a Normal Good: Summary
39

If the substitution and income effects are small, the effect of a
given price change in the quantity demanded will also be small.

This kind of analysis also offers a number of insights about some
commonly used economic statistics.
APPLICATION 3.2: The Consumer Price
Index and Its Biases
40

The Bureau of Labor Statistics monthly calculates the Consumer
Price Index (CPI) which is a principal measure of inflation in the
U.S..

To construct the CPI, a typical market basket of commodities
purchased by consumers in the base year (currently 1982) is
calculated.
APPLICATION 3.2: The Consumer Price
Index and Its Biases
41

The ratio of the current cost of the basket to the base year price is
the measure of the value of the CPI.

The rate of change in the CPI between two periods is the reported
rate of inflation.
An Algebraic Example

Suppose the 1982 typical market basket contained X82 of good X
and Y82 of good Y.

The prices of these goods are PX82 and PY82 .

The cost of this bundle in the 1982 base year would be written as
Cost of bundle in 1982 
B 82  PX82  X 82  PY82  Y 82 .
42
An Algebraic Example

To compute the cost of the same bundle of goods in, say 2002,
requires that we compute the cost of the bundle using current
02
02
prices
( PX , PY )
Cost of bundle in 2002 
B  P  X 82  P  Y82 .
02
43
02
X
02
Y
An Algebraic Example

The CPI is defined as the ratio of the costs of these two market
baskets
B 02
CPI(for2002) 82 .
B

44
If the basket cost $100 in 1982 prices and $180 in 2002, the value
of the CPI would be 1.80 and with a measured 80 percent
increase in prices over the 20 year period.
Substitution Bias in the CPI
45

The CPI does not take into account the real possibility that
consumers would substitute among commodities because of
changes in relative prices.

In Figure 1, the typical individual is initially consuming X82, Y82
maximizing utility on U1 with 1982 constraint I.
FIGURE 1: Substitution Bias of the
Consumer Price Index
Quantity of
Y per year
Y82
I
0
46
X82
U1
I”
I’
Quantity of
X per year
Substitution Bias in the CPI
47

Suppose the 2002 relative prices change so that PX/PY falls.

The cost of the 1982 bundle in terms of 2002 prices is reflected in
the constraint I’ which is flatter and goes though the 1982 bundle.

The consumer would substitute X for Y and stay on U1 on budget
line I’’.
Substitution Bias in the CPI
48

Since I’’ is inside I’ (which is used to compute the CPI), the CPI
tends to overstate the inflation rate.

Unfortunately, adjusting the CPI to take such substitution into
account is difficult because it would require that we know the utility
function of the typical consumer.
New Product Bias in the CPI
49

New products typically experience sharp declines in prices and
rapidly grow in rates of acceptance.

If the CPI does not include these new products, this source of
welfare increase is omitted.

The CPI basket is revised but not rapidly enough to eliminate this
bias.
Outlet Bias in the CPI
50

The typical basket is bought at the same retail outlets every month.

This method can omit the benefits of sales or other bargains.

The CPI does not currently take such price-reducing strategies
and thus tends to overstate inflation.
Consequences of the CPI Biases
51

Measuring and correcting for these biases is not an easy task.

The CPI is such a widely used measure of inflation that any
change becomes a hot political issue.

However, there is a general agreement that the CPI overstates
inflation by as much as 0.75 to 1.0 percent per year.
Consequences of the CPI Biases
52

Politicians have proposed caps on Cost of Living Adjustments
(COLAs) tied to the CPI on government programs, but none have
yet been enacted.

However, the private sector has adjusted so that few private
COLAs provide full offsets to inflation measured by the CPI.
Substitution and Income Effects for
Inferior Goods
53

With an inferior good, the substitution effect and the income
effects work in opposite directions.

The substitution effect results in decreased consumption for a
price increase and increased consumption for a price decrease.
Substitution and Income Effects for
Inferior Goods
54

The income effect results in increased consumption for a price
increase and decreased consumption for a price decrease.

Figure 3.5 shows the two effects for an increase in PX.

The substitution effect, holding real income constant, is shown by
the move from X*, Y* to point B both on U2.
FIGURE 3.5: Income and Substitution
Effects for an Inferior Good
Quantity of Y
per week
Y*
U2
Old budget constraint
55
0
X*
Quantity of X
per week
FIGURE 3.5: Income and Substitution
Effects for an Inferior Good
Quantity of Y
per week
B
New budget constraint
Y*
U2
Old budget constraint
Y**
56
0
U1
X*
Quantity of X
FIGURE 3.5: Income and Substitution
Effects for an Inferior Good
Quantity of Y
per week
B
New budget constraint
Y*
U2
Old budget constraint
Y**
Xb
57
0
X**
U1
X*
Quantity of X
Substitution and Income Effects for
Inferior Goods
58

The income effect reflects the reduced purchasing power due to
the price increase.

Since X is an inferior good, the decrease in income results in an
increase in the consumption of X shown by the move from point B
on U1 to the new utility maximizing point X**, Y** on U1.
Substitution and Income Effects for
Inferior Goods
59

Since X** is less than X* the price increase in X results in a
decrease in the consumption of X.

This occurs because the substitution effect, in this example, is
bigger than the income effect.

Thus, if the substitution effect dominates, the demand curve is
negatively sloped.
Giffen’s Paradox
60

If the income effect of a price change is strong enough with an
inferior good, it is possible for the quantity demanded to change in
the same direction as the price change.

Legend has it that this phenomenon was observed by English
economist Robert Giffen.
Giffen’s Paradox
61

When the price of potatoes rose in Ireland the consumption of
potatoes also increased.

Potatoes were not only an inferior good but constituted the source
of a large portion of Irish people’s income.

The situation I which an increase in a good’s price leads people to
consume more of the good is called Giffen’s paradox.
FIGURE 3.5: Income and Substitution
Effects for an Inferior Good
Quantity of Y
per week
B
New budget constraint
Y*
U2
Old budget constraint
Y**
Xb
62
0
X**
U1
X*
Quantity of X
FIGURE 3.5: Income and Substitution
Effects for an Inferior Good
Quantity of Y
per week
B
New budget constraint
Y*
U2
Old budget constraint
Y**
Xb
63
0
X**
U1
X*
Quantity of X
FIGURE 3.5: Income and Substitution
Effects for a Giffen Good
Quantity of Y
per week
New budget constraint
B
Y*
U2
Old budget constraint
Y**
64
0
Xb
U1
X* X**
Quantity of X
The Lump Sum Principle
65

The “lump-sum principle” hold that taxes that are imposed on
general purchasing power will have a smaller welfare costs than
will taxes imposed on a narrow selection of commodities.

Consider Figure 3.6 where the individual initially has I dollars to
spend and chooses to consume X* and Y* yielding U3 utility.
FIGURE 3.6: The Lump-Sum Principle
Quantity of Y
I
Y*
U3
66
X*
Quantity of X
per week
The Lump Sum Principle
67

A tax on only good X raises its price resulting in budget constraint
I’ and consumption reduced to X1, Y1 and utility level U1.

A general income tax that generates the same total tax revenue is
represented by budget constraint I’’ that goes though X1, Y1.
FIGURE 3.6: The Lump-Sum Principle
Quantity of Y
I
Y1
Y*
Y2
68
I’
U3
X1
X*
U1
Quantity of X
per week
FIGURE 3.6: The Lump-Sum Principle
Quantity of Y
I
Y1
Y*
Y2
I’
I”
U3
U2
69
X1
X2 X*
U1
Quantity of X
per week
The Lump Sum Principle
70

The utility maximizing choice on I’’ is X2, Y2 yielding utility level U2.

The lump-sum general income tax generates the same amount of
tax revenue but leaves the consumer on a higher utility level (U2)
than the utility level associated with the tax only on good X (U1).
The Lump Sum Principle

The intuitive explanation of the lump-sum principle is that a singlecommodity tax affects people in two ways:
–
–

71
it reduces their purchasing power,
it directs consumption away from the good being taxed.
The lump-sum tax only has the first of these two effects.
Generalizations of the Lump-Sum
Principle
72

The utility lass associated with the need to collect a certain
amount of tax revenue will be minimized by taxing goods for which
the substitution effect is small.

Even though the tax will reduce purchasing power, it will minimize
the impact of directing consumption away from the good being
taxed.
APPLICATION 3.3: Wouldn’t Cash Be a
Better Way to Help Poor People?
73

The lump-sum principle suggests that the trends in expanding inkind programs may be unfortunate

These programs do not generate as much welfare for people as
would the spending of the same funds in a cash program
APPLICATION 3.3: Wouldn’t Cash Be a
Better Way to Help Poor People?
74

In Figure 1 a subsidy on good X (constraint I’) raises utility to
U2

For the same funds, an income grant (I’’) raises utility to U3
FIGURE 1: The Superiority of an
Income Grant
Y per
period
I’’
U3
B
I
I’
U2
U1
X per period
75
Changes in the Price of Another
Good
76

When the price of one good changes, it usually has an
effect on the demand for the other good.

The decrease in the price of X (a normal good) caused
both an income and substitution effect that caused an
increase in the quantity demanded of X.
Income and Substitution Effects of a
Fall in Price
Quantity of Y
per week
Old budget constraint
Y**
Y*
U2
B
YB
New budget constraint
U1
0
77
X*
XB X**
Substitution Income
effect
effect
Total increase in X
Quantity of X
per week
Changes in the Price of Another
Good
78

In addition, the substitution effect caused a decrease in
the demand for good Y as the consumer substituted
good X for good Y.

However, the increase in purchasing power brought
about by the price decrease causes an increase in
the demand for good Y (also a normal good).
Changes in the Price of Another
Good
79

Since, in this case, the income effect had a dominant
effect on good Y, the consumption of Y increased due
to a decrease in the price of good X.

With flatter indifference curves as shown in Figure
3.7, the situation is reversed.

A decrease in the price of good X causes a decrease
in good Y, as before.
FIGURE 3.7: Effect on the Demand for Good Y
of a Decrease in the Price of Good X
Quantity of Y
per week
Old budget constraint
Y*
U1
80
0
X*
Quantity of X
per week
FIGURE 3.7: Effect on the Demand for Good
Y of a Decrease in the Price of Good X
Quantity of Y
per week
Old budget constraint
A
Y*
B
New budget constraint
U2
U1
81
0
X*
Quantity of X
per week
FIGURE 3.7: Effect on the Demand for Good
Y of a Decrease in the Price of Good X
Quantity of Y
per week
Old budget constraint
A
Y*
Y**
B
C
New budget constraint
YB
U2
U1
82
0
X*
X**
Quantity of X
per week
Substitutes
83

Substitutes are goods that are used for essentially the
same purpose.

Two goods such that if the price of one increases, the
demand for the other rises are substitutes.

If the price of one good decreases and the demand for
the other good decreases, they are also substitutes.
Complements
84

Complements are goods that go together in the sense
that people will increase their use of both goods
simultaneously.

Two goods are complements if an increase in the
price of one causes a decrease in the quantity
demanded of the other or a decrease in the price of
one good causes an increase in the demand for the
other.
APPLICATION 3.4: Why Are So Many
“Trucks” on the Road?




85
In the 1990s, virtually all new vehicle registrations were trucks, mostly
SUVs
Sharp decline in real gasoline prices
– In 1980s, gas cost $1.5 per gallon
– In 1999, it cost $1.1 per gallon
– Adjusted for inflation, it is a fall of 40% in real terms
– Opportunity costs of operating trucks has thus decreased, causing
substitution effect
Regulation: Corporate Average Fuel Economy standards did not cover
SUVs
By September 2005, 1 gallon of gas cost $3.00
– Sales of large SUVs slumped in 2004-2005
– By 2005 the CAFE standards started to include SUVs as well
Construction of Individual Demand
Curves
86

An individual demand curve is a graphic relationship
between the price of a good and the quantity of it
demanded by a person holding all other factors
(preferences, the prices of other goods, and income)
constant.

Demand curves limit the study to the relationship
between the quantity demanded and changes in the
own price of the good.
FIGURE 3.8: Construction of an
Individual’s Demand Curve
Quantity of Y
per week
Budget constraint for9P
X
U1
0
X’
Quantity of X
per week
(a) Individual’s indifference curve map
Price
P’X
87
0
X’
Quantity of X
per week
(b) Demand curve
FIGURE 3.9: Construction of an
Individual’s Demand Curve
Quantity of Y
per week
Budget constraint for P’X
Budget constraint for P’’X
U2
U1
0
X’
X”
X’”
Quantity of X
per week
(a) Individual’s indifference curve map
Price
P’X
P’’X
88
0
X’
X”
Quantity of X
per week
(b) Demand curve
FIGURE 3.8: Construction of an
Individual’s Demand Curve
Quantity of Y
per week
Budget constraint for P’X
Budget constraint for P’’X
Budget constraint for P’’’X
U3
U2
U1
0
X’
X”
X’”
Quantity of X
per week
(a) Individual’s indifference curve map
Price
P9
X
P0
X
PX
89
0
X’
X”
X’”
(b) Demand curve
Quantity of X
per week
FIGURE 3.8: Construction of an
Individual’s Demand Curve
Quantity of Y
per week
Budget constraint for P’X
Budget constraint for P’’X
Budget constraint for P’’’X
U3
U2
U1
0
X’
X”
X’”
Quantity of X
per week
(a) Individual’s indifference curve map
Price
P9
X
P0
X
PX
90
d
0
X’
X”
X
X’”
(b) Demand curve
Quantity of X
per week
Substitutes and Flat Demand

If a good, say X, has close substitutes, a increase in its
price will cause a large decrease in the quantity
demanded as the substitution effect will be large.
–
91
The demand curve for a type of breakfast cereal will likely be
relatively flat due to the strong substitution effect.
Lack of Substitutes and
Steep Demand

If the good has few substitutes, the substitution effect
of a price increase or decrease will be small and the
demand curve will be relatively steep.
–
92
Water is an example of a good with few substitutes.
Special Case: Food
93

Food has no substitutes so it might be thought that no change in
consumption would occur with a price increase.

But food constitutes a large part of an individual’s budget so
that price changes will cause relatively larger effects on the
quantity demanded that might be thought due to the income
effect.
FIGURE 3.9: Shifts in Individual’s
Demand Curve
PX
PX
P1
P1
P1
0
X1
(a)
94
PX
X2
X
0
X1 X2
(b)
X
0
X2
X1
(c)
X
FIGURE 3.10: Shifts in Individual’s
Demand Curve
PX
PX
P1
P1
P1
0
X1
X2
(a)
Normal Good
95
PX
X
0
X1 X2
X
(b)
Good X is a substitute
with Y, and the price
of Y increases
0
X2
X1
X
(c)
Good X is a
complement to Y, and
the price of Y increases
Shifts in an Individual’s Demand
Curve
96

Changes in preferences can also shift demand curves.

Demand could shift rightward as a result for an
increased preference for cold drinks when a sudden
hot spell occurs.

Increased environmental consciousness during the
1980’s and 1990s increased the demand for recycling
and organic food.
APPLICATION 3.5: Fads, Seasons, and
Health Scares

Fads (bandwagon effects)
–
–
–

Seasonality
–
–
97
Widespread use causes additional demand
When saturation point is reached, demand rapidly dwindles
Impossible to predict which products will catch on
Easy to predict seasonal demand: Christmas trees, turkeys for
Thanksgiving etc
Cod in high demand during Lent: Catholic requirements on
dietary restrictions
Health Scares

Smoking reduction in the US after the surgeon general’s report in 1964

Cholesterol: decline in demand for beef and dairy products, also eggs

1982 Tylenol accident
–
–
98
Cyanide tablets inserted in a few Tylenol bottles
Dramatic drop in demand followed for Tylenol (50%)

1988: cyanide injection in Chilean grapes

1993: study on fat content in Chinese food, Chinese restaurants suffered

Krispy Kreme stock in 2000, 1997 European demand for US beef
Be Careful in Using Terminology
99

A movement downward along a stationary demand curve in
response to a fall in price is called an increase in quantity
demanded while a rise in the price of the good results in a
decrease in quantity demanded.

A rightward shift in a demand curve is called an increase in
demand while a leftward shift is a decrease in demand.
Consumer Surplus
100

The extra value individuals receive from consuming a good over
what they pay for it is called consumer surplus.

Consumer surplus is also what people would be willing to pay for
the right to consume a good at its current price.

This concept is used to study the welfare effects of price changes.
Consumer Surplus
101

In graphical terms, consumer surplus is
given by the area below the demand curve
and above the market price.

In Figure 3.11, total consumer surplus is
given by area AEB ($80).
FIGURE 3.11: Consumer Surplus from
T-Shirt Demand Price ($/shirt)
Price
($/shirt)
15 A
11
9
E
B
102
d
10
15
20
Quantity
(shirts)
Consumer Surplus and Utility

103
Figure 3.12 illustrates the connection between
consumer surplus and utility
FIGURE 3.11: Consumer Surplus
and Utility
Other Goods
A
Initially, the person is at E with utility U1.
He or she would need to be compensated by amount AB in
other goods to get U1 if T-shirts were not available.
B
The individual would be willing to pay BC for
the right to consume T-shirts rather than
spending I only on other goods.
C
E
U1
I
U0
Both distance AB and BC
approximate
the consumer surplus area
104
I’
20
Quantity
(shirts)
Application 3.6: Valuing New
Goods
Price
Only the point E is known right after the introduction of a new product
Consumer surplus from the
introduction of a new product
*
PNewGood
105
E
Economists developed methodologies to
determine the tangency to an indifference
curve that is not observed!
New Good
New Goods
• Cell Phones
 Gains estimated to be $50 billion
 Not entered into CPI until after 15 years after introduction
• Minivans introduced in the US in the 1980s
 Gains of $3 billion over 1984-1988
 Active competition among minivan suppliers contributed to this
welfare increase
106