Presentation on theme: "Introduction to microeconomics Demand relationships Chapter 4."— Presentation transcript:
Introduction to microeconomics Demand relationships Chapter 4
Learning Goals Understand the nature of demand Identify optimum spending for a good in the face of a budget constraint Define the price elasticity of demand Describe the effects of a change in price and income (substitution and income effects) Calculating market demand Define income and cross-price elasticity
Diminishing marginal utility – As the consumption of a good or service increases, the additional utility gained from an extra unit of the commodity tends to decline. – Based on the cost-benefit principle, you continue to order cones as long as the marginal utility from an additional cone is greater or equal to zero. – This assumes no budget constraint or any other good (substitute – chocolate cake) or complement (apple pie)
A demand curve emerges from constrained choices If income rises from $10 to $14 per week, then …? – Extra income stimulates demand by enlarging the set of affordable combinations. If the price of cones rises to $2 rather than $1, then …? – At $1 per cone, marginal utility per dollar is 8 utils/dollar and you buy 4 cones/week. – At $2 per cone, marginal utility per dollar is 4 utils/dollar, you only buy 1 cone/week. By applying the rational spending rule to price changes, a demand curve emerges
Private good (consumption) Total market demand for a private good is the horizontal sum of individual demand. Utility for the consumer is derived solely from his/her personal consumption Private goods involve no sharing of utility (or disutility) among consumers – The smell of tuna on Smiths breath does not repel Wong – Wong is not overjoyed at finding a fellow tuna eater – Singh does not worry that Smith and Wong are eating an endangered species
Will a higher tax on cigarettes curb teenage smoking? Peer influence is the most important determinants of teen smoking. Most teenagers have small disposable incomes, cigarettes are usually large share of a teenage smokers budget. The price elasticity of demand for teens is likely to be fairly high Therefore: A higher tax should make smoking less affordable for some teenagers. How does this apply to hard drugs? Are these price elastic or inelastic? What does a company do to reduce the elasticity of demand for its products? What does government do to increase the price elasticity of demand for cigarettes? View notes page
The strange story of the Giffen good Giffen good: people consume more as the price rises, apparently violating the law of demand. In most cases, substitution dominates demand – price rises lead to reductions in quantity demanded For a Giffen good, income effects dominate – price rises reduce effective income, and in certain cases where the good is a necessity (staple foods for low income families) Example: If the price of Kraft dinner rises, a low income family experiences a loss of effective income, and to maintain calories, cuts back on the consumption more expensive goods. All Giffen goods are inferior goods but not all inferior goods are Giffen goods. Why not? As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it. Source: A. Marshall, Principles of Economics, 3 rd ed.
Experience, credence, post-experience and Veblen goods Experience good: A good whose value can only be determined on consumption (Example: restaurant meal) Search Good: A good whose value can be determined in advance of consumption (Example: computer) Credence goods: Goods that are hard to assess even on consumption (repairs, medical treatment, vitamin supplements…) Veblen goods: Goods consumed as status symbols (a form of luxury good).