1. Individual & Market Demand Chapter 4

2. 4 main topics related to Individual & Market Demand 1. Use the Rational Choice model Derive an individual’s demand curve Construct a relationship that summarizes how individual demands vary with income

3. Individual & Market Demand 2. The total effects of a price change can be broken down into two effects: 1. Substitution Effect 2. Income Effect

4. Individual & Market Demand 3. Individual demand curves can be added to yield the demand curve for the whole market

5. Individual & Market Demand 4. Price elasticity of demand is a responsiveness measure for changes in price Income elasticity of demand measures the individual’s purchase responsiveness to small changes in income

6. Individual & Market Demand Cross-elasticity of demand measures the responsiveness of the quantity demanded of one good to the small price changes of another

7. Effects of Changes in Price: Price- Consumption Curve (PCC) Holding money, income and the prices of all other goods constant, the PCC of good X is the set of optimal bundles traced on an indifference map as the price of X varies

8. The Individual Consumer’s Demand Curve The PCC contains all the information needed to construct an individual demand curve

9. Effects of Changes in Income: The Income-Consumption Curve (ICC) Holding the prices of all goods constant, the ICC is the set of optimal bundles traced on an indifference map as money income varies

10. The Engel Curve A curve that plots the relationship between the quantity of a good consumed and income

11. Normal & Inferior Goods Normal goods have an upward sloping demand curve For inferior goods, an increase in income leads to a reduction in quantity demanded

12. Substitution Effects of a Price Change Component of the total effect Results from the associated change in the relative attractiveness of other goods

13. Income Effect of a Price Change Results from the associated change in real purchasing power The total effect of a price change is the sum of the income and substitution effects

16. Market Demand Aggregating individual demand curves The horizontal sum of individual demand curves.

17. Price Elasticity of Demand The percentage change in the quantity of a good demanded that results from a 1% change in its price

18. Price Elasticity of Demand If the price elasticity is less than -1, demand is said to be elastic If the price elasticity is between -1 and zero the good is inelastic If the price elasticity is equal to -1 the good is unit elastic

19. Price Elasticity of Demand: Three Properties Price elasticity is different at each point along a linear demand curve

20. Price Elasticity of Demand Perfectly elastic demand has infinitely high price elasticity at all points Perfectly inelastic demand is vertical, meaning that price elasticity is equal to zero at all points

21. Elasticity & Total Expenditure “If the price of a product changes, how will the total amount spent on the product be affected?” “Will more be spent on the product if we sell more units at a lower price or fewer units at a higher price?”

22. Determinants of Price Elasticity of Demand Substitution Possibilities Budget Share Direction of Income effect Time

23. The Dependence of Market Demand on Income Government policies that redistribute income from the rich to the poor: Increases demand for goods like food Decreases demand for luxury items like jewellery

24. The Dependence of Market Demand on Income Engel curves, at the market level, relate the quantity demanded to the average income level in the market

25. Income Elasticity of Demand A formal measure of the responsiveness of purchase decisions to variations in the average market income If a good has a stable Engel curve we can define its income elasticity of demand

26. Income Elasticity of Demand Income elasticities for necessities must take on a value of ε<1 Luxuries are those goods for which ε >1

27. Cross-Price Elasticity of Demand The percentage change in the quantity demanded of one good that results from a 1% change in the price of another good