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: 2.

1. Consumer’s income change OR 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.

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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  purchasing power.

Consumer enjoy increase in real  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