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CHAPTER 4

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  1. CHAPTER 4 Individual and market demand

  2. 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

  3. CHANGES IN EQUILIBRIUM How does the equilibrium position change if: 1. Consumer’s income change OR 2. Price of one of the goods change

  4. 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.

  5. 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.

  6. Income Effect on Consumer Equilibrium

  7. 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.

  8. Price Effect on Consumer Equilibrium

  9. 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.

  10. Effect on an inferior good

  11. Engel Curves • Curve relating the quantity of a good consumed to income.

  12. 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

  13. Income and substitution effects: Normal Good

  14. 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)

  15. Income and substitution effects: Inferior Goods

  16. 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.

  17. Market demand curve • Discussed in Chapter 2

  18. 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.

  19. Consumer Surplus • Definition: Difference between • Willing to pay for a good, and; • Amount actually paid • Calculate from the demand curve

  20. 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

  21. 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

  22. 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

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