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Chapter 4 – Individual and
Market Demand.Goals:
• Generate an individual consumer’s demand curve.
* Substitution and Income Effect of a Change
in Price.
* How a change in Income affects the demand
curve.
• Generate the market demand curve from (many)
individual consumer’s demand curve.
* Price Elasticity of Demand.
Individual Consumer’s Demand
Curve. The Effect of Changes in Price.
◦ Price-Consumption Curve (PCC): Holding
everything else constant, the PCC for a good
X is the set of optimal bundles traced on an
indifference map as the price of X varies.
◦ Consider the case when the price of the good
X goes down.
Individual Consumer’s Demand
Curve. The Effect of Changes in Price.
◦ The Substitution Effect: When price of one
good increases, consumer will substitute away
from the now more expensive good.
◦ The Income Effect : When price of one good
increases, the real income that a consumer has
is also reduced.
◦ Total Effect: The sum of Substitution Effect and
Income Effect.
Income and Substitution Effect
of a Normal Good.
Income and Substitution Effects
of an Inferior Good.
Individual Consumer’s Demand
Curve.
An Increase In Price of Good X
Effects Normal Good Inferior Good
Substitution Effect - -
Income Effect - +
Total Effect - -/+
Individual Consumer’s Demand
Curve. The Effects of Changes in Income (holding
prices constant).
◦ The income consumption curve (ICC):
Ceteris paribus, in good X, Y domain, the ICC
is the set of optimal bundles traced on an
indifference map as money income varies.
◦ In Income and Quantity domain, the ICC is
referred to as the Engel Curve.
Normal Good: Upward sloping Engel Curve.
Inferior Good: Downward sloping Engel Curve.
Market Demand.
Aggregating individual demand curves.
◦ Consider the case where we have 2 individuals
in the market. Each individual has his/her own
demand for good X. Suppose
(D1): P = 10 – X1 => X1 = 10 – P.
(D2):P = 10 – 2X2 => X2 = 5 – 1/2P.
XAgg = X1 + X2 = 15 – 3/2P. => (D): P = 10 – 2/3 XAgg
Market Demand
0
2
4
6
8
10
12
0 2 4 6 8 10
(D1)
0
2
4
6
8
10
12
0 1 2 3 4 5
(D2)
0.0
2.0
4.0
6.0
8.0
10.0
12.0
0 2 4 6 8 10 12 14
D
Market Demand
Price Elasticity of Demand.
◦ A percentage change in the quantity of a good
demanded that results from a 1% change in its
own price.
◦ or
Market Demand.
Elasticity of Demand.Cases Elasticity Implication
η = 0 Perfectly Inelastic Any change in price will leave the
quantity demanded unchanged.
0 < η < 1 Inelastic Less sensitive to a change in price an
increase in price will increase total
expenditure.
η = 1 Unit Elastic A 1% change in price will result in 1%
change in quantity.
1 < η < Infinity Elastic More sensitive to a change in price a
decrease in price will increase total
expenditure.
η = Infinity Perfectly Elastic A small change in price results in 0
quantity demanded.
Market Demand.
Concept of Income Elasticity of Demand.
◦ A percentage change in the quantity of a good
demanded that results from a 1% change in
one’s income.
Q I
I Q
Market Demand
Concept of Cross Price Elasticity of
Demand.
◦ A percentage change in the quantity of a good
demanded that results from a 1% change in
another good’s price.
◦ X > 0 => Good X and Y are substitute.
◦ X < 0 => Good X and Y are complement.
X YX
Y X
Q P
P Q
Market Demand
Exercise:
◦ A hot dog vendor faces a market consisting of
30 identical individuals, each has a demand for
hot dog as:
Derive the agg. Market demand for hotdog?
If the vendor has been selling 300 hot dogs/day, how
much revenue has he been collecting?
What is the price elasticity of demand at this level
of sales?
If the vendor wants to increase his daily revenue,
should he raise or lower the price?
At what price would he max. total revenue?
160
2iq P