Micro Megaguide Chapter 5 Complete

7/26/2019 Micro Megaguide Chapter 5 Complete

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Chapter 5Individual and Market Demand

5.1How income changes affect an individuals consumption choices

Normal and inferior goods

Normal Gooda good for which consumption rises when income rises.

Inferior Good- a good for which consumption decreases when income decreases


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Income Elasticities and Types of Goods

Income elasticityThe percentage changed in the quantity consumed of a good in response to a %

change in income.

Income Elasticity-

Necessity goodA normal good for which income elasticity is between zero and 1.Socks, salt,

toothpaste

-

Slower-than-income quantity growth - share of consumers budget declines

Luxury Gooda good with an income elasticity greater than 1jewelry, beach homes, yachts

-

Quantities consumed grow faster than income

The Income Expansion Path

Income Expansion PathA curve that connects a consumers optimal bundles at each income level

Cant graph for both inferior goods would cause less consumption of both goods and consumer would

not be spending their entire income(violates a condition)


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The Engel Curve

Income Expansion curve is useful, but has two important weaknesses

1.

Only has two axes, can only look at two goods at a time.

2.

Although we can see consumption quantities- we cant see directly the income level that a

particular point on the curve corresponds to

Engel CurveA curve that shows the relationship between the quantities of a good consumed

and a consumers income.

- Much better for investigating the impact of income on the consumption of one particular

good.

5.2How price changes affect consumption choices

Up to this point, we know that demand curves slope downward because diminishing marginal utility

implies that consumers willingness to pay falls as quantities rise.


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Deriving a Demand Curve


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Shifts in the Demand Curve

Another way to think about it is that, because the marginal rate of substitution (MRS) equals

MUG/MUMD, this preference shift shrinks Carolines marginal utility of grape juice at any

quantity, reducing her MRSthat is, flattening her indifference curves.

5.3Decomposing Consumer Responses to Price Changes into Income and Substitution effects

Any change in quantity demanded can be decomposed into these two effects-

1.

When the price of one good changes relative to the price of another good, consumers will want

to buy more of the good that has become relatively cheaper and less of the good that is now

relatively more expensive. Economists call this the substitution effect.

2.

A price shift changes the purchasing power of consumers incomesthe amount of goods they

can buy with a given dollar-level expenditure. If a good gets cheaper, for example, consumers

are effectively richer and can buy more of the cheaper good and other goods. If a goods price

increases, the purchasing power of consumers incomes is reduced, and they can buy fewer

goods. Economists refer to consumption changes resulting from this shift in spending power as

the income effect.


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Total effect-The total change (substitution effect + income effect) in a consumers optimal consumption

bundle as a result of a price change.

Isolating the substitution effect


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What determines the size of the substitution and income effects?

When indifference curves are highly curved, as in panel a, the MRSchanges quickly as one moves along

them. This means any given price change wont change consumption choices much,because one doesnt

need to move far along the indifference curve to change the MRSto match the new relative

prices. Thus, the substitution effect is small.


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An example of the income effect with an Inferior good


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If the income effect is large enough, however, it is possible that a reduction in the price of an inferior

good could actually lead to a net decrease in its consumption. A good that exhibits this trait is called a

Giffen good.


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Giffen GoodA good for which price and quantity demanded re positively related.

Giffen goodsare goods for which a fall in price leads the consumer to want lessof the good. That is, an

inverse relationship does not exist between price and quantity demanded and the demand curves of

Giffen goods slope up! The more expensive a Giffen good is, the higher the quantity demanded.

This seemingly paradoxical effect arises because, for Giffen goods, the substitution effect of a price

drop, which acts to increase the quantity a consumer demands of the good, is smaller than the

reduction in the desired quantity caused by the income effect. Note that this means Giffen

goods mustbe inferior goods.


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5.4 Impact of Changes in another goods price: substitutes and complements

A Change in the Price of a Substitute Good

Substitutea good that can be used in place of another good


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ComplementsA good that is purchased and used in a combination with another good

Changes in the price of a complementary good shiftthe demand curve for the other good. Changes in a

goods own price cause amove alongthe same demand curve.


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5.5 Combining Individual Demand Curves to Obtain the Market Demand Curve

.There are a few things to notice about market demand curves. First, a market demand curve will always

be to the right of any individual demand curve, because all consumers combined must consume at leastas much of a good at a given price as any single consumer does. For a similar reason, the slope of the

market demand curve must also be as flat as or flatter than any of the individual demand curves. That is,

for a given change in price, the change in quantity demanded for the market as a whole must be at least

as great as the change in quantity demanded by any individual consumer.[10] Even though the slope of

the market demand curve is always flatter than that of individual demand curves, it doesnt necessarily

imply that the elasticity of the market demand curve is higher than that of individual demand curves

(though this is often the case). This is because the elasticity doesnt just depend on the slope, but also

on the level of demand. The percentage change in prices (the denominator in the elasticity equation)

will be the same for both individuals and the market. While the change in quantity will be smaller for

individuals, the level of demand will be lower too. If the level is small enough, the percentage change inquantities for the individual can be large enough to make individual demand as or more elastic than

market demand. Finally, if the price is so high that only one consumer wants any of the good, the

individual demand curve for that consumer will lie directly on top of the market demand curve at that

price. At that point, the consumer is the market.


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Using algebra to move from individual to market demand

*Q cannot be negativedemand choke price for your cousin is greaterso at prices above 52 the

market demand curve is equal to your demand curve.

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Micro Megaguide Chapter 5 Complete