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ECON-351: Chapter 6 Notes

by: Alexander Harutunian

ECON-351: Chapter 6 Notes Econ 351

Alexander Harutunian

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These notes are from chapter 6 of the textbook. They cover the topic of Individual and Market Demand.
Microeconomics for Business
Dr. Sena Durguner
Class Notes
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This 5 page Class Notes was uploaded by Alexander Harutunian on Sunday September 18, 2016. The Class Notes belongs to Econ 351 at University of Southern California taught by Dr. Sena Durguner in Fall 2016. Since its upload, it has received 3 views. For similar materials see Microeconomics for Business in Business at University of Southern California.

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Date Created: 09/18/16
Chapter 6: Individual and Market Demand  Sections: 6.1, 6.2, 6.3, 6.4, 6.5, 6.6    Section 6.1: Individual Demand  Price Changes  When the price of a good changes, the amount demanded does not change, but the quantity  demanded/quantity consumed changes  If the price increases, the QD decreases  If the price decreases, the QD increases    The Individual Demand Curve  Price consumption curve: curve tracing the utility maximizing combinations of two goods as the  price of one changes  Individual demand curve: curve relating the quantity of a good that a single consumer will buy to  its price; has two important properties:  1. The level of utility that can be attained changes as we move along the curve. The lower  the price of the product, the higher the level of utility; higher indifference curve is  reached as the price falls; as the price falls, the consumer’s purchasing power increases  2. At every point on the demand curve, the consumer is maximizing utility by satisfying the  condition that the MRS equals the ratio of prices    Income Changes  A change in income shifts the demand curve itself, not the quantity demanded  An increase in income shifts the individual demand curve to the right, a decrease in income shifts  the individual demand curve to the left  Income­consumption curve: curve tracing the utility maximizing combinations of two goods as a  consumer’s income changes  An increase in income, with the price of all goods fixed, causes consumers to alter their choice of  market baskets; the baskets that maximize the consumer satisfaction for various incomes trace  out the income­consumption curve    Normal vs. Inferior Goods  Normal goods: consumers buy more of it as their income increases; buy less if income decreases  Income­consumption curve has positive slope  Quantity demanded increases with income  Income elasticity of demand is positive  The greater the shifts to the right of the demand curve, the larger income elasticity  Inferior goods: consumers buy less of it as their income increases; buy more if income decreases  Downward sloping income consumption curve  Quantity demanded decreases with income  Income elasticity of demand is negative    Engel Curves  Relate the quantity of a good consumed to an individual’s income  An upward sloping Engel curve applies to all normal goods  Sideways U shaped engel curve is for a good that:  Begins as a normal good while income rises  Becomes an inferior good when income rises to a greater level  Upward sloping portion is when the good is normal  Backwards sloping portion is when the good is inferior    Substitutes and Complements  Two goods are substitutes if the increase in price of one leads to increased quantity demanded of  the other  Two goods are complements if the increase in price of one leads to decreased quantity demanded  of the other  Two goods are independent if the change in price of one good has no effect on the quantity  demanded of another  Price­consumption curve can show if two goods are complements or substitutes  Upward sloping PCC means two goods are complements  Downward sloping PCC means two goods are substitutes    Section 6.2: Income and Substitution Effects  A fall in the price of a good has two effects:  1. Consumers will tend to buy more of the good that has become cheaper and less of those  goods that are now relatively more expensive (substitution effect)  2. Because one of the goods is now cheaper, consumers enjoy an increase in real purchasing  power (income effect)  Both effects normally occur simultaneously    Substitution Effect  Drop in price → substitution effect = the change in food consumption associated with a change  in the price of food, with the level of utility held constant  Substitution is marked by a movement along an indifference curve  Substitution effect can be obtained by drawing a budget line which is parallel to the new budget  line, but which is tangent to the original indifference curve (holding level of satisfaction  constant)    Income Effect  Drop in price → income effect = the change in food consumption brought about by the increase  in purchasing power, with relative prices held constant  Normal good: positive income effect; as income increases, consumers choose to buy more of it  Inferior good: negative income effect; as income increases, consumer choose to buy less of it  Income effect is rarely large enough to outweigh substitution effect  Substitution effect > income effect    A Special Case: The Giffen Good  Giffen good: a good whose demand curve slopes upward because the negative income effect is  larger than the substitution effect  Substitution effect < income effect    Section 6.3: Market Demand  Market demand curve: curve relating to the quantity of a good that all consumers in a market will  buy to its price    From Individual to Market Demand  In the graph, the market demand curve is the horizontal summation (quantity demanded) of the  demands of each consumer  1. The market demand curve will shift to the right as more consumers enter the market  2. Factors that influence the demands of many consumers will also affect market demand    Elasticity of Demand  Price elasticity of demand measures the percentage change in the quantity demanded resulting  from a 1% increase in price  Price elasticity of demand = E​  = ΔQ/Q = ( )( ΔQ )  P​ ΔP/P Q ΔP Inelastic demand: when E​  iP​< 1 in absolute value; when price increases, total expenditure  increases (expenditure not consumption)  Elastic demand: when E​  isP​ 1 in absolute value; when price increases, total expenditure  decreases (expenditure not consumption)  Isoelastic demand: when E​  isP​onstant all along the demand curve; special case when the  demand curve is unit­elastic ­ a demand curve with a price elasticity always equal to ­1    Demand  If price increases,  If price decreases,  expenditures  expenditures  Inelastic  Increase  Decrease  Unit elastic  Are unchanged  Are unchanged  Elastic  Decrease  Increase    Speculative Demand  Demand driven not by the direct benefits one obtains from owning or consuming the good but  instead by an expectation that the price of the good will increase  Profit by buying the good then reselling it when the price is higher  It is often little more than gambling    Section 6.4: Consumer Surplus  If consumers buy goods to be better off, consumer surplus shows us how much better off  Individual consumer surplus: the difference between what a consumer is willing to pay for a  good and the amount actually paid  Aggregate consumer surplus is the summation of all individual consumer surpluses    Consumer Surplus and Demand  CS is easily calculated if you know the demand curve  Consumer surplus is the area of the triangle created when a line is drawn through the market  price; the area under the demand curve, above the price, and to the left of the intersection  To find aggregate consumer surplus, we find the area of the triangle in the market demand curve      Section 6.5: Network Externalities  Network externality: situation in which each individual’s demand depends on the purchases of  other individuals    Positive Network Externality  Bandwagon effect: positive network externality in which a consumer wishes to possess a good in  part because others do    Negative Network Externality  Snob effect: negative network externality in which a consumer wishes to own an exclusive or  unique good    Section 6.6: Empirical Estimation of Demand  The Statistical Approach to Demand Estimation  Can help researchers sort out the effects of variables like income and price of other products  If price alone is the determinant, then the equation for Q​  is  d​ Q = a ­ bP  If income and price are both determinants, then the equation for Q​  is  d​ Q = a ­ bP + cI    The Form of the Demand Relationship  Bc the demand equations are linear, a change in price affects Q​  at a constad​ rate, but the E​   p (price elasticity of demand) is different for every point  Elasticity increases in magnitude as price increases and Q​  falls  d​   Interview and Experimentation Approaches to Demand Determination  One way to obtain info about demand is through interviews  Consumers are asked how much of a given product they would buy at one price  People may lack info, or want to mislead interviewers, so this method is not as reliable  In direct marketing experiments, actual sales offers are posed to potential customers  Direct experiments are real, not hypothetical, but they too have problems (expensive, different  responses, many factors might have changed) 


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