Understand the definition of Demand. Explain the difference between Marshallian and Hicksian Demand. Be able to describe and explain the substitution and income effect in product space from a change in price.
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Understand the definition of Demand. • Explain the difference between Marshallian and Hicksian Demand. • Be able to describe and explain the substitution and income effect in product space from a change in price. • Understand how proportion of expenditure allocated to a specific good impacts the substitution and income effect. • Understand the difference between demand shifts and structural change. • Calculate Own-Price, Income and Cross-Price Elasticity of Demand. Demand Review EconS 451: Lecture # 6
Why review demand relationships? • Helps us understand market behavior! • Explains price fluctuations! • Provides a foundation for empirical research and analysis! • Equips you with necessary analytical capability to evaluate market dynamics!
Demand Review • Demand Defined: • The various quantities of a particular commodity that an individual consumer is willing and able to buy as the price varies, all other factors held constant.
Demand Review • Begins at the individual level……then summed across all individuals to the market level. Individual Attempting to Solve Max U(x1 , x2) s.t. p1x1 + p2 x2 = I
Demand Review • Marshallian Demand Max U(x1 , x2) s.t. p1x1 + p2 x2 = I • Hicksian (or Compensated) Demand Min Expenditures E(p, U) s.t. U(x1 , x2) = UF
Individual Demand Price 10 5 Demand 25 45 Quantity X
Y 100 r s U 2 t U 1 X 25 37 45 50 100 u v w Product Space
Observations • If the commodity in questions represents a large proportion of expenditures, then the income effect from a change in the price will be relatively large. • Both Income and Substitution effect usually inversely related to price changes.
Static and Dynamic Demand • Static : • Quantity movements or responses to price while all other factors are assumed constant. • Movements along a demand curve. • Dynamic: • Shifts and changes in demand that happen with the passage of time to account for changes in income, population, taste and preferences, etc. • Structural Change • Change in the shape of the demand curve due to changes in technology or information.
Graphical Changes in Demand Parallel Shift Price Shift and Structural Change Quantity
Demand Changes • Shift • Parallel shifts from changes such as income, population. • Structural Change • Changes in the parameters or functional form.
Short Run……….Long Run • Short Run : • Time period too short for complete quantity adjustment from a price change (a snapshot). • Long Run: • The time required for a complete quantity adjustment to occur in response to a “once-and-for-all” price change.
Distributed Lag Models • Refers to a delayed adjustment in quantity as a result of a price change. • And the adjustment may be spread over a period of time.
Speculative Demand • Consumer demand for current consumption • Speculative demand • Anticipated demand and uses • Future cost > current cost + all storage costs • Commodity market financial investment • “open interest” • Current market price impacted by current and expected events.
Primary and Derived Demand Price Pr Pd Primary Demand Derived Demand Quantity
Own-Price Elasticity of Demand • Relates changes in the price of the commodity back to the changes in quantity demanded. • Defined at a point along the demand curve. • At the average • Arc formula • Assuming Q = f(P)
Own-Price Elasticity of Demand Range • Elastic • Unitary Elasticity • Inelastic • Revenue and elasticity • TR = P(Q)
Income Elasticity of Demand • Relates changes in income back to the changes in quantity demanded. • Defined at a point along the demand curve.
Income Elasticity of Demand Range • Inferior • Normal
Cross-Price Elasticity of Demand • Relates changes in the price of the jth product back to the changes in the quantity demanded for the ith product. • Defined at a point along the demand curve.
Cross-Price Elasticity of Demand Range • Independent • Substitute • Complement • Generalizations because of the “income and substitution effects” of a price change of inferior goods.
Summary Questions • Explain the difference between individual and market demand. • Describe the difference between the short and long run as it relates to market demand. • What is meant by a distributed-lag……as it relates to demand? • Explain what the own-price, income, and cross-price elasticity of demand are each measuring.