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CHAPTER 4. Individual and market demand. 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. CHANGES IN EQUILIBRIUM. How does the equilibrium position change if:

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chapter 4


Individual and market demand

  • Derive individual demand curve
  • Effect of change in price and income on the demand curve
  • Market demand curve
  • Consumer surplus
  • Effects of network externalities
changes in equilibrium

How does the equilibrium position change if:

1. Consumer’s income change


2. Price of one of the goods change

income effect on consumer equilibrium
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.

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.

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.
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.

engel curves
Engel Curves
  • Curve relating the quantity of a good consumed to income.
income and substitution effects
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
substitution effect
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)
special case giffen goods
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.
market demand curve
Market demand curve
  • Discussed in Chapter 2
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.
consumer surplus
Consumer Surplus
  • Definition: Difference between
    • Willing to pay for a good, and;
    • Amount actually paid
  • Calculate from the demand curve
network externalities
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
network externalities the bandwagon effect
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
network externalities snob effect
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