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4
Individual
and Market
Demand
Price Changes
Figure 4.1
● price-consumption curve
Curve tracing the utility-maximizing
combinations of two goods as the
price of one changes.
Chapter 4 Individual and Market Demand
Income Changes
Figure 4.2
market baskets.
In part (a), the baskets that
maximize consumer satisfaction
for various incomes (point A, $10;
B, $20; D, $30) trace out the
income-consumption curve.
The shift to the right of the
demand curve in response to the
increases in income is shown in
part (b). (Points E, G, and H
correspond to points A, B, and D,
respectively.)
Figure 4.3
An Inferior Good
An increase in a person’s
income can lead to less
consumption of one of the
Chapter 4 Individual and Market Demand
Engel Curves
● Engel curve Curve relating the quantity of a good consumed to income.
Figure 4.4
Engel Curves
Chapter 4 Individual and Market Demand
Figure 4.5
Engel Curves for U.S.
Consumers
Average per-household
expenditures on rented
dwellings, health care, and
Chapter 4 Individual and Market Demand
Recall that:
Figure 4.6
Income and Substitution Effects:
Normal Good
Substitution Effect
Income Effect
● income effect Change in consumption of a
good resulting from an increase in purchasing
power, with relative prices held constant.
Income Effect
Figure 4.7
Income and Substitution Effects:
Inferior Good
The consumer is initially at A on
budget line RS.
With a decrease in the price of food,
the consumer moves to B.
Chapter 4 Individual and Market Demand
Giffen Good
When food is an inferior good, and
when the income effect is large
enough to dominate the
substitution effect, the demand
curve will be upward-sloping.
The consumer is initially at point
A, but, after the price of food falls,
moves to B and consumes less
food.
Because the income effect EF2 is
larger than the substitution effect
F1E, the decrease in the price of
food leads to a lower quantity of
food demanded.
Figure 4.9
Effect of a Gasoline Tax with a Rebate
Figure 4.10
Summing to Obtain a Market Demand
Curve
Elasticity of Demand
(4.1)
Chapter 4 Individual and Market Demand
Inelastic Demand
When demand is inelastic (i.e. Ep is less than one in absolute value),
the quantity demanded is relatively unresponsive to changes in price.
As a result, total expenditure on the product increases when the price
increases.
Elastic Demand
When demand is elastic (Ep is greater than one in absolute value),
total expenditure on the product decreases as the price goes up.
Elasticity of Demand
Isoelastic Demand
● isoelastic demand curve Demand curve with a constant price
elasticity.
Figure 4.11
Chapter 4 Individual and Market Demand
Elasticity of Demand
Isoelastic Demand
Figure 4.12
The Aggregate Demand for
Wheat
TABLE 4.4 Price and Income Elasticities of the Demand for Rooms
Group Price Elasticity Income Elasticity
Single individuals −0.10 0.21
Chapter 4 Individual and Market Demand
Consumer Surplus
Chapter 4 Individual and Market Demand
good.
Figure 14.5
Figure 4.16
Positive Network Externality:
Bandwagon Effect
A bandwagon effect is a
Chapter 4 Individual and Market Demand
positive network
externality in which the
quantity of a good that an
individual demands grows
in response to the growth
of purchases by other
individuals.
Here, as the price of the
product falls from $30 to
$20, the bandwagon effect
causes the demand for the
good to shift to the right,
from D40 to D80.
Figure 4.17
Chapter 4 Individual and Market Demand
1996 7 20 10
1997 8 17 10
1998 13 17 17
1999 16 10 17
2000 15 15 17
2001 19 12 20
2002 20 9 20
2003 22 5 20
Estimating Demand
demand relationship.
But the same data could
describe a single
demand curve D or three
demand curves d1, d2,
and d3 that shift over
time.
Because the demand relationships discussed above are straight lines, the
effect of a change in price on quantity demanded is constant. However, the
price elasticity of demand varies with the price level. For the demand equation
Q = a – bP, the price elasticity EP is
Chapter 4 Individual and Market Demand
(4.3)
The demand for Grape Nuts is elastic (at current prices), with a price elasticity
of about −2. Income elasticity is 0.62. The cross-price elasticity is 0.14. The two
cereals are not very close substitutes.
© 2008 Prentice Hall Business Publishing • Microeconomics • Pindyck/Rubinfeld, 7e. 36 of 37
*4.6 EMPIRICAL ESTIMATION OF DEMAND
Even if profits and sales rise, the firm cannot be entirely sure that these
increases resulted from the experimental change; other factors probably
changed at the same time.