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Ch 5. Demand Theory

The Effects Of Change In The Price Of A Good On Consumption Price Consumption Curve (PCC): The set of utility maximizing baskets as the price of one good varies (holding constant income and the prices of other goods).

The Effects Of Change In The Price Of A Good On Consumption (continued) Figure 5. 1. Page 137 I = 40 Py = 4 Px = 2 Px = 1

The Effect Of A Change In Income Consumption Curve (ICC): The set of utility maximizing baskets as income varies (and prices are held constant).

The Effect Of A Change In Income (continued) Figure 5. 2. Px = 2 Py = 4 I = 40 I = 68 I = 92

Engel Curve Engel curve: A curve that relates the amount of commodity purchased to the level of income, holding constant the prices of all goods. Figure 5. 3. Page 141 Px = 2 Py = 4 I = 40 I = 68 I = 92

Note: - Normal good: a good that a consumer purchases more of as income rises. - Inferior good: A good that a consumer purchases less of as income rises.

Finding A Demand Curve A consumer purchase two goods (food and clothing). U(x, y) = XY; Px; Py; I - find the demand curve? - Is the food a normal good?

Substitution Effect And Income Effect Substitution effect: the change in the amount of a good that would be consumed as the price of that good changes, holding constant all other prices and the level utility. Income effect: the change in the amount of a good that a consumer would buy as purchasing power changes, holding all prices constant.

Substitution Effect And Income Effect (continued) Figure 5. 6 Page 148 Price of food drops from Px 1 to Px 2. Price of clothing is constant.

Consumer Surplus Consumer surplus: The difference between the maximum amount a consumer is willing to pay for a good and the amount he or she must actually pay when purchasing. Figure 5. 13. Page 159

Consumer Surplus (continued) Suppose the equation Q = 40 -4 P Represents a consumer’s monthly demand curve for milk, where Q is the number of gallons of milk purchased when the price is P dollars per gallon. 1. What is the consumer surplus per month if the price of milk is \$ 3 per gallon? 2. What is the increase in consumer surplus if the price falls to \$ 2 per gallon

Market Demand Market demand curve: the horizontal sum of demand of the individual consumers. Qb(P) = 15 – 3 P, when P < 5 = 0, when P = 5 or P > 5 Qc(P) = 6 – 2 P, when P > 3 = 0, when P = 3 or P > 3 Q market (P) = ?

Homework: 5. 7. Page 180