Microecon Chapter 4

Engel Curves

Curve relating the quantity of a good consumed to income. A good can be normal up to a certain level and then become inferior: Inferior within income range over portion of Engel curve that slopes downward.

Individual demand curve

Curve relating the quantity of a good that a single consumer will buy to its price. Important properties: The level of utility that can be attained changes as we move along the curve. At every point on the demand curve, the consumer is maximizing utility satisfying the condition that the marginal rate of substitution (MRS) of good a for good b equals the ratio of the prices of a and b.

Market demand curves

Curve relating the quantity of a good that all consumers in a market will buy to its price. Features of curve: 1. The 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.

Income-consumption curve

Curve tracing the utility-maximizing combinations of two goods as a consumer's income changes. Upward sloping curve implies that an increase in income causes a shift to the right in the demand curve.

Price-consumption curve

Curve tracing the utility-maximizing combinations of two goods as the price of one changes.

Consumer surplus

Difference between what a consumer is willing to pay for a good and the amount actually paid. To calculate, find the area below the market demand curve and above the price line.

Total effect

Total effect = Substitution Effect + Income Effect Direction of substitution effect always the same: A decline in price leads to an increase in consumption of the good. Income effect can move in either direction. A good is inferior when the income effect is negative: As income rises consumption falls.

Substitution effect

The change in consumption of a good associated with a change in its price, with the level of utility held constant. Marked by a movement along an indifference curve.

Income effect

The change in consumption of a good resulting from an increase in purchasing power with relative prices held constant.

Changes in demand curve

A change in the price of a good corresponds to a movement along a demand curve. A change in income leads to a shift in the demand curve itself.

Giffen good

Good whose demand curve slopes upward because the (negative) income effect is larger than the substitution effect.

Different kinds of elasticity

Inelastic demand - (When Ep is less than 1 in absolute value) the quantity demanded is relatively unresponsive to changes in price. Elastic demand - (When Ep is greater than 1 in absolute value) total expenditure on the product decreases as the price goes up. Isoelastic demand - When the price elasticity of demand is constant all along the demand curve. - unit-elastic demand curve: a demand curve with price elasticity always equal to -1

Elasticity of demand

Measures the percentage change in the quantity demanded resulting from a 1-percent increase in price. Measures the sensitivity of quantity demanded to price. Ep = (∆Q/Q)/(∆P/P) = (P/Q)(∆Q/∆P)

Snob effect

Negative network externality in which a consumer wishes to own an exclusive or unique good.

Bandwagon effect

Positive network externality in which a consumer wishes to possess a good in part because others do.

Substitutes and Complements

Two goods are substitutes if an increase in the price of one leads to an increase in the quantity demanded of the other. Two goods are complements if an increase in the price of one good leads to a decrease in the quantity demanded of the other. Two goods are independent if a change in the price of one good has no effect on the quantity demanded of the other.

Network externality

When each individual's demand depends on the purchases of other individuals. Positive if the quantity of a good demanded by a typical consumer increases in response to the growth in purchases of other consumers.

Normal vs Inferior goods

When the income-consumption curve has a positive slope, the quantity demanded increases with income. This implies that the goods are described as normal: Consumers want to buy more of them as their income increases. If the reverse happens, then we describe the good as inferior: Consumers want to buy less of them as their income increases.