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Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good

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Microeconomics ­ECO402
VU
Lesson 10
Review of Consumer Equilibrium
Consumer Preferences
Budget Constraint
Consumer Choices
INDIVIDUAL DEMAND
Price Changes
­ Using the figures developed in the previous chapter, the impact of a change in the price
of food can be illustrated using indifference curves.
Effect of a Price Change
Clothing
Assume:
(units
·I = $20
per
1
month)
·P = $2
C
A
6
U1
Three separate
D
5
B
indifference curves
are tangent to
U3
4
each budget line.
U2
Food (units
per month)
4
12
20
Effect of a Price Change
The price-consumption
Clothing
curve traces out the
(units per
utility maximizing
month)
market basket for the
various prices for food.
6
A
Price-Consumption Curve
U1
D
5
B
U3
4
U2
Food (units
4
20
12
per month)
47
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Microeconomics ­ECO402
VU
Effect of a Price Change
Price
of Food
Individual Demand relates
E
the quantity of a good that
$2.00
a consumer will buy to the
price of that good.
G
$1.00
Demand Curve
$.50
H
Food (units
4
12
20
per month)
Individual Demand
The Individual Demand Curve
­  Two Important Properties of Demand Curves
­  1) The level of utility that can be attained changes as we move along the curve.
­  2) At every point on the demand curve, the consumer is maximizing utility by satisfying
the condition that the MRS of food for clothing equals the ratio of the prices of food and
clothing.
Effect of a Price Change
When the price falls: Pf /Pc & MRS also fall
Price
of Food
E
$2.00
·E: P /P = 2/2 = 1 = MRS
f
c
·G: P /P = 1/2 = .5 = MRS
G
$1.00
f
c
·H:P /P = .5/2 = .25 = MRS
Demand Curve
f
c
$.50
H
Food (units
12
4
20
per month)
Individual Demand
Income Changes
­ Using the figures developed in the previous chapter, the impact of a change in the
income can be illustrated using indifference curves.
48
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Microeconomics ­ECO402
VU
Effects of Income Changes
Clothing
Assume: Pf = $1
(units per
Pc = $2
month)
I = $10,
$20, $30
Income-Consumption
Curve
7
D
An increase in income,
U3
with the prices fixed,
5
U2
causes consumers to alter
B
their choice of
3
U1
market basket.
A
Food (units
per month)
16
10
4
Effects of Income Changes
Price
An increase in income,
of
from $10 to $20 to $30,
food
with the prices fixed,
shifts the consumer's
demand curve to the right.
E
H
G
$100
D3
D2
D1
Food (units
10
4
16
per month)
­  The income-consumption curve traces out the utility-maximizing combinations of food
and clothing associated with every income level.
­ An increase in income shifts the budget line to the right, increasing consumption along
the income-consumption curve.
­ Simultaneously, the increase in income shifts the demand curve to the right.
Normal Good vs. Inferior Good
­  Income Changes
·  When the income-consumption curve has a positive slope:
­The quantity demanded increases with income.
­The income elasticity of demand is positive.
­The good is a normal good.
·  When the income-consumption curve has a negative slope:
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Microeconomics ­ECO402
VU
­The quantity demanded decreases with income.
­The income elasticity of demand is negative.
­The good is an inferior good.
An Inferior Good
Coffee 15
(units per
Income-Consumption
month)
Curve
Both Tea
and Coffee behave
C
as a normal good,
between A and B...
10
U3
...but Tea
becomes an inferior
good when the income
B
5
consumption curve
bends backward
between B and C.
U2
A
U1
Tea
30 (units per month)
5
10
20
Engel Curves
Engel Curves
­Engel curves relate the quantity of good consumed to income.
­If the good is a normal good, the Engel curve is upward sloping.
­If the good is an inferior good, the Engel curve is downward sloping.
Income
Income
($ per
30
30
($ per
month)
month)
Inferior
Engel curves slope
Engel curves
backward bending
slope
20
20
for inferior goods.
upward for
normal
goods.
Normal
10
10
Food (units
Food (units
per month)
0
16
4
8
12
per month)
0
16
4
8
12
50
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Microeconomics ­ECO402
VU
Consumer Expenditures in US
Income Group (1997 $)
Expenditure
Less than 1,000- 20,000- 30,000- 40,000- 50,000-  70,000-
($) on
$10,000 19,000 29,000 39,000 49,000  69,000  and above
Entertainment
700
947
1274
1514
2054
2654
4300
Owned Res.
1116
1725
253
3243
4454
5793
9898
Rented Res.
1957
2170
2371
2536
2137
1540
1266
Health Care
1031
1697
1918
820
2052
2214
2642
Food
656
3385
4109 4888
5429
6220
8279
Clothing
859
978
1363 1772
1778
2614
3442
Individual Demand
Substitutes and Complements
1) Two goods are considered substitutes if an increase (decrease) in the price of one leads to
an increase (decrease) in the quantity demanded of the other.
·e.g. movie tickets and video rentals
2) Two goods are considered complements if an increase (decrease) in the price of one leads
to a decrease (increase) in the quantity demanded of the other.
·e.g. gasoline and motor oil
3) Two goods are independent when a change in the price of one good has no effect on the
quantity demanded of the other
­If the price consumption curve is downward-sloping, the two goods are considered
substitutes.
­If the price consumption curve is upward-sloping, the two goods are considered
complements.
They could be both!
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Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firm’s Short-Run Costs ($):The Effect of Effluent Fees on Firms’ Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industry’s Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisoners’ Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor