layout: true background-image: url(figs/tcb-logo.png) background-position: bottom right background-attachment: fixed; background-origin: content-box; background-size: 10% --- class: title-slide .row[ .col-7[ .title[ # Consumer Behavior ] .subtitle[ ## Individual and Market Demand ] .author[ ### Dennis A.V. Dittrich ] .affiliation[ ] ] .col-5[ ] ] --- # Demand .pull-left[ ### The Demand Function The consumer's demand function yields the optimum consumption decision as a function of prices and income Formal: `\(x_1^\star(p_1,p_2,I)\)` optimal demand for good 1 as a function of prices `\(p_1\)` and `\(p_2\)` and Income `\(I\)` ] .pull-right[ ### Inverse Demand Function The inverse demand functions measures the marginal willings to pay for a good given all other prices and the income Formal: `\(p_1^\star(x_1,p_2,I)\)` maximal price for one additional unit of good 1 as a function of quantity `\(x_1\)`, price `\(p_2\)`, and income `\(I\)` ] --- # Properties of demand curves .row[.col-7[ **Price\-consumption curve \(PCC\)**: for a good X is the set of optimal bundles traced on an indifference map as the price of X varies (holding income and the price of Y constant) ![](img03/Chapter040.png) With the price `\(P_S\)` decreasing the (absolute) slope of the budget line `\(\frac{P_S}{P_Y}\)` decreases as well as the MRS. ] .col-5[ At every point on the **individual demand curve**, the consumer is maximizing utility by satisfying the condition that the marginal rate of substitution (MRS) of shelter for Y equals the ratio of the prices of shelter and Y. ![](img03/Chapter041.png) The utility level changes along the demand curve ]] --- # The Effects of Income Changes .row[.col-6[ The **income-consumption curve** depicts the changes in the choices of bundles of goods due to changes in income while keeping the prices fixed. ![](img03/Chapter042.png) An increase in income shifts the demand curve to the right. ] .col-6[ **Engel curve**: curve that plots the relationship between the quantity of X consumed and income. ![](img03/Chapter043.png) **Normal good**: one whose quantity demanded rises as income rises. **Inferior good**: one whose quantity demanded falls as income rises. ]] --- class: practice-slide .col-8[ What can you say about the shape or slope of the income consumption curve for an inferior good? What can you say about the shape or slope of the Engel curve for an inferior good? ] ??? They are both downward sloping. --- # Normal and Inferior Goods .row[.col-6[ When the income-consumption curve has a positive slope: * the quantity demanded (for the good on the x-axis) increases with income. * in this case, the good is normal. ] .col-6[ When the income-consumption curve has a negative slope: * the quantity demanded (for the good on the x-axis) falls as income increases. * the good is inferior. ]] .row[ .col-4[## Engel Curves Engel curves relate the quantity of a good consumed to income. * For normal goods, the Engel curve is upward sloping. * For inferior goods, the Engel curve is downward sloping. ] .col-8[ ![](img03/Chapter044.png) ] ] --- # The effect of a price increase ![](img03/Chapter045.png) .col-7[ Increase in the price of shelter decreases the consumption, consumers switch from A to B. ] --- ## A change in the price of a good has two effects .row[.col-6[ ### Substitution Effect Consumers will tend to buy more of the good that has become cheaper and less of those goods that are now relatively more expensive. * The substitution effect is the change in consumption of a good associated with a change in the price of that good, with the level of utility held constant. * When the price of a good declines, the substitution effect leads to an increase in the quantity of demanded good. ] .col-6[ ### Income Effect Because one of the goods is now cheaper, consumers enjoy an increase in real purchasing power. * The income effect is the change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant. * Increases in a person's income may increase or decrease the quantity demanded of a good. ]] --- # Income & Substitution Effects: .row[ .col-6[ ### Normal Goods * Point C is the previous level of utility, but with different (relative) prices. * Through the substitution effect from A to C relative prices change, but the real income (utility) remains constant. * The income effect from C to D keeps the relative prices constant, but decreases the purchasing power. ] .col-6[ ![](img03/Chapter046.png) ] ] --- class: practice-slide .col-8[ What can you say about the income and substitution effect for an inferior good? What happens when the good is inferior and becomes more expensive? ] --- # Income and Substitution Effects: .row[ .col-5[ ### Inferior Goods A good is inferior when the income effect is negative (opposite the substitution effect). Still, the substitution effect is (most likely) greater than the income effect. ] .col-7[ ![](img03/Chapter047.png) ] ] --- # Income and Substitution Effects: .row[ .col-7[ ### Giffen Goods Theoretically, the income effect may be large enough to cause the demand curve for a good to slope upward. * The more expensive the more is demanded. * a _low quality_ good may be substituted for higher quality good (potatoes in Russia). * _The Snob Effect_: the demand for a luxury good decreases with its price, because it will no longer be a status symbol. ] .col-5[ Demand curve for a Giffen good ![](img03/Chapter048.png) ] ] --- ## Effects on quantity of a price increase |type of good | substitution effect | income effect | total effect| |:---|---|---|---| |Normal | decrease | decrease | decrease | |Inferior | decrease | increase | decrease | |Giffen | decrease | increase | increase | --- # From Individual to Market Demand .col-7[ _Market Demand Curve_: A curve showing the quantity of a good consumers in a market are willing to buy at a given price. |Price (Euro) | Person A (Units) | Person B (Units) | Market (Units) | |:---|---|---|---| |0 | 5 | 10 | 15 |1 | 3.3 | 7.5 | 10.8 |2 | 1.7 | 5 | 6.7 |3 | 0 | 2.5 | 2.5 |4 | 0 | 0 | 0 ] --- ## How to Obtain a Market Demand Curve .col-7[ The market demand curve is the _horizontal summation_ of the demands of each consumer. ] ![](img03/Chapter0415.png) .col-7[ The market demand curve will shift to the right as more consumers enter the market. ] --- class: practice-slide .col-8[ Suppose a market has 10 identical consumers, each with a demand given by `\(P=10-5Q_i\)`. How does an individual demand curve and the market demand curve look like, which curve is steeper? ] --- ## Market Demand with Identical Consumers Individual demand `\(P=10-5Q_i\)` and market demand with 10 identical consumers ![](img03/Chapter0417.png) `$$P=a-bQ_i$$` `$$Q_i= \frac{a}{b}-\frac{1}{b}P$$` `$$Q= nQ_i = n\left(\frac{a}{b} -\frac{1}{b}P\right)= \frac{na}{b} - \frac{n}{b}P$$` --- # Network effects .col-7[ * preferences and consequently demand can be interdependent. * If the individual demand depends on other people's demand we talk about network effects. * Positive network effects lead to a right-shift in the individual demand if the number of consumer increases. * The market demand become more elastic * Telecommunication, software, language * Negative network effects lead to a left-shift in the individual demand if the number of consumer increases * The market demand becomes less elastic. * luxuries ] --- # Slope and Price-Sensitivity .col-10[ ![](img03/slope.svg) ] .col-7[ In which case is the demand more sensitive to the price? ] --- # Price Elasticity: Demand .row[.col-7[ **Price elasticity of demand** is the percentage change in quantity demanded divided by the percentage change in price $$E_D = \frac{\text{% change in Quantity Demanded}}{\text{% change in Price}} $$ This tells us exactly how quantity demanded responds to a change in price * Elasticity is independent of units ] .col-5[ ![](img03/Chapter0418.png) ] ] .row[.col-6[ * Demand is **elastic** if the percentage change in quantity is greater than the percentage change in price .center[ Elastic demand is when `\(|E_D| > 1\)` ] ] .col-6[ * Demand is **inelastic** if the percentage change in quantity is less than the percentage change in price .center[ Inelastic demand is when `\(|E_D| < 1\)` ] ]] --- # Calculating Elasticities .row[.col-6[ ![](img03/Chapter0419.png) .center[![](img03/Chapter0431.png)] ] .col-6[ The Unit-Free Property of Elasticity ![](img03/Chapter0421.png) When describing how quantity demanded responds to changes in price, it’s generally best to speak in terms of proportions. When weighing costs and benefits, compare absolute dollar amounts, not proportions. ]] --- ## Elasticity at Different Positions Along a Straight-Line Demand Curve ![](img03/Chapter0432.png) --- ## Elasticity and straight-line Supply and Demand Curves ![](img03/Chapter0420.png) --- # Slope and Elasticity .row[ .col-8[ ![](img03/2slopes.png) ] .col-4[ A demand curve is elastic when an increase in price reduces the quantity demanded a lot (and vice versa). When the same increase in price reduces quantity demanded just a little, then the demand curve is inelastic. Elasticity is not equal to the slope BUT: If two linear demand (or supply) curves run through a common point, then at any given quantity the curve that is FLATTER is MORE ELASTIC ]] --- class: practice-slide .col-8[ Rank the absolute values of the price elasticities of demand at the points A, B, C, D, and E on the following three demand curves.] ![](img03/ex-elast.png) ??? Ep A = 4/2 = 2 Ep B = 3/3 = 1 Ep C = 2/2 = 1 Ep D = 3/1 = 3 Ep E = 3/3 = 1 So Ep D > A > B = C = E --- ## Elasticity & Expenditures ![](img03/Chapter0423.png) --- class: practice-slide # Elasticity What makes demand more or less elastic? --- ## What makes demand more or less elastic? .row[.col-4[ **Substitution** A general rule is: The more substitutes a good has, the more elastic its demand If a good has substitutes, a rise in the price of that good will cause the consumer to shift consumption to those substitute goods ] .col-8[ **Substitution possibilities:** the substitution effect of a price change tends to be small for goods with no close substitutes. **Budget share:** the larger the share of total expenditures accounted for by the product, the more important will be the income effect of a price change. **Direction of income effect:** a normal good will have a higher price elasticity than an inferior good. **Time:** demand for a good will be more responsive to price in the long\-run than in the short-run. ] ] .col-7[ ![](img03/tab701.svg) ] --- class: practice-slide .row[ .col-5[ 1. How can a successful advertising campaign reduce consumers' responsiveness to changes in price of a good like Molson beer? 2. Why is it in the interest of a firm like Molson to decrease the price elasticity of demand for its product? ] .col-7[ <iframe width="560" height="315" src="https://www.youtube.com/embed/eKLkmTz-kJw" frameborder="0" allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture" allowfullscreen></iframe> <iframe width="560" height="315" src="https://www.youtube.com/embed/WMxGVfk09lU" frameborder="0" allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture" allowfullscreen></iframe> ]] --- # Elasticity, Demand, and Expenditure = Total Revenue .row[ .col-6[ The elasticity of demand tells suppliers how their total revenue will change if their price changes Expenditure and Total revenue is price multiplied by quantity, `\(TR = P\times Q\)` ] .col-6[ A price reduction will increase total revenue if and only if the absolute value of the price elasticity of demand is greater than 1\. An increase in price will increase total revenue if and only if the absolute value of the price elasticity is less than 1\. ] ] ![](img03/0703.jpg) --- class: practice-slide .col-8[ For a straight-line demand curve, what is the price elasticity at the revenue maximizing point? ] --- ## Elasticity along Straight-Line Curves: Revenues .row[ .col-8[ ![](img03/Chapter0423.png) ] .col-4[ If `\(|E_D| > 1\)`, an increase in price decreases total revenue If `\(|E_D| = 1\)`, an increase in price leaves total revenue unchanged If `\(|E_D| < 1\)`, an increase in price increases total revenue ]] --- ## Elasticity of Individual and Market Demand .col-7[ * **Price discrimination** occurs when a firm separates the people with less elastic demand from those with more elastic demand * Firms that price discriminate charge more to the individuals with inelastic demand and less to individuals with elastic demand * Examples of price discrimination: * Airlines' Saturday stay-over specials * Sales of new cars * Almost-continual sales ] --- ![](img03/meme-substitute.jpg) --- # Cross-price elasticity .row[ .col-7[ **Cross-price elasticity** of demand measures the responsiveness of demand to changes in prices of other goods `$$E_\text{cross-price} = \frac{\text{% change in Demand}}{\text{% change in P of related good}}$$` ] .col-5[ **Substitutes** are goods that can be used in place of another, `$$E_\text{cross-price} > 0$$` **Complements** are goods that are used conjunction with other goods, `$$E_\text{cross-price} < 0$$` ]] .row[.col-8[ ![](img03/tab704.svg) ]] --- # Substitutes and Complements .row[.col-7[ Two goods are **substitutes** if an increase in the price of one leads to an increase in the quantity demanded of the other. * movie tickets and dvds * The cross price elasticity of substitutes is positive. * Their price-consumption curve is downward-sloping. Two goods are **complements** if an increase in the price of one good leads to a decrease in the quantity demanded of the other. * gasoline and motor oil * The cross price elasticity of complements is negative. * Their price-consumption curve is upward-sloping. Two goods are **independent** if a change in the price of one good has no effect on the quantity demanded of the other. ] .col-5[Goods can be both, substitutes and complements, at different prices and levels of income! ]] --- class: practice-slide ## Income and Substitution Effects: .row[ .col-6[ ### Perfect Complements With perfect complements which price adjustment effect is likely to be stronger: the income or the substitution effect? ]] --- class: practice-slide ## Income and Substitution Effects: .row[ .col-6[ ### Perfect Complements With perfect complements which price adjustment effect is likely to be stronger: the income or the substitution effect? ] .col-6[ ![](img03/Chapter049.png) With perfect complements there is no substitution effect ]] --- class: practice-slide ## Income and Substitution Effects: .row[.col-5[ ### Perfect Substitutes With perfect substitutes which price adjustment effect is likely to be stronger: the income or the substitution effect? ]] --- class: practice-slide ## Income and Substitution Effects: .row[.col-5[ ### Perfect Substitutes With perfect substitutes which price adjustment effect is likely to be stronger: the income or the substitution effect? ] .col-7[ ![](img03/Chapter0410.png) With perfect substitutes there is no income effect ]] --- ## Income elasticity .row[.col-7[ **Income elasticity** of demand measures the responsiveness of demand to changes in income ].col-5[ `$$E_I = \frac{\text{% change in Demand}}{\text{% change in Income}}$$` ]] .row[.col-7[ ![](img03/tab703.svg) ] .col-5[ **Normal goods** are those whose consumption increases with an increase in income **Necessity**: `$$0 < E_I < 1$$` **Luxury**: `$$E_I > 1$$` **Inferior goods** are those whose consumption decreases with an increase in income, `$$E_I < 0$$` ]] --- class: practice-slide .col-8[ How can changes in the distribution of income across consumers affect the market demand for a product? ] ??? If income is shifted from the rich to the poor, those products consumed by poor people and not by rich will increase in demand and those goods consumed by the rich and not the poor will have a decrease in demand. --- ## Normal and Inferior Goods .center[![](img03/Chapter0429.png)] .row[ .col-6[ When the income-consumption curve has a positive slope: * the quantity demanded increases with income. * as a result, the income elasticity of demand is positive. * in this case, the goods are normal. ] .col-6[ When the income-consumption curve has a negative slope: * the quantity demanded falls as income increases. * the income elasticity of demand is negative. * the good is inferior. ]] --- class: practice-slide .col-8[ Suppose your budget is spent entirely on two goods: bread and butter. If bread is an inferior good, can butter be inferior as well? ] ??? No. If bread is an inferior good, then as income increases, quantity demanded of bread decreases. If butter were an inferior good also, then likewise, quantity demanded of butter would decline as income grows. However, spending on both goods cannot decline, because there would be no way of spending the added income. Thus, not all goods can be inferior.