lecture05 - Key issues 1 deriving demand curves 2 income...

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Key issues 1. deriving demand curves 2. income effect 3. effects of a price change 4. CPI bias 5. labor supply curve
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trace out the demand curve by holding income and the price of wine constant, and varying the price of beer example: estimated set of indifference curves for the typical American consumer are bowed away from origin, so beer and wine are imperfect substitutions Deriving Demand Curves
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Deriving an Individual’s Demand Curve
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Price-consumption curve shows how the optimal pairs of beer and wine vary as the relative price varies
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How income changes shift demand curves hold prices fixed and vary income increase in income causes shift of the demand curve movement along income-consumption curve movement along the Engel curve
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Effect of a Budget Increase on an Individual’s Demand Curve
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Income elasticities income elasticity: normal good: E I > 0 inferior good: E I 0 percentage change in quantity demanded percentage change in income / / I E Q Q I I = =
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Mimi's income elasticities beer: E b = 0.88 wine: E w = 1.38 both are normal goods
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Are children inferior? mother with relative little education: E I = -0.18 mother relatively well educated: E I = 0.044
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Income-consumption curves and income elasticities shape of income-consumption curve for 2 goods tells us sign of income elasticities some goods must be normal: not all goods can be inferior
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Income-Consumption Curves and Income Elasticities
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Income elasticities may vary with income Gail may view hamburger as a normal good at a low income an inferior good at a high income
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A Good That Is Both Inferior and Normal
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Quality and income elasticities when their incomes rise, some people buy higher quality goods rather than more of what they’re currently buying examples: fancier cars fancier foods designer clothing
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Effects of a price change as price of one good goes up (all else the same), there are two effects: a substitution effect an income effect
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Substitution effect consumers substitute other, now relatively cheaper, goods for the one whose price rose direction of the effect is unambiguous
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Income effect price increase consumers' buying power falls, reducing “income” (opportunity set) so consumer buys less of at least some goods direction of income effect depends on income elasticity of each good
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Income and substitution effects price rise substitution effect income effect normal good negative negative inferior good negative positive
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Substitution and Income Effects with Normal Goods
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