Topic 2 Lecture Notes

Topic 2 Lecture Notes - Econ 1 ELEMENTS OF ECONOMICS 1...

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Econ 1 – ELEMENTS OF ECONOMICS 1 LECTURE NOTES Foster, UCSD 15-Oct-09 TOPIC 2 – DEMAND, SUPPLY & ELASTICITY A. Consumer and Market Demand 1. Individual Consumer Demand Functions and Curves: a) Definition of demand. b) An individual consumer's demand function for a commodity X: x d = d(P x , P o , y; tastes and preferences), where: o x d = quantity of good X demanded per time period (units) o P x = price of X ($) o P o = [P a , P b , … ] = list of prices of other related commodities A, B, etc. ($) o y = consumer’s income or budget per time period ($) c) If we examine the relation between x d and P x , ceteris paribus ( i.e. , holding all other influences P o , y, and tastes/preferences constant at some level), we get x d = d(P x ). A table of this relationship is a demand schedule ; a graph (with P on the vertical axis) is a demand curve . d) Example. 2. The Law of Demand: a) Negative relationship between x d and P x , cet. par. 1) As P rises (falls), x d falls (rises). 2) Algebraically, x d / P x < 0. 3) In other words, demand curve slopes down. b) Reason -- income and substitution effect of price change. [Table 1] 1) When price of apples is $1 each, family buys 100/year at total apple expenditure of $100. When price drops to $0.70, family increases quantity demanded to 131/year. J. Burns Beer Demand Price ($/can) Demand (cans/wk) $0.00 $0.25 $0.50 $0.75 $1.00 40 29 24 16 8 Table 1 Price Demand Expenditure Before: After: $1.0 0 $0.7 0 100/yr 131/yr $100.00/yr $ 91.70/yr d P $1.00 $0.75 $0.50 $0.25 0 10 20 30 40 X Fig. 1 Beer Demand
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Ec 1 DEMAND/SUPPLY/ELASTICITY p. 2 2) Income effect -- At new price, family can buy old quantity for $70, having $30 left over. This is like a $30 increase in income, which can be spent on a variety of com- modities, including apples. Suppose they buy 10 more apples. This is the income effect of the price change. 3) Substitution effect -- Apples are now cheaper than before, so the family buys fewer bananas and oranges and more apples. Say they substitute 21 more apples for other kinds of fruit. This is the substitution effect of the price change. c) Law of demand and the inverse demand function. 1) We usually write x d = d(P x ), where x d is quantity demanded of good X and P x is its price. But we draw demand curves with price on vertical axis and quantity on the horizontal. 2) Actually, we are graphing an inverse demand function expressing P x in terms of x d : P x = d -1 (x d ) = p(x d ) 3. Changes in Quantity Demanded vs. Changes in Demand: [Fig. 2] 4. Why Demand Curves Shift: a) Changes in income. 1) Normal – if an increase in y increases the demand for X, then X is “normal.” 2) Inferior – if an increase in y decreases the demand for X, then X is “inferior.” b) Changes in price of other related commodities. 1) Substitutes – if an increase in P a increases demand for X, then X and A are “substitutes.” [coffee and tea] 2) Complements – if an increase in P a decreases demand for X, then X and A are “complements.” [coffee and cream] c) Changes in tastes and preferences.
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