Lecture 6 _Feb 4_ - Economics 100A Lecture #6: Thursday,...

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Economics 100A Lecture #6: Thursday, Feb. 4 Individual Consumer Demand 1. Deriving demand curves 2. Income changes 3. Price changes 4. The “CPI bias”
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A case of beer … and wine How does beer consumption vary with its price? How does it vary with income? How is beer consumption affected by availability & prices of substitutes (e.g., wine) and complements (e.g., ESPN)? How much will consumption change with an excise tax?
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Deriving individual demand curve 1) Start with consumer’s optimal basket given their income and given prices ( MRS x,y = p x /p y ) 2) Vary price of one good, holding all other prices and income constant ( Δ p x > 0, Δ p y = 0, Δ I = 0 ) 3) Trace out the optimal baskets as the one price varies: the “price-consumption curve.” 4) Plot quantity demanded against its own price: the “individual demand curve” ( D x (p x ;p y ,I) )
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Deriving price- consumption curve, and an individual’s demand curve 4.3 5.2 12.0 2.8 12.0 6.0 4.0 26.7 0 44.5 58.9 L 1 ( p b = $12) p b $ per gal. of beer/yr L 2 ( p b = $6) L 3 ( p b = $4) 26.7 0 44.5 58.9 e 3 e 2 e 1 E 3 E 2 E 1 I 1 I 2 I 3 Beer, Gallons per year Beer, Gallons per year D B Demand for beer Price-consumption curve Wine, Gallons per year Change in price of beer Individual beer demand curve
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Price elasticity of demand Percentage change in quantity demanded for 1% increase in price: Estimates of price elasticity of beer demand fall in the range: -0.1 to -0.9 (inelastic region) One study finds the wine cross -price elasticity of beer demand of +0.31 (substitutes) while others find them to be complements . x x x x x x x x x x p Q p Q Q p p p Q Q p Q x x / / % % ,
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Income changes Hold all prices constant, vary income, and measure the effect on quantities consumed. Start with consumer’s optimal basket ( MRS x,y = p x /p y ) Vary income holding all prices constant ( Δ I > 0, Δ p x = Δ p y = 0 ). Trace out the optimal baskets as income varies: the “income-consumption curve.” Plot quantity demanded of the good against income: the “Engel curve.”
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Construction of the income- consumption and Engel curves per year Income-consumption curve Engel curve for beer 0 2.8 4.8 7.1 49.1 38.2 26.7 Beer, Gallons per year 0 12 0 49.1 38.2 26.7 Beer, Gallons per year 49.1 38.2 26.7 Beer, Gallons per year I 2 I 3 I 1 Change in Income Price of beer, $ per unit (b) Demand Curves I , Budget (c) Engel Curve e 2 e 3 E 3 E 1 E 2 I 1 = $419 I 2 = $628 I 3 = $837 L 3 L 2 L 1 e 1 D 1 D 2 D 3 E 1 * E 2 * E 3 * Wine, Gallons Shift in demand curve
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Income elasticity of demand Income elasticity Classification of goods “Normal” good: ε Q,I >0 “Inferior” good: ε Q,I <0 Empirical studies find income elasticities for beer demand around +0.8 (mildly normal)
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This note was uploaded on 03/18/2010 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at University of California, Berkeley.

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Lecture 6 _Feb 4_ - Economics 100A Lecture #6: Thursday,...

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