Lec 4 Demand Analysis

Lec 4 Demand Analysis - 1 Demand analysis When the world...

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1 Demand analysis When the world price of oil increases, should the government reduce gas taxes to keep the retail price of gas the same or should the government give a lump sum tax credit to consumers? Individual demand: 1. Income e/ects 2. Substitution e/ects 3. Total e/ect of price change Market demand: 1. Derive from individual demand 2. Price elasticity and changes in expenditure 3. Consumer surplus
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2 Max U ( F;C ) subject to: P C C + P F F I 3 Income e/ect ± Normal versus inferior good ± Engel curve
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4 Substitution e/ect of price change Minimize cost when price changes subject to utility held constant. What is the change in quantity when relative prices change? Why do you care about substitution e/ect? Com- paring cost of living. Buy more of good that is relatively cheaper. Buy less of good that is relatively more expensive.
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5 Total quantity change due to price change Total price change decomposes into (1) Income and (2) Substitution e/ect. Assume price of C increases. 1. Income e/ect can be negative or positive. 2. Substitution e/ect is negative. E/ect of subsidizing electricity prices versus tax re- bate for consumers when cost of producing electricity rises.
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6 Market demand Market demand is horizontal sum of individual de- mand. Demand elasticity and expenditure: E = PQ E P Q + Q P E P = P Q P + Q E P = Q ( P Q Q P + 1) E P = Q ( " P + 1) " P is inelastic, E P is positive. " P is unitary, E P is zero. " P is elastic, E P is nega- tive.
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7 Consumer surplus We want a measure of change in consumer welfare as price of commodity changes. Consumer surplus measures the di/erence between
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Lec 4 Demand Analysis - 1 Demand analysis When the world...

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