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Lecture_6_for_students

# Lecture_6_for_students - Lecture 6 Demand Click to edit...

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Click to edit Master subtitle style 1/1/11 Demand Lecture 6 Consumer Welfare and Policy Analysis

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1/1/11 Total Effect of a Price Change q1,Music CD q2,Movi e DVD e 1 e 2 I 1 I 2 M=1 2 N= 6 P1 increases to 30. Budget line rotates inward. She moves from e1 to e2. 1 5 L 1 L 2 TE is total change in Mimi’s consumption resulted from the rise in the price of CD holding income Assume a consumer is using music CD (P1=\$15 ) and movie DVD (P2=\$20). Her income is 300\$. Both goods are normal .
1/1/11 The price change (in the example P1↑) leads to a change in relative prices and purchasing power (PP) of the consumer. -Relative prices is ( ) -PP is the amount of goods that the consumer’s income can buy Substitution Effect (SE) SE and IE of a Price change 2 1 p p

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1/1/11 Total effect ( TE ) of the P1↑ is divided into SE and IE: SE means when P1↑, ↑. To maintain PP constant, the consumer has to substitute the cheaper good for the expensive one. This implies . IE means when P1↑, PP of the consumer is lower because her income is the same, but the SE and IE of a Price change 2 1 p p
1/1/11 TE=SE+IE=-3+(-3)=-6 (SE and IE same direction) Back to the previous example, assume P1=\$15 and P2=\$20. Incomeis 300\$. Then P1 ↑ from \$15 to \$30 (L1 to L2). Show the TE,SE, and IE on the graph? TE=SE+IE (e1→e2)= (e1→e*)+ (e*→e2) Plot a Parallel line ( L* ) to the new budget line (L2) and tangent to the original Indifference curve (I1). SE : ( ) IE : . Move on indiff curve Shift of indiff curve SE and IE of a Price change

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1/1/11 Normal good (eI>0): More of the good is demanded as income goes up [Luxury (eI>1) and necessity (0≤eI≤1)]. ( ) Inferior good (eI<0): Less of the good is demanded as income rises. ( ) Giffen good (eI<0): An inferior good that has a demand with positive slope. ( ) Type of goods
1/1/11 Assume Bobby is consuming Juice and Soda. The original budget line is B1 with equilibrium e2 and the new budget is B2 with equilibrium e1. Is soda Example e *

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1/1/11 Some Reminder UD is also called Marshallian Demand Curve. Unless otherwise noted, when we talk about demand curve, we always Assume Mimi is consuming Beer and wine. Pb is \$12, and she is in e1. Then, Pb ↓ twice=> e2 and e3. Using the info in e1 to e3, we find her D. This D is uncompensated D (UD) Which is plotted based on TE ( Utility varies as P changes )
1/1/11 Compensated demand Compensated demand is based on the substitution effect only. (Uncompensated demand is based on TE) To plot compensated demand, we need to find price and quantity at the substitution effect.

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1/1/11 Driving Compensated Demand q 1 q 2 q 1 q 2 e 2 e 2 L L I I e 0 e 1 1 2 7. 8 e2: p1=15 & q1=12 e1: p1=45 & q1=7.8 e 4 e 3 1 2 17. 4 e2: p1=15 & q1=12 e3: p1=6 & q1=17.4 p1↑ => SE=e2 e1 IE=e1e 0 TE=e2 e0 In both graph, consumer is originally in equilibrium e2.
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Lecture_6_for_students - Lecture 6 Demand Click to edit...

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