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Economics
MBAFT 6103
Today
Theory of Demand
Overview
1. Individual Demand Curves
2. Substitute Goods/ Complementary Goods
3. Normal Goods/Inferior Goods
4. Income Effect and Substitution Effect
5. Constructing Aggregate Demand
For each value of Px calculate consumer demand for good x by solving the
consumers utility maximization problem, holding Py and income constant. Plot.
PX
PX = 4
PX = 2
PX = 1
XA
XB
XC
U increasing
X
Some Denitions
Substitute Goods
Complementary Goods
Engel Curve
The income consumption curve for good x also
can be written as the quantity consumed of good
x for any income level. This is the individuals
Engel Curve for good x. When the income
consumption curve is positively sloped, the slope
of the Engel Curve is positive.
Engel Curve
I ($)
Engel Curve
X is a normal good
92
68
40
10
18
24
X (units)
Inferior Good
If the consumer purchases less of good x as her
income rises, good x is an inferior good.
Equivalently, if the slope of the Engel curve is
negative, the good is an inferior good.
Substitution Eect
As the price of x falls, all else constant,
good x becomes cheaper relative to good y.
This change in relative prices alone causes
the consumer to adjust his/ her consumption
basket. This effect is called the substitution
effect.
The substitution effect always is negative.
Usually, a move along a demand curve will
be composed of both effects.
Aggregate Demand
The market, or aggregate, demand function is
the horizontal sum of the individual (or
segment) demands.
In other words, market demand is obtained by
adding the quantities demanded by the
individuals (or segments) at each price and
plotting this total quantity for all possible
prices.
P
Q = 10 - p
Segment 1
Q = 20 - 5p
Q
Segment 2
P
Q = 10 - p
Q = 20 - 5p
4
Segment 1
Segment 2
Aggregate demand
An Important Concept
Network Externality
If one consumer's demand for a good changes
with the number of other consumers who buy
the good, there are network externalities.
If one person's demand increases with the
number of other consumers, then the
externality is positive.
If one person's demand decreases with the
number of other consumers, then the
externality is negative.
Examples: ?
PX
D60
D30
20
10
Pure
Price
Effect
30 38
Market Demand
Bandwagon Effect
60
X (units)
D1000
D1300
Snob Effect
Pure Price Effect
1000 1300
1800
X (units)
Next
Production and Cost