Economics 2150A/B Lecture Notes - Lecture 5: Giffen Good, Economic Surplus, Demand Curve

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2150 Micro - Chapter 5: The Theory of Demand Notes
ļ‚·Substitution Effect: the change in the quantity of the good the consumer would purchase after the price
change to achieve the same level of utility.
oFor example, if the price of food falls, the consumer can achieve the same level of utility by
substituting food for other goods (i.e., by buying more food and less of other goods
oAs the price of x fall, all else constant, good x becomes cheaper relative to good y ļƒ  this change
in relative price causes the consumer to adjust his/her consumption basket
oThe substitution effect is always negative
ļ‚·Income Effect: (The change in purchasing power) ā€“ as the price of x falls, all else constant, purchasing
power rises. As price of x rises, all else constant, purchasing power falls
oIncome effect of a change in price may be positive (normal good) or negative (inferior good)
ļ‚·Impact of a change in price of a good
oIf prices of a normal good fall ā€“ consumers substitute into the good to achieve the same level of
utility, and purchasing power increases since the consumer can buy the same amount and still
have money left
ļ‚§The slope of the graph (-Px/Py) will also change as the MRS would have changed
oIf price of an inferior good falls ā€“ net effect of a price decrease of good x, all else constant, is a
decrease in the consumption of good x, good x is a Giffen good
ļ‚§For giffen goods, demand does not slope down
Example ā€“ Income and substitution effect
ļ‚·Consumer Surplus: The difference between
what the consumer is willing to pay and
what the consumer actually pays ī€€ Net
economic benefit to the consumer due to a purchase
oThe area under an ordinary demand curve and above the market price provides a measure of
consumer surplus
ļ‚·Market Demand Function: The horizontal sum of the individual (or segmented) demands ī€€ obtained
by adding the quantities demanded by the individuals at each price and plotting this total quantity for all
possible prices
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ECON 2150A/B Full Course Notes
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2150 micro - chapter 5: the theory of demand notes. Income effect: (the change in purchasing power) as the price of x falls, all else constant, purchasing power rises. As price of x rises, all else constant, purchasing power falls: income effect of a change in price may be positive (normal good) or negative (inferior good) For giffen goods, demand does not slope down. Consumer what the what the economic benefit to the consumer due to a purchase. Surplus: the difference between consumer is willing to pay and. Net consumer actually pays (cid:0: the area under an ordinary demand curve and above the market price provides a measure of consumer surplus. Market demand function: the horizontal sum of the individual (or segmented) demands (cid:0) obtained by adding the quantities demanded by the individuals at each price and plotting this total quantity for all possible prices.

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