Economics Unit 1

INDIFFERENCE CURVE ANALYSIS

DEMAND
ELASTICITY OF DEMAND
Consumer Equilibrium-
Indifference Curve Analysis
Deriving the demand curve using
IC Analysis
Income and Substitution effect of a price
change
► The substitution effect takes place when, as the price of a good falls and the
prices of other substitutes remain unchanged, more of the cheaper goods will be
demanded since the prices of other substitute goods are now higher.

► The Income effect of a price change is the impact on the quantity of a good
purchased due to a change in the purchasing power brought about by a fall in
price.
Separating the Substitution and
Income effects (fall in p)
Limitations of Indifference Curve
Theory

• Consumers do not always act rationally.

• The theory may not apply to goods that are long lasting
such as cars, houses, refrigerators for example.
Conditions of Demand

• Price of the good itself (movements along the demand curve -

extensions and contractions)

• Other Factors (Leftward/ Rightward Shifts of the demand curve)

Elasticity of Demand

► Price Elasticity of Demand (PED) – measures the degree of responsiveness of

quantity demanded to the change in price of a commodity.

► Income Elasticity of Demand (YED) – measures the degree of responsiveness of

quantity demanded due to a change in income.

► Cross Elasticity of Demand (XED) – measures the degree of responsiveness of

quantity demanded of one good to a change in the price of another good.
Price Elasticity of Demand (PED)

► PED= %Change in Quantity Demanded/ %Change in Price

► If PED < 1 : inelastic since there is a less than proportionate change in quantity
demanded (%Change in Q < % Change in P)

► If PED > 1 : elastic since there is a more than proportionate change in quantity
demanded (%Change in Q > % Change in P)

► If PED = 1 : unitary since there is a proportionate change in quantity demanded

(%Change in Q = % Change in P)
 Identifying and Measuring PED on one
point on the Demand Curve
Activity: Calculating PED

► P1 = $17
► P2 = $29
► Q1= 8
► Q2 = 4
► Question: Calculate PED
► PED= %Change in Quantity Demanded/ %Change in Price