Chapter 4: Individual and Market

demand
Concave Shaped Demand Curve: Delta Q/Dellta P is decreasing but in convex- Delta
Q/Delta P is increasing
Convex: Delta P/ Delta Q- The slope is falling- for every additional unit of food, the
decrease in price is required is lower

Fall in price is basically an increase in real income

Individual Demand
Price Changes:

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 Price of clothing is the same and price of food is changing

Price Consumption Curve: As the price changes, how does your consumption
changes

At A= MUf/Pf = MUc/pc

But becaue price of food falls

MUf/Pf > MUc/pc
Becade MRS will keep falling due to which MUf and MUc keeps increasing, then one
time they will become equal again
Pc = 1, Pf = 2
Pf/pc= 2 = MRS
Pf= 1
Pf/pc= 1 (slope of budget line has decreased, it must mean that the point of equality
between MRS = Pf/pc, MRS = 1)
As you consumer more and more of food, Mu of food is decreasing and Mu of C is
increasing, you will be willing to give less and less of food for clothing

WHY reducing price leads to more demand?

MUf will keep increasing, the only to contain is to decrease the prices in order to
equate to MUc/pc

Reducing Consumption of clothing and increase consumption of food from B to D

From A to B, food and clothing are considered as some form of substitutes

From B to D, they are acting as a complemetary products (Higher income levels, they
start consuming more of both, food and dress up exmaples)

The Individual Demand Curve:

In Figure 4.1 (a),the price-consumption curve traces the utility-maximising

combinations of food and clothing associated with every possible price of
food.

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 As the price of food falls, attainable utility increases and the consumer buys more
food.

The impact of the fall of the prices of food on clothing could lead to an increase or
decrease in its units.

The consumption of both food and clothing can increase because the decrease in
the price of food has increased the consumer’s ability to purchase both goods

Individual Demand Curve: An individual demand curve relates the quantity of a

good that a single consumer will buy to the price of that good. (4.1 {b}), It has two
important properties:

1. The level of utility that can be attained changes as we move along the
curve: The lower the price of the product, the higher will be the level of utility.

Figure 4.1 (a) that a higher indifference curve is reached as the price falls.
Again, this result simply reflects the fact that as the price of a product falls,
the consumer’s purchasing power increases

2. At every point on the demand curve, the consumer is maximizing utility by

satisfying the condition that the marginal rate of substitution (MRS) of
food for clothing equals the ratio of the prices of food and clothing: As the
price of food falls, the price ratio and the MRS also fall. In Figure 4.1 (b), the
price ratio falls from 1 ($2/$2) at E (because the curve U1 is tangent to a budget
line with a slope of -1 at A) to 1/2 ($1/$2) at G, to 1/4 ($0.50/$2) at H. Because
the consumer
is maximizing utility, the MRS of food for clothing decreases as we move down
the demand curve. This phenomenon makes intuitive sense because it tells us
that the relative value of food falls as the consumer buys more of it.

Income Changes

Previously, we saw that a change in the price of a good corresponds to a movement

along a demand curve., Here any change in Income (non price factor) should cause a
shift in the demand curve.

Chapter 4: Individual and Market demand 3

 Income Consumption Curve: Curve tracing the utility maximizing combinations of two
goods as a consumer’s income changes.

Normal Vs Inferior Goods:

NORMAL

Chapter 4: Individual and Market demand 4

 INFERIOR

GIFFEN

Chapter 4: Individual and Market demand 5

 Normal: The greater the shifts to the right of the demand curve, the larger the
income elasticity. In this case, the goods are described as normal: Consumers want
to buy more of them as their incomes increase.

Inferior: The quantity demanded falls as income increases; the income elasticity of
demand is negative

Hicksian Appraoch - Only consider changed in relative prices without considering

changes in income ( Substitution effect only ) hence when we consider it the real
income must not be increased due fall in prices ( ignore income effect )

So a new budget constraint that would be tangential to the new IC by substitution effect

Market Demand

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 Market Demand: Curve relating the quantity of a good that all consumers in a market
will buy to its price.
Two points should be noted as a result of this analysis:

1. The market demand curve will shift to the right as more consumers enter the
market.
2. Factors that influence the demands of many consumers will also affect market
demand.

Elasticity of Demand

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 Inelastic Demand: Total expenditure on the product increases when the price
increases.
Elastic Demand: Total expenditure on the product decreases as the price goes up.

Isoelastic Demand: When the price elasticity of demand is constant all

along the demand curve, we say that the curve is Isoelastic.

Although the slope of the linear curve is constant, the price elasticity of demand is
not.

It is zero when the price is zero, and it increases in magnitude until it becomes
infinite when the price is sufficiently high for the quantity demanded to become zero.

Unit Elastic Demand Curve: A demand curve where price elasticity is always equal to
-1

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 When demand is inelastic, a price increase leads only to a
small decrease in quantity demanded; thus, the seller’s total revenue increases.

But when demand is elastic, a price increase leads to a large decline in quantity
demanded and total revenue falls

Speculative Demand
Speculative Demand: Demand driven not by the direct benefits one obtains from
owning or consuming a good but instead by an expectation that the price of the
good will increase

Consumer Surplus

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 Consumer Surplus: Difference between what a consumer is willing to pay for a
good and the amount actually paid.

You're willing to only pay for those products whose utility (consumer surplus) is
more than the disutility (price)

Govt wants to take up a cleaning activity to get rid of pollution, its got to decide
whether it is worth it, check if consumers value it- 'Free Rider' Problem: Undervalue
what they would pay so that they don't have to actually pay it- Assumption: Pay a
lower price and get the benefits- Public goods- the benefit not just who consumes it
but also others 17:56

Firms internalizing the negative externality when they control for pollution, this can
be done via govt fines for pollution, carbon ceilings, higher taxes on the polluting
objects etc

Externalities: Marginal Benefit> Marginal Cost

For positive externalities, since marginal benefit cannot be captured they are
underproduced, while negative externalities' marginal cost is not captured they are
over produced

So to correct these externalities govt may subsidise things, give rebates etc for
things that give positive externalities to increase marginal benefit, while in negative

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 externalities they may be fined, taxed at a higher rate to increase marginal cost

Externalities can lead to market failiure

Merit Goods - goods with higher social benefit than private benefit

Public Goods

Very difficult to exclude

One person's use does not reduce anyone else's use (Non Rivalrous)

Ex: Light tower, clean air

Network Externalities
Situation in which each individual’s demand depends on the purchases of other
individuals.

Its a fad (bandwagon effect)

Benefit from consuming that product is increasing

In particular, a person’s demand may be affected by the number of other people

who have purchased the good. If this is the case, there exists a network externality

A positive network externality exists if the quantity of a good demanded by a typical

consumer increases in response to the growth in purchases of other consumers. If
the quantity demanded decreases, there is a negative network externality

Positive Network Externalities

The more people use a particular product or participate in a particular activity, the
greater the intrinsic value of that activity or product to each individual

Bandwagon effect

Positive network externality in which a consumer wishes to possess a good in part

because others do.

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 The bandwagon effect often arises with children’s toys (video games, for
example). In fact, exploiting this effect is a major objective in marketing and
advertising toys. Often it is the key to success in selling clothing

Initially price gets low, more people join, people assume a lot of people are joining

Negative Network Externalities

Snob Effect: Negative network externality in which a consumer wishes to own an
exclusive or unique good

Overcrowding on roads

The snob effect is a negative network externality in which the quantity of a good that an
individual demands falls in response to the growth of purchases by other individuals.

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 negative network externality makes market demand less elastic.

For a variety of goods, marketing and advertising are geared to creating a snob
effect. (Think of Rolex watches.) The goal is a very inelastic demand—which makes
it possible for firms to charge very high prices.

Why fashion brands destroy billions worth

Network Externality- The effect hasnt been captured yet

Netword Effect- Positive Network Etxernality captured by the platforms

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