Individual and market demand
Outcomes
 Derive individual demand curve
 Effect of change in price and income on the demand
curve
 Market demand curve
 Consumer surplus
 Effects of network externalities
CHANGES IN EQUILIBRIUM
How does the equilibrium position change if:
1. Consumer’s income change
OR
2. Price of one of the goods change
Income Effect on Consumer Equilibrium
 Change in income, all prices remaining constant.
 If prices of goods, tastes and preferences of the consumer
remain constant and there is a change in income, it will
directly affect consumer’s equilibrium.
 A rise in the income of a consumer shifts the Budget line
to the right upward on higher IC.
 A fall in the income shifts the Budget line to the left side
on lower IC.
Income Effect on Consumer Equilibrium

A rise in the Income: Consumer can buy more of
both commodities = Higher level of satisfaction and
increase in equilibrium.

A fall in the Income = Consumer buy less of both
the commodities = Lower level of satisfaction and
decrease in equilibrium.

The line which touches all the consumer equilibrium
points = Income Consumption Curve (ICC).

ICC = The consumption of two goods is affected by
change in income when prices are constant.
Income Effect on
Consumer
Equilibrium
Price Effect on Consumer Equilibrium

Price Effect = A result of change in the price of one
commodity while price of other good and income of the
consumer remain constant.

The change in demand in response to a change in price of a
commodity, other things remaining the same (Ceteris
Paribus), is called Price effect.

If we draw a line which touches all the consumer equilibrium
points so we will get Price Consumption Curve (PCC).

PCC = The consumption of good X changes, as its price
changes, remaining constant the price of good Y and the
income of the consumer.
Price Effect
on Consumer
Equilibrium
NORMAL AND INFERIOR GOODS
 Normal goods = Willing and able to buy anything
with an income increases or the price decreases
Example: NEW clothing, NEW car, NEW
computer.
 Inferior goods = Comparable to the normal good.
More willing to purchase as income decreases or
the price increases
Example: USED clothing, USED car, USED
computer i.e.  income and  quantity.
Effect on an inferior good
Engel Curves
 Curve relating the quantity of a good consumed to
income.
Income and substitution effects
  Price:
 Consumer will buy more of cheaper good and less of
relatively more expensive good.
 One good cheaper  Consumer enjoy increase in real
purchasing power.
 Two effects occur simultaneously
Income and
substitution
effects:
Normal Good
Substitution effect
 Change in consumption of a good with a change in its
price, with the level of utility held constant.
Income effect
 Change in consumption of a good resulting from an
increase in purchasing power, with relative prices held
constant.
Total effect
 Total Effect (F1F2) = Substitution effect (F1E) + Income
Effect (EF2)
Income and
substitution
effects:
Inferior Goods
Special Case:
GIFFEN GOODS
 Theoretically possible
(but doubted):
 Good whose demand
curve slopes upward
because the negative
income effect is larger
than the substitution
effect.
Market demand curve
 Discussed in Chapter 2
ELASTICITY: Recap
 Inelastic demand: Quantity demanded is relatively
unresponsive to changes in price, e.g.. Gasoline
 Elastic demand: Expenditure on the product decreases
as the price goes up, e.g.. Beef
 Isoelastic demand: Demand curve with constant price
elasticity.
 Special isoelastic demand curve: unit-elastic demand
curve -1.
Consumer Surplus
 Definition: Difference between
 Willing to pay for a good, and;
 Amount actually paid
 Calculate from the demand curve
Network externalities
 Assumption: Demand for a good are independent of
one another.
 However, for some goods demand depends on the
demand of other people.
 Network externalities exist.
 Definition:
 Situation in which each individual’s demand,
 depends on the purchases of other individuals
 Positive or negative
 Positive = Quantity of good demand by consumer
increase in response to the growth in purchases of other
consumers.
 Negative = Vice versa, demand decreases
Network externalities
- The bandwagon effect
 Positive network externality
 Definition: Consumer wishes to possess a good in
part because others do, e.g.. Toys: Playstation, Xbox
 Exploited by marketers
Network externalities
- Snob effect
 Negative externality.
 Definition:
 Consumer wishes to own an exclusive or unique good
e.g.. Works of art, sports car
 Prestige, status and exclusivity