Micro Economics

Zaka · #1 Saturday, November 24, 2007

What r income & substitution effects? How can we drive a demand curve of an individual with the help of income & substitution effects & with diminishing MU.

#2 Monday, November 26, 2007

increase in income shifts the demand curve towards right, meaning that there is an increase in demand and prices increase accordingly.

in case of substitutes if the price of substitute is low then there is a decrease in demand. but if the substitute is inferiror and the income is high then there wount be any change to the demand of the superior product as people can afford the superior item.

Zaka · #3 Saturday, December 01, 2007

thanks for information.Would u plz tel me what are inferiror goods normal & superior goods

ARMAN · #4 Wednesday, January 02, 2008

Inferior Goods Are Like Milk And Wheat These Agoods Are Important For Human Beings.and Normal Goods Are Like Cold Drinks Ans Etc Like Something That We Can Live Without That.

Khyber · #5 Saturday, January 05, 2008

Quote:

Originally Posted by ARMAN

Inferior Goods Are Like Milk And Wheat These Agoods Are Important For Human Beings.and Normal Goods Are Like Cold Drinks Ans Etc Like Something That We Can Live Without That.

With apology, this definition is diametrically non-technical with respect to "Economics" and in exams it carries certitude of "Zero Marks" in case you write aforementioned definition.

Normal Good is the one which has positive relation with your income whereas inferior or strong inferior (Giffon) has negative relation. As regards Strong Inferior Good (Giffon) then in theory it exists but in practical there is no real instance of "Giffon Good". Here, i paste some of my personal notes which i prepared during my first semester at Quaid-i-Azam University Islamabad.
I hope you will find it of great worth. If any further help is solicited by you then feel free to let me know via PM.

Basics of demand

1. Concept of demand

i- Desire
ii- Price
iii- Willingness
iv- Ability to purchase

All the commodities which has ability to satisfy humans and must have price and willingness to purchase, economic good is one which has ability to satisfy humans and have price is called “good” and dissatisfy is called “bad commodity” and not have ability to satisfy humans is called “neutral commodity”.

“A commodity which a person would be willing and financially able to purchase at various prices and have desire is called “Demand”.

2. Demand function

Factors on which demand depends

DX = f (PX, PY, Income)

[Assume other is not measurable just like taste, habits and preferences]
3. Determinants of demand

i- Own price
Change in price of commodity leads change in demand

∆ PX ∆ DX
When ever price of commodity changes it have two effects

1. Substitution effect
Commodity becomes relatively cheaper or expensive as compare to other commodities.
|X1| PX1 = 10 to PX1 = 20
|X2| PX2 = 20
2. Income effect
Purchasing power of consumer change “real income” change
Case 1
Let PX increases:

PX increases  Real income decreases  DX decreases

Income effect will be negative (-)

PX increases  relatively expensive as compare to X2  DX decreases

Substitution effect will be negative (-)

Price effect = Income effect + Substitution effect
(-) = (-) + (-)

Positive Relationship [+ shows Normal Good]

PX increases  Real income decreases  DX decreases

Negative Relationship

 Normal commodity has negative (-) relationship with price and positive (+) with real income
Negative Relationship [- shows Inferior Good]

PX increases  Real income decreases  DX decreases

Positive Relationship

 Inferior commodity has positive (+) relationship with price and negative (-) with income
Income effect + Substitution effect = Price effect

Normal Good (-) + (-) = (-)

|IE| > |SE| (+) Giffen
Inferior Good (+) + (-) =
|IE| <|SE| (-) Inferior

ii- Cross price

Change in PX1 will leads to change in demand of X commodity or may not change
∆ PY ∆ DX or ∆
Case 2
Let PX increases:

i. DX decreases  Complimentary goods (use together)

Petrol price increases  Demand for cars decreases (complimentary goods)

ii. DX increases  Substitutes goods (In place of others)
Sweater price increases  Demand for coats increases (substitute goods)

iii. DX increases  unrelated goods (Neutral goods)

Milk price increases  Demand for shoe constant (unrelated goods)

iii- Income of consumer

Let Income (Y) increases:

Positive Relationship [+ shows Normal Good]

Y increases  DX increases

Negative Relationship [- shows Inferior Good]

Y increases  DX decreases (low)

Negative Relationship [- shows Giffen Good]

Y increases  DX decreases (high)

Conclusion:
(+) Giffen/Strong inferior
1. Own Price with demand
(-) Normal good

(+) Substitute goods
2. Cross Price with demand
(-) Complimentary goods

(+) Normal goods
3. Income with demand
(-) Inferior good

Khyber · #6 Saturday, January 05, 2008

Quote:

Originally Posted by sibtainafzaal

increase in income shifts the demand curve towards right, meaning that there is an increase in demand and prices increase accordingly. .

No, Not Necessarily it happens. Increase in income may shift demand curve downward signifying the "good" as "inferior". And as regards "Change in price accordingly" then Demand curve remains unshifted with variation in prices. Change in prices only makes movement along the curve or it creates rotation along the Demand Curve and it doesn't shift either upward or downward. Mind that factors other than "price change" brings shift in demand curve and price itself doesn't.

Quote:

Originally Posted by sibtainafzaal

in case of substitutes if the price of substitute is low then there is a decrease in demand. but if the substitute is inferiror and the income is high then there wount be any change to the demand of the superior product as people can afford the superior item.

Mind that susbstitution effect is always negative regardless of the nature of the commodity, be it Normal or Inferior or Strong Inferior.

Kind Regards,

Astute Accountant · #7 Sunday, January 06, 2008

Inferior Goods: Goods whose demand decreases with the increase in income are called inferior goods.

Marginal Utility: is the satisfaction gained from consuming one addition unit of a good or the satisfaction forgone by consuming one unit less.

Explanation: If someone eats six apples and then eats a seventh, total utility refers to the satisfaction he derives from all seven apples together, while marginal utility refers to the additional satisfaction from eating the seventh apple, having already eaten six.

Demand curve showing the effects of Marginal Utility: A demand curve showing the effects of the Marginal Utility would be a curved line convex to the origin. Such a demand curve means that there are progressively larger increases in quantity demanded as price falls. This happens because of the fall in the Marginal Utility experienced as consumption of good increases.

Hope that helps...

Regards

Astute Accountant · #8 Monday, January 07, 2008

Demand: Demand for a good is the quantity of that good that potential purchasers would buy, or attempt to buy, if the price of the good were at a certain level.

Factors That Determine the Level of Demand: There are a number of factors which determine the level of demand:

 The price of the good
 The price of other goods (products and services)
 The size of household’s income
 Tastes and fashions
 Expectations of future price changes
 The distribution of income among households

Demand Curve: A demand curve shows how the quantity demanded will change in response to a change in price; provided that all other conditions affecting demand are unchanged --- that is, provided that there is no change in the price of other goods, tastes, expectations or the distribution of household income. (Cateris paribus, remember, is the assumption that all other things remain equal.)

Shifts of the Demand Curve:

Change in Price of the Goods: If the price of a good goes up or down, given no changes in the other factors that affect price, then there will be a change in the quantity demanded, depicted as a movement along the demand curve.

Change in other factors that affect demand: When there is a change in other factors that affect demand, the relationship between demand quantity and price will also change, and there will be a different price/quantity demand schedule and so a different demand curve. Such a change is referred to as a shift of the demand curve.

Substitute Goods: Substitute goods are goods that are alternatives to each other, so that an increase in the demand for one is likely to cause a decrease in the demand for another.

Substitution: Switching demand from one good to another ‘rival’ good is substitution.

Examples of Substitute Goods:

 Rival brands of the same commodity like coca-cola and Pepsi-cola
 Tea and coffee
 Some different forms of entertainment

Inter-related Goods: A change in the price of one good will not necessarily change the demand for another e.g. we would not expect an increase in the price of cocoa to affect the demand for motor cars. However, there are goods for which the market demand is inter-related and these inter-related goods are referred to as either substitutes or compliments.
Here we will merely consider substitute goods…

Substitution: takes place when the price of one good rises relative to a substitute good.

Explanation: If the price of good increases relative to its substitute, demand would switch towards its substitute. Similarly, if the price of good decreases, demand would shift towards the good and hence the demand for its substitute good decreases.

Demand Curve and Substitution: When the demand of good increases (as compared to its substitute) there will be a rightward shift in the demand curve of the good.

When the demand of good decreases (as compared to its substitute) there will be a leftward shift in the demand curve of the good.

Astute Accountant · #9 Monday, January 07, 2008

Income and Demand: As you might imagine, more income will give households more to spend and they will want to buy more goods at existing price. However, a rise in household income will not increase market demand for all goods and services. The effect of a rise in income on demand for an individual good will depend on the nature of the good.

Demand and the level of income may be related in different ways…

Normal Goods: A rise in household income may increase demand for a good. This is what we might normally expect to happen, and the goods for which demand rises as household income increases are called normal goods.

Superior Goods: Superior goods are goods that are bought for the purposes of ostentation, so that an increase in income makes the good more desirable to consumers and thus increases their demand.

Examples of Superior goods: Luxury Cars

Explanation: The demand of luxury cars would increase with the increase in household income because the increase in income would make luxury cars more desirable to the consumers as compared to cheap cars.

Inferior Goods: demand may rise with income up to a certain level but then fall as income rises beyond that point. Goods whose demand eventually falls as income rises are called inferior goods.

Examples of Inferior Goods:
Tripe (stomach of ruminant animal prepared for food)
Cheap wine

Reason of such a shift in demand: The reason for falling demand is that as incomes rise, demand switches to superior products, e.g. beef instead of tripe, better quality wines instead of a cheaper variety.

Demand Curve: The change in quantity demanded takes the form of a shift in the position of the demand curve, and not a moment along it, since it is not stimulated by a change in price.

If the demand of a good increases with the increase in income, there will be a rightward shift in the demand curve while if the demand of good decreases (as in the case of inferior goods), the demand curve will move inwards i.e. it would move towards left.

Income Elasticity of demand: Income elasticity of demand measures the responsiveness of demand to changes in household income.

Income elasticity of demand = % change in quantity demanded / % change in household income

Income Elastic: Demand for a good is income elastic if income elasticity is greater than 1 so that quantity rises by a larger %age than the rise in income e.g. if the demand for compact discs will rise by 10% if household income rises by 7%, we should say that the demand for compact discs is income elastic.

Income Inelastic: Demand for a good is income inelastic if income elasticity is between 0 and 1 and the demand rises less than the proportionate increase in income e.g. if the demand for books will rise by 6% if household income rises by 10%, we would say that the demand for books is income inelastic.

For most commodities, an increase in income will increase demand. The exact affect on demand will depend on the type of product e.g. the demand for some products like bread will not increase much as income rises. Therefore, bread has a low income elasticity of demand. In contrast, the demand for luxuries increases rapidly as income rises and luxury goods therefore have a high income elasticity of demand.

Hope that you'll grasp the point....

Regards

Zaka · #10 Monday, March 24, 2008

how can i make difference btween normal,inferiror & superiror goods through elasticity demand