04 demand

Question 1

Topics of this class:

Answer 1

• Change in demand due to price change
• Substitution and income effect
• In which direction both effects go?
• Law of Demand
• Aggregate Demand
• Consumer Surplus

Question 2

What is the difference between Normal good and Giffen good?

Answer 2

In Normal good: demand decreases as price increases
In Giffen good: demand increases when price increases

Question 3

Substitution effect

Answer 3

Change in demand due to changed rate of exchange, other goods become relatively cheaper. (Fiyat artınca başka mal al.)

Formula: x1(p’1,p2,m+Δm)-x1(p1,p2,m)

Key Rule: Always negative (price ↑, demand ↓).

Question 4

Income effect

Answer 4

Definition: The change in demand due to reduced purchasing power caused by a price increase. (Fiyat artınca satın alma gücü düşer, buna göre talep değişir (normal malda negatif, düşük malda pozitif.)

Formula: x1(p’1,p2,m) - x1(p’1,p2,m+Δm)

Question 5

Δm?

Answer 5

Δm=(p’1-p1) . x1(p1,p2,m)

Δm: the amount of money that would need to be given to the consumer so they could still afford their bundle

Question 6

Sign of the Substitution Effect

Answer 6

xC ≤ xA or xC−xA ≤ 0

(the substitution effect is either negative or zero)

Question 7

How is Total Effect calculated?

Answer 7

Total Effect=Substitution Effect+Income Effect

Example:
Substitution: −2 units (switch to alternatives).
Income: −1 unit (purchasing power loss).
Total: −3 units (price rise reduces demand).

Question 8

How demand for goods changes depending on income?

Answer 8

Normal Good: Demand increases as income increases.
Examples: high-quality food, electronics, or vacations.

Inferior Good: Demand decreases as income increases.
Examples: instant noodles or low-cost discount products.

Question 9

The aggregate demand function for good 1

Answer 9

D(p′1) = ∑x1k (p′1, p2, mk)
k

Question 10

Elastic vs. Inelastic Demand

Answer 10

If demand reacts only slightly to a price change, such that εD ∈[−1, 0], we say demand is inelastic. If εD <−1, we say demand is elastic.

Question 11

Consumer Surplus?

Answer 11

The total benefit to consumers is the consumer surplus!

The change in consumer surplus directly reflects the change in welfare.

If consumers do not have fixed willingness to pay, consumer surplus is still often used — even though its interpretation is less clear. 🤷🏻‍♀️

Question 12

What Have We Learned?

Answer 12

Concepts you should know and understand:
-Substitution and income effect
-Law of demand
-Aggregate demand
-Consumer surplus

Methods you should be able to apply:
-Decompose into substitution and income effects to formally prove the law of demand and similar propositions.

Things you should be able to explain:
-Why demand might have increased with price during the mid-19th
century in Ireland
-Why consumer surplus is a meaningful measure when consumers have fixed willingness to pay

Additional topics we discussed:
-Why refunding the climate bonus does not necessarily mean consumers are unaffected by a CO tax