o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Week 3

Chapter 4: Individual and Market Demand

Microeconomics 1 – I (Rasi Lucentezza)

TA:
Sendy Jasmine Karunia Hadi
E-mail: sendy.jasmine@ui.ac.id

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Outline
• Individual Demand
• Price change
• Income change
• Income Effect and Substitution Effect
• Market Demand
• Speculative Demand
• Consumer Surplus
• Network Externality Effect

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Individual Demand

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Price Change
• Will affect the budget line (BL) by: rotating inward (price of the
good increases) or outward (price of the good decreases).
• Assuming that the Income is fixed (unchanged).

• The initial utility-maximizing

consumption is at point B.
• If price of Food:
• decreases: BL will
rotate outward and now
the point is at D;
• increases: BL will rotate
inward and now the
point is at A.

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

(cont.)
• All those possible changes in the utility-maximizing points, can
generate another curve named: Price-Consumption Curve (PCC).
• PCC traces utility-maximizing combinations of 2 goods (Food & Clothing) as
the price of 1 changes (in this case, Food).

*Purple curve = PCC

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

(cont.)
• Further, this PCC curve
can be derived to form
individual demand
curve.
• Individual demand
curve properties:
• Level of utility will
change as we move
along the curve;
• Every point of the
demand curve reflects
utility-maximizing point.

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Income Change
• Will affect the budget line (BL) by: shifting inward (income decreases) or outward
(income increases).
• Just like before, these changes can generate Income-Consumption Curve (ICC).
• ICC traces the utility-maximizing combinations of 2 goods as consumer’s income changes.

There’s an increase in income so

the BL shifts outward parallelly
from U1 to U2. Point B > A.

*Purple curve = ICC

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

(cont.)
• ICC curve can be
derived to form Engel
Curve.
• Engel curve is a curve
relating the quantity of Income
a good consumed to
income. Engel Curve

Food

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Income Change: Normal vs. Inferior Good

• Normal good: income increases, quantity demanded increases à
positive slope ICC.
• Inferior good: income increases, quantity demanded decreases.

At low level of income, both

goods are normal goods.
However, as income increases,
hamburger becomes inferior
good.

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Income Effect and Substitution Effect

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

What is the difference?

• Substitution effect: when the price of a good falls (increases), the good
becomes cheaper (more expensive) relative to other goods. SE reflects
the change in the Q that consumer would purchase after relative price
change to achieve the same level of utility à same IC, imaginary BC.
• When the price of a good falls (increases), the SE leads to an increase (reduction)
of good consumption as the good become cheaper (more expensive) than the
others.
• The consumer substitutes relatively cheaper goods for goods which have become
relatively expensive.
• Income effect: When the price of a good falls (increases), the
consumer’s purchasing power increases (falls). If the price falls, the
consumer can now buy the same basket of goods and still have money
left, vice versa. à new BC.
• Differentiate between normal good (+) and inferior good (-).
• Total effect (TE) = SE + IE
Source: lectures of Maggioni (2020)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

(cont.)

(a) Food is a Normal good (b) Food is an Inferior good

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

(cont.)
• Special case: Giffen goods
• If:
• The good is inferior;
• IE > SE;
• IE = (-)
• But, the case is assumed to be very rare à SE is usually stronger than IE.

Source: Pindyck & Rubinfeld (2017)

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Market Demand

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Market Demand
• Is form from individual demands

Source: Pindyck & Rubinfeld (2017)

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

(cont.)
• *Notes:
• Market demand will shift to the right as more consumers enter the market.
• Factors that influence the demands of many customers will also affect
market demand.

• *Speculative demand: demand driven by expectation that the price

of the good will increase.

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Consumer Surplus

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o Individual Demand o Income & Substitution Effect o Market Demand o Consumer Surplus o Network Externality Effect

Consumer Surplus (CS)

• CS = WTP – Price actually paid
• Formula: calculate the triangle shape above the market price (1/2 x
Base x Height)

How about for market as a

whole?

Source: Pindyck & Rubinfeld (2017)

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Network Externalities

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NetworkExternality
ExternalityEffect
Effect

Network Externalities
Positive N.E. Negative N.E.

• If the Q of a good demanded by a typical consumer • If the Q of a good demanded falls in response to the
increases in response to the growth in purchases of growth in purchases of other consumers.
other consumers. • More inelastic demand curve
• More elastic demand curve • Example:
• Example: • Snob effect: the Q demanded is higher if fewer
• Bandwagon effect -- FOMO people have it. à rare paintings
• What are the consumers looking for?
Prestige, status, and exclusivity.

Shifting according to
“intrinsic value” of a
good.

Source: Pindyck & Rubinfeld (2017)

Source: Pindyck & Rubinfeld (2017)

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