Demand Review

1
Demand Review

• EconS 451 Lecture 6

• Understand the definition of Demand.
• Explain the difference between Marshallian and
  Hicksian Demand.
• Be able to describe and explain the substitution
  and income effect in product space from a change
  in price.
• Understand how proportion of expenditure
  allocated to a specific good impacts the
  substitution and income effect.
• Understand the difference between demand shifts
  and structural change.
• Calculate Own-Price, Income and Cross-Price
  Elasticity of Demand.

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Why review demand relationships?

• Helps us understand market behavior!
• Explains price fluctuations!
• Provides a foundation for empirical research and
  analysis!
• Equips you with necessary analytical capability
  to evaluate market dynamics!

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Demand Review

• Demand Defined
• The various quantities of a particular commodity
  that an individual consumer is willing and able
  to buy as the price varies, all other factors
  held constant.

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Demand Review

• Begins at the individual levelthen summed
  across all individuals to the market level.
• Individual Attempting to Solve
• Max U(x1 , x2) s.t. p1x1 p2 x2 I

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Demand Review

• Marshallian Demand
• Max U(x1 , x2) s.t. p1x1 p2 x2 I
• Hicksian (or Compensated) Demand
• Min Expenditures E(p, U) s.t. U(x1 , x2) UF
  

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Individual Demand
Price
10
5
Demand
Quantity X
25
45
7
Product Space
8
Observations

• If the commodity in questions represents a large
  proportion of expenditures, then the income
  effect from a change in the price will be
  relatively large.
• Both Income and Substitution effect usually
  inversely related to price changes.

9
Static and Dynamic Demand

• Static
• Quantity movements or responses to price while
  all other factors are assumed constant.
• Movements along a demand curve.
• Dynamic
• Shifts and changes in demand that happen with the
  passage of time to account for changes in income,
  population, taste and preferences, etc.
• Structural Change
• Change in the shape of the demand curve due to
  changes in technology or information.

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Graphical Changes in Demand
Parallel Shift
Price
Shift and Structural Change
Quantity
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Demand Changes

• Shift
• Parallel shifts from changes such as income,
  population.
• Structural Change
• Changes in the parameters or functional form.

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Short Run.Long Run

• Short Run
• Time period too short for complete quantity
  adjustment from a price change (a snapshot).
• Long Run
• The time required for a complete quantity
  adjustment to occur in response to a
  once-and-for-all price change.

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Distributed Lag Models

• Refers to a delayed adjustment in quantity as a
  result of a price change.
• And the adjustment may be spread over a period of
  time.

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Speculative Demand

• Consumer demand for current consumption
• Speculative demand
• Anticipated demand and uses
• Future cost gt current cost all storage costs
• Commodity market financial investment
• open interest
• Current market price impacted by current and
  expected events.

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Primary and Derived Demand
Price
Pr
Pd
Primary Demand
Derived Demand
Quantity
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Own-Price Elasticity of Demand

• Relates changes in the price of the commodity
  back to the changes in quantity demanded.
• Defined at a point along the demand curve.
• At the average
• Arc formula
• Assuming Q f(P)

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Own-Price Elasticity of Demand

• Range
• Elastic
• Unitary Elasticity
• Inelastic
• Revenue and elasticity
• TR P(Q)

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Income Elasticity of Demand

• Relates changes in income back to the changes in
  quantity demanded.
• Defined at a point along the demand curve.

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Income Elasticity of Demand

• Range
• Inferior
• Normal

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Cross-Price Elasticity of Demand

• Relates changes in the price of the jth product
  back to the changes in the quantity demanded for
  the ith product.
• Defined at a point along the demand curve.

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Cross-Price Elasticity of Demand

• Range
• Independent
• Substitute
• Complement
• Generalizations because of the income and
  substitution effects of a price change of
  inferior goods.

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Summary Questions

• Explain the difference between individual and
  market demand.
• Describe the difference between the short and
  long run as it relates to market demand.
• What is meant by a distributed-lagas it relates
  to demand?
• Explain what the own-price, income, and
  cross-price elasticity of demand are each
  measuring.