CONSUMER BEHAVIOUR Theory Determinants of demand The Demand

CONSUMER BEHAVIOUR Theory • Determinants of demand • The Demand Curve • Explanations of Demand - utility - indifference curve analysis - revealed preference - characteristics approach

Indifference Analysis • Good A All combinations of A and B for which the consumer is indifferent AN INDIFFERENCE CURVE Good B

Indifference Analysis • Good A Slopes show relative preferences for A and B Good B An A-lover

An Indifference Map • Good A The preferred direction if A and B are both‘goods Good B

The Optimal Combination of A and B • Good A Budget Line Good B

If the Price of B Falls • Good A More B is bought and (in this example only) the same amount of A Budget Line Good B

How to Find the Substitution and Income Effects? • Good A More B is bought (and in this example only) the same amount of A Budget Line Good B

Substitution Effect • Good A If the consumer was on the same I-curve as before (same real income) but prices moved to their new level, (budget line has the new slope) more B must be bought Good B

Income Effect • Good A If relative prices don’t change but real income rises Good B

DEMAND ELASTICITY • Price Elasticity of Demand - Measures responsiveness in demand to a change in price - Elastic and inelastic demand - Arc and point measurements • Some important applications of elasticity - tax revenue decisions - state company price increases - exports and imports

FACTORS INFLUENCING ELASTICITY • Availability of substitutes • Proportion of income spent on goods • Durability of good • Number of uses for goods • Addictive goods

DIFFICULTIES IN MEASURING ELASTICITY • Influence of other factors affecting demand • Time period involved • Changes - between different places - over time • Lack of precise information • Ambiguities in measurement

INCOME ELASTICITY OF DEMAND • Measures responsiveness in demand to a change in income • measurement usually positive and > 1 for luxuries and < 1 for necessities • Normal, Inferior and Giffen goods - price effects - income and substitution effects

CROSS ELASTICITY OF DEMAND • Measures responsiveness in demand of one product to a change in the price of another - substitutes - complements - independent goods

PRICE ELASTICITY OF SUPPLY • Measures responsiveness of a change in supply to a change in price - immediate market period - short run - long run - very long run