Here are the lecture notes for today's lecture and a recording of it. Click below the fold for more notes relating to today's lecture.
You can buy an aplia code directly on the website. The course key is UF98-C9H3-KCDW. Register for the course on aplia.com, and you can pay for an aplia key with a credit card.
Economics for Business Lecture 4 from Stephen Kinsella on Vimeo.
- Image via Wikipedia
Introduction
The theory of demand concerns behavioural adaptation and change in response to different circumstances. The idea is that a demand curve represents a cloud of 'what ifs', where different prices are called out and the consumer then decides how many units of a good to buy or consume.
The demand function is a correspondence between the quantity of some good 
demanded, and the price of , the existence of alternatives like 
, and the individuals income, 
. Finally, using the ceteris paribus assumption we discussed last week, we hold all the other factors which might have some effect on demand (like time, place, elevation, and so forth) constant. The demand function is given by
demanded 
Preferences are included after the semi colon because we want to show that most of the time, preferences don't change.
Caution. Be careful when discussing changes in the demand curve. The only thing which causes a movement in quantity demanded is a change in the good's price. If anything else (like preferences or the price of another good) changes then that is a shift in demand.
The demand function has a few properties we need to talk about.
Homogeneity
This is a simple idea with a complicated title. If you double the prices and the income available for the purchase of and , then quantity demanded won't change. If we assume a budget constraint like
which is the same as:
Substitution and Income EffectsDefinition. The Substitution Effect is the effect due only to the relative price change, controlling for the change in real income.
In order to compute it we ask: what is the bundle that would make the consumer just as happy as before the price change, but if they had to make their choice faced with the new prices. To find this point we consider a budget line characterized by the new prices but with a level of income such that it is tangent to the initial indifference curve.
Definition. The Income Effect is the effect due to the change in real income.
For example, when the price goes up the consumer is not able to buy as many bundles that she could purchase before. This means that in real terms she has become worse off. The effect is measured as the difference between the 'intermediate' consumption and the final consumption which I'll show in class.
Unlike the Substitution Effect, the Income Effect can be both positive and negative depending on whether the product is normal or inferior. By construction, the Substitution Effect plus the Income Effect equals the total effect of the price change.
We'll use a Mathematica demonstration to show the substitution and income effects in class.
Application
We'll use a Mathematica demonstration to show the changes in Consumer Surplus as well.
