Engel curve

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Jump to: navigation, search This article needs additional citations for verification. Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (December 2009) An Engel curve describes how household expenditure on a particular good or service varies with household income.[1][2] There are two varieties of Engel Curves. Budget share Engel Curves describe how the proportion of household income spent on a good varies with income. Alternatively, Engel curves can also describe how real expenditure varies with household income. They are named after the German statistician Ernst Engel (1821 1896) who was the first to investigate this relationship between goods expenditure and income systematically in 1857. The best-known single result from the article is Engel's law which states that the poorer a family is, the larger the budget share it spends on nourishment.

Contents
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1 The Shape of Engel Curves 2 Engel Curves in microeconomics 3 Applications 4 Problems o 4.1 Low Explanatory Power o 4.2 Accounting for the shape of Engel Curves 5 Notes

[edit] The Shape of Engel Curves

The shape of Engel curves depend on many demographic variables and other consumer characteristics. A goods Engel curve reflects its income elasticity and indicates whether the good is an inferior, normal, or luxury good. Empirical Engel curves are close to linear for some goods, and highly nonlinear for others. Graphically, the Engel curve is represented in the first-quadrant of the cartesian coordinate system. Income is shown on the Y-axis and the quantity demanded for the selected good or service is shown on the X-axis. For normal goods, the Engel curve has a positive gradient. That is, as income increases, the quantity demanded increases. Amongst normal goods, there are two possibilities.

Although the Engel curve remains upward sloping in both cases, it bends toward the yaxis for necessities and towards the x-axis for luxury goods. For inferior goods, the Engel curve has a negative gradient. That means that as the consumer has more income, they will buy less of the inferior good because they are able to purchase better goods. For goods with Marshallian demand function generated from a utility function of Gorman polar form, the Engel curve has a constant slope. Many Engel Curves feature saturation properties in that their slope tends to diminish at hight income levels, which suggests that there exists an absolute limit on how much expenditure on a good will rise as household income increases [3] This saturation property has been linked to slowdowns in the growth of demand for some sectors in the economy, causing major changes in an economy's sectoral composition to take place.[4]

[edit] Engel Curves in microeconomics

In microeconomics, an Engel curve shows how the quantity demanded of a good or service changes as the consumer's income level changes. In order to be consistent with the standard model of utility-maximization, Engel Curves must possess certain properties. For example, Gorman (1981) proved that a system of Engel curves must have a matrix of coefficients with rank three (or less) in order to be consistent with utility maximization.[5] When considering a system of Engel curves, the adding-up theorem also dictates that the sum of all total expenditure elasticities, when weighted by the corresponding budget share, must add up to unity. This rules out the possibility of saturation being a general property of Engel Curves across all goods as this would imply that the income elasticity of all goods approaches zero starting from a certain level of income. The adding-up restriction stems from the assumption that consumption always takes place at the upper boundary of the household's opportunity set, which is only fulfilled if the household cannot completely satisfy all its wants within the boundaries of the opportunity set [6] Other scholars argue that an upper saturation level exists for all types of goods and services.[7][8]

[edit] Applications
In microeconomics Engel curves are used for equivalence scale calculations and related welfare comparisons, and determine properties of demand systems such as aggregability and rank. Engel curves have also been used to study how the changing industrial composition of growing economies are linked to the changes in the composition of household demand [9]

In trade theory, one explanation inter-industry trade has been the hypothesis that countries with similar income levels possess similar preferences for goods and services (the Lindner hypothesis), which suggests that understanding how the composition of household demand changes with income may play an important role in determining global trade patterns.[10] Engel curves are also of great relevance in the measurement of inflation [11] and tax policy.[12]

[edit] Problems
[edit] Low Explanatory Power
Heteroscedasticity is a well known problem in the Estimation of Engel curves: as income rises the difference between actual observation and the estimated expenditure level tends to increase dramatically. Engel curve and other demand function models still fail to explain most of the observed variation in individual consumption behavior.[13] As result, many scholars acknowledge that influences other than current prices and current total expenditure must be systematically modeled if even the broad pattern of demand is to be explained in a theoretically coherent and empirically robust way.[14] For example, some success has been achieved in understanding how social status concerns have influenced household expenditure on highly visible goods.[15][16]

[edit] Accounting for the shape of Engel Curves

No established theory exists that can explain the observed shape of Engel Curves and their associated income elasticity values. Ernst Engel himself argued that households possessed a hierarchy of wants that determined the shape of Engel Curves. As household income rises some motivations become more prominent in household expenditure as the more basic wants that dominate consumption patterns at low-income levels, such as hunger, eventually become satiated at higher income levels.[17]

[edit] Notes
1.
^ Chai, A., Moneta, A., 2010. Retrospectives: Engel Curves. Journal of Economic Perspectives 24 (1), 225-240 2. ^ Lewbel, A. 2007. Engel Curves. The New Palgrave Dictionary of Economics. 3. ^ Chai, A., Moneta, A., 2010. The evolution of Engel curves and its implications for structural change. Griffith Business School Discussion Papers Economics. No. 201009.[1] 4. ^ Pasinetti, L. (1981), Structural Change and Economic Growth, Cambridge University Press, Cambridge.

5.

^ Gorman, William M. 1981. Some Engel Curves. In Essays on the Theory and Measurements of Demand in Honour of Sir Richard Stone, ed. Angus Deaton. Cambridge: Cambridge University Press. 6. ^ Deaton, A., Muellbauer, J., 1980. Economics and Consumer Behavior. Cambridge University Press, Cambridge. 7. ^ Pasinetti, L. (1981), Structural Change and Economic Growth, Cambridge University Press, Cambridge. 8. ^ Metcalfe, S., Foster, J., Ramlogan, R., 2006. Adaptive Economic Growth. Cambridge Journalof Economics 30, 7-32. 9. ^ Krger, J., 2008. Productivity and Structural Change: A Review of the Literature. Journal of Economic Surveys 22 (2), 330-363. 10. ^ Hallak, Juan Carlos, (2010), A Product-Quality View of the Linder Hypothesis, The Review of Economics and Statistics, 92, issue 3, p. 453-466 11. ^ Bils, M. and P.J. Klenow (2001b), Quantifying Quality Growth, The American Economic Review,91 (4), 1006-1030. 12. ^ Banks, J., Blundell, R., Lewbel, A., 1997. Quadratic Engel Curves and Consumer Demand. The Review of Economics and Statistics 79(4), 527-539 13. ^ Lewbel, A. 2007. Engel Curves. The New Palgrave Dictionary of Economics. 14. ^ Deaton, A., Muellbauer, J., 1980b. Economics and Consumer Behavior. Cambridge University Press, Cambridge. 15. ^ Charles, K.K., Hurst, E. and Roussanov, N. (2009). Conspicuous consumption and race, Quarterly Journal of Economics, vol. 124, pp. 42568. 16. ^ Heffetz, Ori. Forthcoming. A Test of Conspicuous Consumption: Visibility and Income Elasticities. Review of Economics and Statistics. 17. ^ Witt, U. (2001), Learning to consume - A theory of wants and the growth of demand, Journal of Evolutionary Economics, 11 (1), 23-36.

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Diminishing Marginal Utility

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History

Diminishing Marginal UtilityEdit

"The 'Law of Diminishing Marginal Utility' states that for any good or service, the marginal utility of that good or service decreases as the quantity of the good increases, ceteris paribus. In other words, total utility increases more and more slowly as the quantity consumed increases. This is 'diminishing returns' from the viewpoint of the consumer, and is a general principle of economics. There might be a threshold before the principle applies. For example, the marginal utility of golf clubs might increase until you have a fairly full set. But beyond some threshold, marginal utility will diminish with increasing consumption of any good." [1]

Utility is a decreasing function of X: The marginal change is decreasing hence the name Added by Mthomas1776

A concept in Economics which explains how the satisfaction for any one good will decrease as more quantities are obtained.

Note the absence of a price on this graph. This is the utility from one good. A price would indicate trade-offs from other goods. Comparing the relative marginal utility of two goods allows insight into how economic choice is made.

This concept is used to explain why the demand curve (for a given moment in time) will be downward sloping. Added by Mthomas1776

Law of Diminishing Marginal Utility and its application to our daily consumption
February 10, 2008 in Heavy Not totally anime related, but anyway Ive been wanting to blog about LDMU for a long time now (probably a few months ago) but never did because firstly, it takes a bit of effort, and secondly, its rather offensive to those who have lived their entire lives without modifying their consumption patterns according to theoretical economics. Many normal people wonder why I spend so much on anime related goods such as DVDs and CDs. For the sake of arguement, lets talk about normal Singaporeans. Most people think that the number one reason why some guys buy original is because of guilty conscience and think that such people are soft-hearted losers. In Singapore if youre anywhere from 15 to 25 years old, being an opponent of piracy will instantly make you unpopular among your peers. They will say stuff like wah lao,

you too rich or wad. Then gimme your money lar! instead of honouring your decision in doing the right thing. This is obviously because, a lot of people on this country actively engage in piracy, and possess an inherent guilty conscience. I mean it did appear in the papers that Singapore downloads the most (fansubbed) anime per capita in the entire world. In fact, if youre Singaporean just ask yourself: how many Heroes fans have actually bought the original DVDs? Are they truly fans, or are they just chasing another stupid trend? Is Heroes really that good? Obviously not, its a stupid show about unrealistic superpowers I simply dont understand how such a stupid show can get so popular. The real reason why I spend my money is because of a little concept in economics called utility. Its a very simple concept so dont worry if youve not taken economics at any point in your life. Its not because I oppose piracy, nor is it because I have a guilty conscience. Its just that I am concerned in maximising my overall utility and thus not waste time in the things I do in life. In fact, piracy has its uses in free promotion of products that benefits both consumers and producers, but when you fully embrace piracy and ignore commercial purchases, you are actually doing yourself more harm than good. Utility, in lay man terms, is basically the amount of satisfaction you derive from consuming a product. In a perfect economy, producers seek to maximise profit, while consumers (us) seek to maximise utility. But since the world is filled with Kiasu (scared to lose), Kiasee (scared to die) and cheapskate Singaporeans, the Singaporean economy is obviously far from perfect. This is because most consumers would rather consume without maximising utility, which is to consume pirated goods. For the sake of arguement and to keep within the theme of this blog, lets use anime as an example. Fansubbed anime is always encoded in video compression formats such as mpeg or mkv. Since these formats are compressed, the quality will never be as good as watching uncompressed video on a DVD. Even the so called DVD-ripped anime are not DVD quality, because they are instantly compressed after being ripped. If image quality doesnt bother you, compressed sound in a compressed video is definitely inferior to DVD quality sound. The utility that we derive is governed by a law known as The Law of Diminishing Marginal Utility which is illustrated in the following graph:

Ignoring the blue line, the red curve in the graph illustrates our utility curve which is plotted Utility (U) against the Quantity Consumed (Q). This is best illustrated when we listen to songs. You should have realised by now that when your favourite artiste releases a brand new song, you can keep listening to it for many times over. Lets say the utility you derive from listening to the song is 70. As you listen to the song the amount of utility you derive from listening to the song repeatedly increases as you continue listening. However, after a certain point of time (at 80) you will start to become less satisfied listening to the song, which is illustrated after the red curve goes past its turning point. Youll find that if you force yourself to listen to the song continuously for the entire day, youll eventually derive negative utility (below 0) from listening to it, or in other words youll get sick of listening to it. Youll have to wait for a few days before you feel like listening to the song again. If the song is really that good, it would only take one day to derive its original utility value from it, or even half a day. We can use the same example when it comes to anime. For example, you have just watched a fansubbed episode of Suzumiya Haruhi. You believe its the best freaking thing in the world and derive 50 utility from veiwing it. You burn it on a disc to watch it again the next time you feel that you want to. The fallacy is that if you re-watch that episode again, it is not possible to derive more than 50 utility from watching it. However, if you purchase the DVD, it is possible to derive more than 50 utility from watching it due to superior sound and video quality. Moreover, it would have saved you the trouble of burning it onto a disc, and the space storing it. Lets say you decide to forgo the DVD and re-watch the episode on your computer. Since you derive lesser than 50 utility, arent you actually wasting your time watching the episode again? Isnt it better to wait until you have enough money to purchase the DVD

before watching the episode again? Or if you lack the money, isnt there other stuff in life that you have to do? By then, due to time lag (think about the song example I provided above), the amount of utility you derive from receiving the DVD, unwrapping it slowly and finally savouring it, will be much higher than the 50 utility you have initially derived. This is exactly how I pattern my consumption of anime. Ill view the fansub and if I really like what Im watching, I will consider buying it on DVD to re-watch. Not only am I giving back to the industry, I am also getting the most out of what I watch. Consequently, I only watch each episode of anime 1 time fully, a 2nd time if I need to look for screencaps that I want to blog about. And with all these theoretical terms, you may think that deriving more than your initially utility in consumption is not worth experiencing. This is not true, as by deriving more utility, it is similar to experiencing that song or anime episode for the first time again. Something that you can never get by listening to new MP3s or watching new anime. I mean ask yourself, would you rather go for quality and re-watch Suzumiya Haruhi on DVD or watch all the sub-par anime that each new season churns out? Isnt it better to just watch the best anime each season and spend the rest of your time on your DVDs instead of watching everything? This is why I am opposed to chionging anime or marathoning anime or any show. I usually only watch 1 or 2 episodes of anime in one sitting. In fact for the last week, the only episode of anime Ive watched is CLANNAD episode 16. Yes, I am very discriminative of what anime I watch and blog. I rather spend my time going through a ton of reviews and blogs than just blindly watching anything. I mean, I still got Hellgate London to play and recently Russell asked me to play D2 again which I really dont mind. On top of that, I still have my visual novels to play and my sister constantly bugs me for tennis among a lot of other crap. It simply isnt worth it to derive lesser utility than you deserve to derive when you invest time in watching anime. By marathoning a show, the overall experience will suffer as the amount of utility will keep dropping after a point of time. I mean, I do know how it feels like. I watched the entire Full Metal Panic! The Second Raid in one shot and I felt totally sick after doing it. Urgh. It is so much better to buy the DVDs and savour the series slowly. And honestly, if it is not possible to savour a particular series, it must be because it sucks anyway. Arguebly one reason why people marathon shows is to keep up with what everyone is talking about, but that isnt necessary, since many anime blogs already provide summaries on anime episodes to read. Reading a summary will take at most 1 min as opposed to watching a 22 min episode. Summary blogs are an excellent method to cheat during social situations. For example, I think the anime adaption of Bleach is for childish losers, or trend chasers, but since its popular in Singapore (popular stuff in Singapore tend to suck), I just read Random Curiositys summaries to keep up on what is going on and not consume digusting animation quality and wind up deriving negative utility like the rest of Singapore is doing.

So anyway in conclusion, piracy has an overall positive benefit to both producers and consumers by providing free promotion material. But beyond that, piracy is bad as we are all bounded by the Law of Diminishing Marginal Utility. In a perfect world, well have perfect people who consume to maximise utility, and probably will stop watching an anime/drama and wait for the DVDs after only watching a few episodes. Even though a perfect world is impossible to achieve, moving closer to a perfect economy will infinitely benefit both producers and consumers (ourselves). And to end off, here is my really small R1 DVD collection together with some of my manga and light novels:

P.S. This utility shit can be applied to manga and books in general. There is nothing compared to curling up in a comfy couch with a book or manga/light novel. Online free manga is really a waste of time and their function is really similar to fansubs as free promotion for the particular manga.
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Shift in the demand curve

Usually demand curves are drawn based on the assumption except for price all other factors remain the same. But there might be instances when demand may be affected by factors other than price. This will result in the cause the demand curve to SHIFT inwards or outwards.

change in

demand although the price will remain the same. This change in demand may

Shift of demand curve OUTWARDS shows an increase in demand at the same Shift of demand curve INWARDS shows that less is demanded at the same

price level. It is known as INCREASE IN DEMAND.

price level. It is known as a FALL IN DEMAND.

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Change in quantity demand:

A movement along a given demand curve caused by a change in demand price. The only factor that can cause a change in quantity demanded is price. A related, but distinct, concept is a change in demand. A change in quantity demanded is a change in the specific quantity of a good that buyers are willing and able to buy. This change in quantity demanded is caused by a change in the demand price. It is illustrated by a movement along a given demand curve.

In fact, the only way to induce a change in quantity demanded is with a change in the price. Anything else, everything else, causes a change in demand. As the demand price induces a change in the quantity demanded and a movement along the demand curve, the five demand determinants (buyers' income, buyers' preferences, other prices, buyers' expectations, and number of buyers) remain unchanged.

Demand and Quantity Demanded

To set the stage for an understanding of this difference, take note of two related concepts: Quantity Demanded: Quantity demand is a specific quantity that buyers are willing and able to buy at a specific demand price. It is but ONE point on a demand curve. Demand: Demand is the range of quantities that buyers are willing and able to buy at a range of demand prices. It is ALL points that make up a demand curve.

Making Changes
So what happens when the phrase "change in" is placed in front of each term? Change in Quantity Demanded: A change in quantity demanded is a change from one price-quantity pair on an existing demand curve to a new pricequantity pair on the SAME demand curve. In other words, this is a movement along the demand curve. A change in quantity demanded is caused by a change in price. Change in Demand: A change in demand is a change in the ENTIRE demand relation. This means changing, A Change in Quantity Demanded moving, and shifting the entire demand curve. The entire set of prices and quantities is changing. In other words, this is a shift of the demand curve. A change in demand is caused by a change in the five demand determinants.

Changing the Quantity

A change in quantity demanded is a movement along a given demand curve. A change in demand is a shift of the demand curve. These alternatives can be illustrated with the negatively-sloped demand curve presented in this exhibit. This demand curve captures the specific one-to-one, law of demand relation between demand price and quantity demanded. The five demand determinants are assumed to remain constant with the construction of this demand curve. A Change in Quantity Demanded: A change in quantity demanded, which is only triggered by a change in demand price, is a movement along the demand curve. Click the [A Price Change] button to demonstrate. A Change in Demand: A change in demand, which is triggered by a change in any of the five demand determinants, is a shift of the demand curve. Click the [A Determinant Change] button to demonstrate.

An Important Difference
Why is this difference so important? The answer is as simple as cause and effect. The demand curve is used (together with supply) to explain and analyze market exchanges. The sequence of events follows a particular pattern. First, a demand (or supply) determinant changes. Second, this determinant change causes the demand curve (or supply curve) to shift. Third, the change in demand (or supply) causes either a shortage or a surplus imbalance in the market. The market is in a temporary state of disequilibrium. Fourth, the shortage and surplus imbalance causes the price of the good to change. Fifth, the change in price causes a change in quantity demanded (and supplied). Sixth, the change in quantity demanded (and supplied) eliminates the shortage or surplus and restores market equilibrium.

The key conclusion is that demand (and supply) determinants, which induce changes in demand (and supply), are the source of instability in the market. The change in price, which induces a change in quantity demanded (and supplied) is the means of eliminating the instability and restoring equilibrium.