Consumer Behaviour and Individual Demand

1. Changes in Income
a. Income-Consumption Curve
i. It is a locus of consumer optimum points resulting when only the
consumer’s income varies

b. Engel Curve
i. It shows the amount of a good that the consumer would purchase per unit
of time at various income levels
 ii. To derive it we keep the horizontal scale as in the income-consumption
curve and measure money income on the vertical axis
iii. Since, it is derived from consumer utility maximization,
MRSXY = PX/PY
At every point.
iv. For some goods, the Engel Curve rise
1. Gently
a. Indicating that a given increasing in income leads to a
proportionately larger increase in the quantity purchased of
the good
b. These goods are referred to as Luxuries. Eg. Education,
recreation, steaks, lobsters, etc.
2. Rapidly
a. Indicating that a given increase in income leads to a
proportionately smaller increase in the quantity purchased
of these goods
b. These goods are called necessities. Eg. Basic foodstuff, etc.
v. Engel’s Law
1. Decline in expenditure on necessities with rise in income
c. Goods
i. Normal
1. It is one of which the consumer purchases more with an increase in
income
2. Income-consumption and Engel are both positively sloped
ii. Inferior
1. It is one of which the consumer purchases less with an increase in
income
 2. Income-consumption curve and Engel curve are both negatively
sloped
2. Change in Price and Individual Demand Curve
a. Price-Consumption Curve
i. It is the locus of consumer optimum points resulting when only the price of
good X varies

b. Consumer-Demand Curve
i. It shows the amount of good that the consumer would purchase per unit of
time at various alternative price of the good while holding everything else
constant.
ii. Negatively Sloped
1. Because of the law of demand
3. Substitution and Income Effect
a. Substitution Effect
i. It measures the increase in the quantity demanded of a good when its price
falls resulting only from the relative price decline and independent of the
change in real income
ii. It results exclusively from the reduction in the relative price of good with the
level of satisfaction held constant
iii. As indifference curve are convex, substitution effect always involves
increase in the quantity demanded of the good when its price falls
iv. Generally, much larger than income effect
1. Consumer substitute the now-cheaper good for others
2. Consumer purchases many goods and spend a small fraction of
income on any one good
v. Normal Good
1. Price Declines
a. Positive
b. Income Effect
i. It measures the increase in the quantity purchased of a good resulting only
from the increase in real income that accompanies a price decline
ii. It results only from the increase in satisfaction or real income
iii. Normal Good
1. Price Declines
a. Positive
c. Inferior Good
i. Price Declines
1. Substitution Effect – Positive
2. Income Effect – Negative
3. Demand curve is negatively sloped
 d. Giffen Goods
i. If the positive substitution effect is smaller than the negative income effect
when the price of an inferior good falls, the good is called giffen good
ii. The demand curve is positively sloped
4. Substitution between Domestic and Foreign Goods
a. It has reached an all-time high, because
i. Transportation cost having fallen to very low levels for most products
ii. Increased knowledge of foreign products due to an international
information revolution
iii. Global advertising campaigns by multinational corporations
iv. The explosion of international travel
v. Rapid convergence of tastes internationally
b. For homogeneous products
i. Eg. Computer chips, special grade of wheat or steel, fiber optics, etc.
ii. Substitution is almost perfect
iii. Small price difference leads to large shift in sales from domestic to foreign
sources and vice versa.
c. For differentiated products
i. Similar but not identical, eg. Television, automobile, etc.
ii. Substitution is very high and rising
5. Application of Indifference curve analysis
a. Cash Subsidy vs Food Stamp
b. Consumer surplus measures unpaid benefits
c. Benefits from exchange