CHAPTER-4: INDIVIDUAL

AND MARKET DEMAND

MANAGERIAL ECONOMICS (BUS-525)

COURSE CONVENER:
DR. TAMGID AHMED CHOWDHURY
CHAPTER OUTLINE
We will learn about:
- Individual demand and derivation of demand

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curve by using IC approach
- Price effect, income effect and substitution effect
for normal, inferior and giffen goods
- Impact of tax on socially desirable consequences
- Market demand curve from individual demand
schedule
- Consumer and producer surplus analysis

2
PRICE CHANGE AND
INDIVIDUAL DEMAND CURVE

Effect of price change:

When price of one
product decreases,

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that will rotate the
budget line, hence the
demand curve of the
product can be
drawn.
Price consumption
curve: curve tracking
the utility
maximizing
combinations. 3
INCOME CHANGE AND CONSUMERS
RESPONSE

If income increases
with price constant,
the consumers will

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demand more of a
normal product

4
 INCOME CHANGE AND CONSUMERS
RESPONSE: INFERIOR GOODS

Consumers prefer

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less of inferior
goods when income
increases. Thus
income
consumption curve
becomes backward

5
ENGEL CURVE
Curve relating the
quantity of a good
consumed to income.

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In (a), food is a
normal good and the
Engel curve is
upward sloping. In
(b), however,
rotten rice is
inferior good after
a certain income
level. 6
INCOME AND SUBSTITUTION EFFECT
When price of a product declines, it has two
important effects

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1) People can get that product at a cheaper price
thus the ability or purchasing power rises
2) People may not increase the consumption of the
product to maximum thus there is an income
gain.

7
PRICE, INCOME AND SUBSTITUTION
EFFECT: NORMAL GOODS

Substitution effect: It
shows the change in
consumption of a

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product (whose price has
changed) while keeping
the utility constant. For
example, even if the
consumer can consume
F1F2 extra, they will
actually consume F2E.
Thus EF2 is income
gain. 8
INCOME AND SUBSTITUTION EFFECT FROM
INFERIOR GOODS

For inferior
goods, income

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effect is
always
negative as
can be seen in
the diagram.

9
TRY YOURSELF: THE CASE OF GIFFEN
GOOD

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For giffen goods, price effect is positive which
means traditional demand rule is not applicable.

10
 Cash vs. a Price Subsidy: Lessons

A cash transfer and an equal-cost price subsidy have

the same income effect, but the price subsidy also has
a price effect.

It follows that
the cash transfer leads to higher utility, and
the price subsidy leads to more consumption of the
subsidized good.
A Price Subsidy and an Equal-Cost Cash Grant

Budget Line with

Cash Grant

Tangency Point
Clothing with Cash Grant
Tangency Point
with Price Subsidy

I3
I2 Budget Line with
Price Subsidy
I1
F1 F3 F2
Food
Cost of Both Programs
(in Units of Food)
 Food Stamps

Are poor people better off receiving

food stamps or a comparable amount
of cash?
 Food Stamps Versus Cash

All other goods

per month
Budget line with cash
Y + 100
f

C e
Y I3
d I2

I1

B
Budget line with
food stamps
A Original
budget line

0 100 Y Y + 100
Food per month
COMPARE DISCOUNT CARD AND GIFT CARD

INCOME

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C

A B IC3

IC2

IC1
BL1 BL3 BL2
0 Q1 Q3 Q2 Good X
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 COMPARE DISCOUNT CARD, GIFT CARD AND CASH GIFT

INCOME
D
IC4

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IC3

A B IC2

IC1
BL1 BL3 BL2
0 Q1 Q3 Q2 Good X
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TAX ON GASOLINE FOR SOCIAL CAUSE

Tax on gasoline has been imposed to reduce

pollution in the society. But after that

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government has given some rebate or cash
transfer to the citizen. Show the impact in
diagram

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MARKET DEMAND CURVE
How to derive market demand curve from the
demand of the individual.

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Consumer surplus: It is the difference between
what consumers are willing to pay and what they
are actually paying.
Producer surplus: It is the difference between the
production cost and the revenue earned.

Show the change in consumer surplus, producer

surplus and dead weighted loss if a tax is imposed
on a product.
Discuss about the revenue maximization rule of
elasticity
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