Chapter Outline

Consumer theory explores the effects of changes in price on the amount consumed.
1. The price-consumption curve of the indifference curve model documents the quantity consumed for various prices of a good when nominal income is held constant.
2. The individual demand curve can be plotted from the information shown on a price consumption curve.
Consumer theory also explores the effects of changes in income on the amount consumed. An income-consumption curve relates quantity consumed to changes in income while prices are held constant.
1. The Engel curve is the plot of the income and quantity information shown in the income-consumption curve.
2. When consumer income rises, demand for normal goods increases, while demand for inferior goods falls.
Income and substitution effects show two influences at work when the relative price of a good changes.
1. The substitution effect is always inversely related to the price change as consumers purchase relatively more of the cheaper good because of the price change.
2. The income effect measures the consumer response to the real income effect of a price change, and its sign depends on whether the good is a normal or inferior good.
When individual demand curves are summed horizontally, a market demand curve results.
The price elasticity of demand indicates how sensitive market demand is to price changes.
1. It is calculated by dividing the percentage change in quantity by the percentage change in price.
2. An elasticity less than -1 is elastic, greater than -1 is inelastic, and equal to -1 is unit elastic
3. The point-slope method, the total expenditure method, the line-segment ratio method, (Appendix) and the arc calculation method (Appendix) are all ways of determining elasticity.
The determinants of price elasticity include such things as
1. the availability of substitutes,
2. the share of the budget the commodity commands,
3. the direction of the income effect, and
4. the length of time involved.
Market demand also depends on income levels and the distribution of income.
1. Income elasticity relates the percentage change in quantity demanded to the percentage change in income.
2. The income elasticity of a luxury exceeds 1.
3. The income elasticity of a necessity or normal good is less than 1.
4. The income elasticity of an inferior good is negative.
Cross-price elasticities are often useful in categorizing goods as either substitutes or complements in consumption.
(Appendix) Additional topics in demand theory include Giffen goods, constant elasticity, arc elasticity, and income compensated demand curves.

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