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The foundations of a demand curve: an example of housing

The two graphs show how budget constraints influence the demand curve.
(a) As the price increases from P 0 to P 1 to P 2 to P 3 , the budget constraint on the upper part of the diagram shifts to the left. The utility-maximizing choice changes from M 0 to M 1 to M 2 to M 3 . As a result, the quantity demanded of housing shifts from Q 0 to Q 1 to Q 2 to Q 3 , ceteris paribus . (b) The demand curve graphs each combination of the price of housing and the quantity of housing demanded, ceteris paribus . Indeed, the quantities of housing are the same at the points on both (a) and (b). Thus, the original price of housing (P 0 ) and the original quantity of housing (Q 0 ) appear on the demand curve as point E 0 . The higher price of housing (P 1 ) and the corresponding lower quantity demanded of housing (Q 1 ) appear on the demand curve as point E 1 .

So, as the price of housing rises, the budget constraint shifts to the left, and the quantity consumed of housing falls, ceteris paribus (meaning, with all other things being the same). This relationship—the price of housing rising from P 0 to P 1 to P 2 to P 3 , while the quantity of housing demanded falls from Q 0 to Q 1 to Q 2 to Q 3 —is graphed on the demand curve in [link] (b). Indeed, the vertical dashed lines stretching between the top and bottom of [link] show that the quantity of housing demanded at each point is the same in both (a) and (b). The shape of a demand curve is ultimately determined by the underlying choices about maximizing utility subject to a budget constraint. And while economists may not be able to measure “utils,” they can certainly measure price and quantity demanded.

Applications in government and business

The budget constraint framework for making utility-maximizing choices offers a reminder that people can react to a change in price or income in a range of different ways. For example, in the winter months of 2005, costs for heating homes increased significantly in many parts of the country as prices for natural gas and electricity soared, due in large part to the disruption caused by Hurricanes Katrina and Rita. Some people reacted by reducing the quantity demanded of energy; for example, by turning down the thermostats in their homes by a few degrees and wearing a heavier sweater inside. Even so, many home heating bills rose, so people adjusted their consumption in other ways, too. As you learned in the chapter on Elasticity , the short run demand for home heating is generally inelastic. Each household cut back on what it valued least on the margin; for some it might have been some dinners out, or a vacation, or postponing buying a new refrigerator or a new car. Indeed, sharply higher energy prices can have effects beyond the energy market, leading to a widespread reduction in purchasing throughout the rest of the economy.

A similar issue arises when the government imposes taxes on certain products, like it does on gasoline, cigarettes, and alcohol. Say that a tax on alcohol leads to a higher price at the liquor store, the higher price of alcohol causes the budget constraint to pivot left, and consumption of alcoholic beverages is likely to decrease. However, people may also react to the higher price of alcoholic beverages by cutting back on other purchases. For example, they might cut back on snacks at restaurants like chicken wings and nachos. It would be unwise to assume that the liquor industry is the only one affected by the tax on alcoholic beverages. Read the next Clear It Up to learn about how buying decisions are influenced by who controls the household income.

Does who controls household income make a difference?

In the mid-1970s, the United Kingdom made an interesting policy change in its “child allowance” policy. This program provides a fixed amount of money per child to every family, regardless of family income. Traditionally, the child allowance had been distributed to families by withholding less in taxes from the paycheck of the family wage earner—typically the father in this time period. The new policy instead provided the child allowance as a cash payment to the mother. As a result of this change, households have the same level of income and face the same prices in the market, but the money is more likely to be in the purse of the mother than in the wallet of the father.

Should this change in policy alter household consumption patterns? Basic models of consumption decisions, of the sort examined in this chapter, assume that it does not matter whether the mother or the father receives the money, because both parents seek to maximize the utility of the family as a whole. In effect, this model assumes that everyone in the family has the same preferences.

In reality, the share of income controlled by the father or the mother does affect what the household consumes. When the mother controls a larger share of family income a number of studies, in the United Kingdom and in a wide variety of other countries, have found that the family tends to spend more on restaurant meals, child care, and women’s clothing, and less on alcohol and tobacco. As the mother controls a larger share of household resources, children’s health improves, too. These findings suggest that when providing assistance to poor families, in high-income countries and low-income countries alike, the monetary amount of assistance is not all that matters: it also matters which member of the family actually receives the money.

The budget constraint framework serves as a constant reminder to think about the full range of effects that can arise from changes in income or price, not just effects on the one product that might seem most immediately affected.

Key concepts and summary

The budget constraint framework suggest that when income or price changes, a range of responses are possible. When income rises, households will demand a higher quantity of normal goods, but a lower quantity of inferior goods. When the price of a good rises, households will typically demand less of that good—but whether they will demand a much lower quantity or only a slightly lower quantity will depend on personal preferences. Also, a higher price for one good can lead to more or less of the other good being demanded.

Problems

If a 10% decrease in the price of one product that you buy causes an 8% increase in quantity demanded of that product, will another 10% decrease in the price cause another 8% increase (no more and no less) in quantity demanded?

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Questions & Answers

What is national income
Benjamin Reply
national income it means the value of goods and services produce by a country for every financial year.
Simon
The quantity of a good demanded rises from 1000 to 1500 units when the price fallsfrom$1. 50 to$1. 00 per unit. Find the price elasticity of demand?
Rishiraj Reply
what is meant by Regional policy
Itz Reply
what is demand
Tangwe Reply
nice question..
Suman
what is aggregate demand and the equation for Y(GDP)
Davido Reply
what is cost concept
Fatai Reply
is a type of mechanism which makes consumers and individuals understand the price of goods and services
Davido
who is the father of Economics
John Reply
i dont know
Suman
Adam Smith
deep
hi
Zafraan
Adam
Zafraan
smith
Zafraan
Adam Smith
Bevingtone
What is opportunity cost
Bevingtone
is the value of the next best thing you give up when making a decision.
Bongiwe
opportunity cost is a made in order to enjoy something else
Laila
what is cost concept
Fatai
Adam Smith
Md
Adam Smith
Akligo
Adam Smith
Samura
What is demand and supply
Ehwehwe
demand refers to goods and services which consumers are willing and able to buy at a particular period of time and supply refers to the goods and services which consumers are willing and able to offer for sale at a particular period of time
Davido
demand is the quantity of goods and services which a particular customer is willing and able to purchase at that point in time.while supply is a quantity of goods and services which the company is willing and able to render to the customer who purchased it at that point
Israel
Adam Smith
Israel
cost concept. it is used for analyzing the cost of a project in short and long run
Israel
opportunity cost can be seen as a forgone alternative. it can be seen as the loss of other alternatives when one alternative is chosen
Israel
cost is value of imput and output at particular period of time. but we can classify in short run and long run.
Nago
Cost is the aggregated sum accrue in procuring something worthwhile.
KATUNKUS
Adam Smith
Som
Adam Smith
Tandan
Adam smith
Hafiz
what is the formula for elasticity
Umar Reply
perc of qty chg/perc of price chg
Suman
ok
Umar
I need some help regarding economic numericals.
Hassan
Send your problems
Tandan
utility
Oppong
demand or supply equation dy hn OK iska schedule bnana above equation ko dekhty hue kasy bnaye gy
Saba
what is cobweb?
Solomon Reply
A spider's web, especially when old and dusty (The wooden carvings were almost obliterated by cobwebs)
huzaif
what is Economic
Mbarohey Reply
Economic is a social science that study human behavior in relationship with end and scarce means which have alternative uses
Agyenkwa
Economics is an inquiry into nature that causes wealth of nations.
Eric
what are the importance of economic
Mbarohey
it helps us use our limited resources to satisfy our unlimited wants
Daniel
economic is the science of wealth
Joseph
it's helps us to be current on what's going on in the world
Joseph
economics can be defined as the science of wealth
Joseph
what are the advantages of sole proprietorship
Mbarohey
is the study of mankind in the ordinary business
Awini
Economic is science which study human behavior in relation to relatively scarce resources and how they are managed
Akligo
What is the formula for calculating elasticity?
Haruna Reply
(%change in quantity) / (%change in price)
Rahul
thx
lil
.
Tandan
.
Tandan
government spending increase will cause economic grew
Jia Reply
no
Helicia
no because government expenditure is very high the growth of the economy will decrease
Davido
what is trade by batter
Iko Reply
trade involves the transfer of good or services from one person to another, often in exchange for money.
musadique
Now trade by batter :it may define as form of trading in which good are exchange directly for other goods without the use of money as medium of exchange
musadique
is it good to trade with something with a value but given something which has no value
sandra
trade in batter means the exchange of goods and services without using money
Maa
It may be defined as an exchange of goods to satisfy the needs of two parties
Haruna
is the exchange of goods and services for the consumption of human wants
Davido
mention six factors that explain efficiency and productivity of labour
fanelchainz Reply
mention six factors that explain efficiency and productivity of labour
bohvy
factors that explain efficiency of labor are 1.population, 2.technology, 3.education, 4.working environment, 5.incentives (tax holidays) and 6.religious or cultural beliefs.
Solomon
What is demand
SoFIA Reply
is the abulity and willingness of a consumer to purchase goods and services at a particular peeiod of time in a given price
Fadhil
Is goods or service that a consumer is willing and able to purchase at a particular time over a giving period of time
Konja
is the ability and the willingness to buy a goods at a particular period of time in a given price
Prince
please go ahead it's been long time you all are explaining basic topics so now there are many topics left you have to discuss them .
Zahid

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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