Composite good
Encyclopedia
In economics
, demand for a good
is often the focus as to a change in its price. A composite good is an abstraction used in economics
that represents all goods in the relevant budget besides the one in question.
shows how the composite may be treated as if it were only a single good as to properties hypothesized about demand. The composite good represents what is given up along consumer's budget constraint to consume more of the first good.
s cannot be calculated.
The addition of one new good to a single-good market allows for opportunity costs to be determined only in relation to that other good. However, its weakness is that it ignores all other possible choices. Trying to solve this problem by adding even more goods to the market makes analysis unwieldy. Under these circumstances, economic modelers are forced to choose between goods in order to create a simple model.
The concept of the composite good addresses this problem. The addition of a composite good in a single-good model (bringing it up to two) allows for all other opportunities to be accounted for. Since the composite is considered a single good only for purposes of the model, analysis can be made on a two-dimensional graph. Optimal choices represent the bundle of two goods; the first good and the composite.
A final step can be taken in relating the composite good to a unit of account
such as money
by setting the price of the composite good to 1. Since the prices of all other goods are known, the composite good can be converted into any combination of bundles that represent the optimal choice other than the first good. This final step clarifies the relation of the model to the real world where many goods can be stated in terms of money value. In John R. Hicks's classic Value and Capital
(1939), a composite good was used to generalize mathematically from consumer demand equilibrium for an individual in the 2-good case to market equilibrium via supply and demand
in the n-good case.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, demand for a good
Good (economics and accounting)
In economics, a good is something that is intended to satisfy some wants or needs of a consumer and thus has economic utility. It is normally used in the plural form—goods—to denote tangible commodities such as products and materials....
is often the focus as to a change in its price. A composite good is an abstraction used in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
that represents all goods in the relevant budget besides the one in question.
Purpose
Consumer demand theoryConsumer theory
Consumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in...
shows how the composite may be treated as if it were only a single good as to properties hypothesized about demand. The composite good represents what is given up along consumer's budget constraint to consume more of the first good.
Reason for use
Budget constraints are designed to show the maximum amount of a good, or combination of goods, that can be purchased by a consumer given a limited budget. In a single-good world, the cost of a good cannot be related to any other opportunities. Therefore, opportunity costOpportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
s cannot be calculated.
The addition of one new good to a single-good market allows for opportunity costs to be determined only in relation to that other good. However, its weakness is that it ignores all other possible choices. Trying to solve this problem by adding even more goods to the market makes analysis unwieldy. Under these circumstances, economic modelers are forced to choose between goods in order to create a simple model.
The concept of the composite good addresses this problem. The addition of a composite good in a single-good model (bringing it up to two) allows for all other opportunities to be accounted for. Since the composite is considered a single good only for purposes of the model, analysis can be made on a two-dimensional graph. Optimal choices represent the bundle of two goods; the first good and the composite.
A final step can be taken in relating the composite good to a unit of account
Unit of account
A unit of account is a standard monetary unit of measurement of value/cost of goods, services, or assets. It is one of three well-known functions of money. It lends meaning to profits, losses, liability, or assets....
such as money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
by setting the price of the composite good to 1. Since the prices of all other goods are known, the composite good can be converted into any combination of bundles that represent the optimal choice other than the first good. This final step clarifies the relation of the model to the real world where many goods can be stated in terms of money value. In John R. Hicks's classic Value and Capital
Value and Capital
Value and Capital is a book by the British economist John Richard Hicks, published in 1939. It is considered a classic exposition of microeconomic theory...
(1939), a composite good was used to generalize mathematically from consumer demand equilibrium for an individual in the 2-good case to market equilibrium via supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
in the n-good case.
See also
- economicsEconomicsEconomics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
- microeconomicsMicroeconomicsMicroeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold...
- Budget constraintBudget constraintA budget constraint represents the combinations of goods and services that a consumer can purchase given current prices with his or her income. Consumer theory uses the concepts of a budget constraint and a preference map to analyze consumer choices...
- unit of accountUnit of accountA unit of account is a standard monetary unit of measurement of value/cost of goods, services, or assets. It is one of three well-known functions of money. It lends meaning to profits, losses, liability, or assets....
- moneyMoneyMoney is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...