1 / 41

Lecture # 07-b The Theory of Demand Lecturer: Martin Paredes

Lecture # 07-b The Theory of Demand Lecturer: Martin Paredes. Outline. Individual Demand Curves Income and Substitution Effects and the Slope of Demand Applications: the Work-Leisure Trade-off Consumer Surplus Constructing Aggregate Demand. Individual Demand Curves.

cullen-head
Download Presentation

Lecture # 07-b The Theory of Demand Lecturer: Martin Paredes

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Lecture # 07-b The Theory of Demand Lecturer: Martin Paredes

  2. Outline Individual Demand Curves Income and Substitution Effects and the Slope of Demand Applications: the Work-Leisure Trade-off Consumer Surplus Constructing Aggregate Demand

  3. Individual Demand Curves Definition: The price-consumption curve of good X is the set of optimal baskets for every possible price of good X • Assumes all other variables remain constant.

  4. Y (units) The Price-Consumption Curve PY = € 4 I = € 40 10 • PX = 4 X (units) 0 XA=2 20

  5. Y (units) The Price-Consumption Curve PY = € 4 I = € 40 10 • • PX = 2 PX = 4 X (units) 0 XA=2 XB=10 20

  6. Y (units) The Price-Consumption Curve PY = € 4 I = € 40 10 • • • PX = 1 PX = 2 PX = 4 X (units) 0 XA=2 XB=10 XC=16 20

  7. Y (units) The Price-Consumption Curve PY = € 4 I = € 40 10 Price-consumption curve • • • PX = 1 PX = 2 PX = 4 X (units) 0 XA=2 XB=10 XC=16 20

  8. Individual Demand Curves Note: • The price-consumption curve for good X can be written as the quantity consumed of good X for any price of X. • This is the individual’s demand curve for good X.

  9. Individual's Demand Curve PX Individual Demand Curve For X • PX = 4 • PX = 2 U increasing • PX = 1 X XA XB XC

  10. Individual Demand Curves Notes: • The consumer is maximizing utility at every point along the demand curve • The marginal rate of substitution falls along the demand curve as the price of X falls (if there was an interior solution). • As the price of X falls, utility increases along the demand curve.

  11. Example: Finding a Demand Curve with an Interior Solution • Suppose U(X,Y) = XY • The optimal conditions are: 1. MUX = MUY Y = X PY . Y = PX . X PX PY PX PY 2. PX . X + PY . Y = I 2 PX . X = I  X = I . 2 PX

  12. PX Example: Demand Curve for an Interior Solution QD = I/(2 PX) X

  13. Example: • Suppose U(X,Y) = X + Y • What is the price-consumption curve for good X? • What is the demand curve for good X?

  14. Price-consumption curve: • When PX < PY, then X* = I/PX and Y* = 0 • When PX > PY, then X* = 0 and Y* = I/PY • When PX = PY, the consumer chooses any point in the budget line.

  15. Y (units) Example: Perfect Substitutes • Y*=I/PY PX>PY IC X (units) 0

  16. Y (units) Example: Perfect Substitutes • Y*=I/PY PX=PY IC X (units) 0

  17. Y (units) Example: Perfect Substitutes Y*=I/PY PX<PY IC X (units) 0

  18. Y (units) Example: Perfect Substitutes • Y*=I/PY Price-consumption curve IC X (units) 0

  19. Demand curve for X: 0 when PX > PY QDX = {0, I/P*} when PX = PY = P* I/PX when PX < PY

  20. PX Example: Perfect Substitutes PY I/PX Demand curve for X X 0 I/PY

  21. Individual Demand when Income Changes Definition: The income-consumption curve of good X is the set of optimal baskets for every possible income level. • Assumes all other variables remain constant.

  22. Y (units) Income-Consumption Curve I=40 U1 0 10 X (units)

  23. Y (units) Income-Consumption Curve I=68 I=40 U1 U2 0 10 18 X (units)

  24. Y (units) Income-Consumption Curve I=92 I=68 U3 I=40 U1 U2 0 10 18 24 X (units)

  25. Y (units) Income-Consumption Curve I=92 Income consumption curve I=68 U3 I=40 U1 U2 0 10 18 24 X (units)

  26. Individual Demand when Income Changes Note: • The points on the income-consumption curve can be graphed as points on a shifting demand curve.

  27. Y (units) Income-Consumption Curve Income consumption curve I=40 U1 0 X (units) 10 PX $2 I=40 X (units) 10

  28. Y (units) Income-Consumption Curve I=68 Income consumption curve U2 I=40 U1 0 X (units) 10 18 PX $2 I=68 I=40 X (units) 10 18

  29. Y (units) Income-Consumption Curve I=92 I=68 U3 Income consumption curve U2 I=40 U1 0 X (units) 10 18 24 PX $2 I=92 I=68 I=40 X (units) 10 18 24

  30. The Engel Curve • The income-consumption curve for good X can also be written as the quantity consumed of good X for any income level. • This is the individual’s Engel curve for good X.

  31. I (€) The Engel Curve 40 X (units) 0 10

  32. I (€) The Engel Curve 68 40 X (units) 0 10 18

  33. I (€) The Engel Curve 92 68 40 X (units) 0 10 18 24

  34. I (€) The Engel Curve Engel Curve 92 68 40 X (units) 0 10 18 24

  35. The Engel Curve Note: • When the slope of the income-consumption curve is positive, then the slope of the Engel curve is also positive.

  36. Definitions of Goods Normal Good: • If the income consumption curve shows that the consumer purchases more of good X as her income rises, good X is a normal good. • Equivalently, if the slope of the Engel curve is positive, the good is a normal good.

  37. Definitions of Goods Inferior Good: • If the income consumption curve shows that the consumer purchases less of good X as her income rises, good X is a inferior good. • Equivalently, if the slope of the Engel curve is negative, the good is a normal good. Note: A good can be normal over some ranges of income, and inferior over others.

  38. Y (units) Example: Backward Bending Engel Curve I=200 U1 • 0 X (units) 13 I (€) • 200 X (units) 13

  39. Y (units) Example: Backward Bending Engel Curve I=300 I=200 U2 U1 • • 0 X (units) 13 18 I (€) • 300 • 200 X (units) 13 18

  40. Y (units) Example: Backward Bending Engel Curve I=400 U3 I=300 • I=200 U2 U1 • • 0 X (units) 13 1618 I (€) • 400 • 300 • 200 X (units) 13 1618

  41. Y (units) Example: Backward Bending Engel Curve I=400 U3 I=300 • Income consumption curve I=200 U2 U1 • • 0 X (units) 13 16 18 I (€) • 400 • Engel Curve 300 • 200 X (units) 13 16 18

More Related