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Individual Demand

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Individual Demand

How Does the Best Affordable Bundle Change when the Prices or the Income Change

- Assume consumer’s preferences over bundles of two goods, x and y, can be represented by a utility function U(x,y).
- The prices of the two goods are
- Consumer’s income is I.
- The optimal bundle will be a solution to the following problem:

- Assuming convexity and “more-is-better” properties, plus some other technical assumptions, an interior solution will satisfy:
- In words: the marginal rate of substitution between the two goods is equal to the ratio of prices and all the income is spent on purchases of the two goods.

y

- If the goods are perfect substitutes, so that the marginal rate of substitution is constant no matter how much of each one of the goods the consumer has, the best affordable bundle may contain only one of the goods.

5

x

- If the goods are perfect complements, so that a consumer uses, say, 5 units of good y for every unit of good x, the best affordable bundle will always contain a fixed proportion of goods independent of the ratio of prices.

y

x

- Income Expansion Path traces the changes in the composition of the best affordable bundle as the income changes
- The Engel Curve is the relationship between the income and the amount of a good consumed

As the consumer’s income increases, the quantity demanded increases

A good is inferior if the quantity demanded falls with the consumer’s income

- Holding income and price of the second goodfixed, the Price Consumption Path for good one is the set of best affordable bundles as the price of this good varies.

- The individual demand curve is the relationship that shows how much of a good the consumer wants to purchase when the price of this good varies and the rest of the prices and the income are held constant.