Microeconomics: Chapter 6 Demand

The consumers demand functions give the optimal amounts of each of the
goods as a function of the prices and income faced by the consumer.

Studying how a choice responds to changes in the economic environment is
known as comparative statics. The comparative statics questions in consumer
theory therefore involve investigating how demand changes when prices and
income change.
Now, we want to know how the optimal choice at one income compares to the
optimal choice at another level of income.
TYPE OF GOODS:
Normal goods: If good 1 is a normal good, then the demand for it increases when
income increases, and decreases when income decreases.
Inferior goods: Goods for which demand decreases when income increases. As I
said, an increase of income results in a reduction in the consumption of one of the
goods.
INCOME OFFER CURVES AND ENGEL CURVES:

Income offer curve: This curve
illustrates the bundles of goods that
are demanded at the different levels
income, as depicted in Figure 6.3A.
The income offer curve is also known
the income expansion path. If
both goods are normal goods, then
the income expansion path will have
positive slope.
of
as
a
For each level of income, m, there

will be some optimal choice for each
of
the goods. If we hold the prices of
goods 1 and 2 fixed and look at how demand changes as we change income, we
generate a curve known as the Engel curve.
EXAMPLES
PERFECT SUBSTITUTES
If p1 < p2, so that the consumer is
specializing in consuming good 1,
then if his income increases he will
increase his consumption of good 1.
Thus the income offer curve is the
horizontal axis, as shown in Figure
6.4A.
Since the demand for good 1 is x1 =
m/p1 in this case, the Engel curve
will be a straight line with a slope of
p1, as depicted in Figure 6.4B. (Since
m is on the vertical axis, and x1 on the horizontal axis, we can write m = p1x1).
PERFECT COMPLEMENTS
Since the consumer will always consume the
same amount of each good, no matter what,
We have seen that the demand for good 1 is
x1 = m/(p1 + p2), so the Engel curve is a
straight line with a slope of ap1 + bp2.
Example: u (x1,x2)= min (2X1, x2)
X1*= m/ (p1+2p2)
X2*= 2m/ (p1+2p2)
DEMAND CURVE:
COBB-DOUGLAS
If u(x1, x2) = x1a x21a , the Cobb-Douglas demand for good 1 has the form x1 =
am/p1. For a fixed value of p1, this is a
linear function of m. The demand for good
2
is x2 = (1a)m/p2, and this is also clearly
linear.
Real Engel curves do not have to be
straight lines. In general, when income
goes up, the demand for a good could
increase more or less rapidly than income
increases. If the demand for a good
goes up by a greater proportion than
income, we say that it is a luxury
good, and if it goes up by a lesser
proportion than income we say that it is a necessary good.
HOMOTHETIC PREFERENCES
Suppose that the consumers preferences
only depend on the ratio of good 1 to good
2. This means that if the consumer prefers
(x1, x2) to (y1, y2), then she automatically
prefers (2x1, 2x2) to (2y1, 2y2), (3x1, 3x2)
to (3y1, 3y2), and so on, since the ratio of
good 1 to good 2 is the same for all of
these bundles. In fact, the consumer
prefers (tx1, tx2) to (ty1, ty2) for any
positive value of t.
If
the
consumer
has
homothetic
preferences, then the income offer curves
are all straight lines through the origin, as
shown in Figure 6.7. More specifically, if
preferences are homothetic, it means that when income is scaled up or
down by any amount t > 0, the demanded bundle scales up or down by
the same amount.

QUASILINEAR PREFERENCES
The utility function for these preferences
takes the form u(x1, x2) = v(x1)+x2. In this
case, if an indifference curve is tangent to
the budget line at a bundle (x1, x2), then
another indifference curve must also be
tangent at (x1, x2+k) for any constant k.
Increasing income doesnt change the
demand for good 1 at all, and all the extra
income goes entirely to the consumption of
good 2.
BADS AND NEUTRAL GOODS

Neutral good or bad= 0
Demand curve: vertical line in the y axis x=0 zero
consumption of this good whatever the prices are.
The other good= m/p
Demand curve: income/ price
ORDINARY GOOD AND GIFFEN GOOD
DEMAND CURVES
SUBSTITUTES AND COMPLEMENTS

If the demand for good 1 goes up when the price of good 2 goes up, then we say
that good 1 is a substitute for good 2.
On the other hand, if the demand for good 1 goes down when the price of good 2
goes up, we say that good 1 is a complement to good 2.
INVERSE DEMAND FUNCTION
The inverse demand function is the demand function viewing price as a function
of quantity. The heigh of the demand curve at a given level of consumption
measures the marginal willingness to pay for an additional unit of the good at that
consumption level.

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The consumers demand functions give the optimal amounts of each of the

goods as a function of the prices and income faced by the consumer.

INCOME OFFER CURVES AND ENGEL CURVES:

For each level of income, m, there

the same amount.

BADS AND NEUTRAL GOODS

SUBSTITUTES AND COMPLEMENTS

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