CH 6

CHAPTER 6
Demand
Copyright © 2019 Hal R. Varian

Properties of Demand Functions
• Comparative statics analysis of ordinary demand functions—the study of
how ordinary demands x1*(p1, p2, m) and x2*(p1, p2, m) change as prices (p1,
p2) and income (m) change.
“Statics” means that we are not concerned with any adjustment process that may be involved in
moving from one choice to another; rather we will only examine the equilibrium choice.

Own-Price Changes - 1
• How does x1*(p1, p2, m) change as p1 changes, holding p2 and m constant?
• Suppose only p1 increases, from p1′ to p1″ and then to p1‴.

Normal Vs. Inferior Goods
• Normal goods is when the demand for each good would increase
when income increases
Δx1
>0
Δm
• Inferior goods is when increase of income results in a reduction
in the consumption of one of the goods
• E.g. : low quality foods/goods

Own-Price Changes – Fixed p2 and m - 1












• The curve containing all the utility-maximizing bundles traced out as p1
changes, with p2 and y constant, is the p1-price offer curve.
• The plot of the x1-coordinate of the p1-price offer curve against p1 is the
ordinary demand curve for commodity 1.

• What does a p1 price offer curve look like for Cobb-Douglas preferences?

• What does a p1 price offer curve look like for Cobb-Douglas preferences? Take:
U ( x1 , x2 ) = x1a x2b .
• Then the ordinary demand functions for commodities 1 and 2 are . . .

a m
x ( p1 , p2 , m) =
*

a + b p1
1
and
b m
x ( p1 , p2 , m) =
*
 .
a + b p2
2
• Notice that x2* does not vary with p1 so the p1 price offer curve is flat.



• What does a p1 price offer curve look like for a perfect complements utility
function?

• What does a p1 price offer curve look like for a perfect complements utility
function?

m
x ( p1 , p2 , m) = x ( p1 , p2 , m) =
* *
.
p1 + p2
1 2
• With p2 and y fixed, higher p1 causes smaller x1* and x2*.
m
As p1 → 0 x1 = x2 →
* *
.
p2
As p1 →  x1* = x2* → 0.





• What does a p1 price-offer curve look like for a perfect-substitutes utility
function?

and







• Usually we ask “Given the price for commodity 1 what is the quantity
demanded of commodity 1?”
• But we could also ask the inverse question “At what price for commodity 1
would a given quantity of commodity 1 be demanded?”

Given p1′, what quantity is
demanded of commodity 1?
Answer: x1′ units.

Given p1′, what quantity is
demanded of commodity 1?
Answer: x1′ units.
The inverse question is:

Given x1′ units are demanded,
what is the price of
commodity 1?
Answer: p1
• Taking quantity demanded as given and then asking what must be price
describes the inverse demand function of a commodity.

am
A Cobb-Douglas example: x = *
is the ordinary demand function and
(a + b) p1
1
is the inverse demand function.

am
p1 =
(a + b) x1*

m
A perfect-complements example: x =*
is the ordinary demand
p1 + p2
1
m
function and 1
p = *
− p2 is the inverse demand function.
x1

Income Changes - 1
• How does the value of x1*(p1, p2, m) change as y changes, holding both p1 and
p2 constant?

Income Changes - 2
Fixed p1 and p2.

Income Changes - 3
Fixed p1 and p2.

Income Changes - 4
Fixed p1 and p2.

Income Changes - 5
• A plot of quantity demanded against income is called an Engel curve.
If we hold the prices of goods fixed and look at how demand changes as we change income, we generate
a curve known as the Engel curve.
The Engel curve is a graph of the demand for one of the goods as a function of income, with all prices
being held constant.

Income Changes – Fixed p1 and p2 - 1



Income Changes and Cobb-Douglas Preferences - 1
• An example of computing the equations of Engel curves; the Cobb-Douglas
case.
• The ordinary demand equations are
am bm
x =
*
x =
*
(a + b) p1 ( a + b ) p2
1 2

• Rearranged to isolate y, these are
• Engel curve for good 1


Income Changes and Perfectly Complementary Preferences - 1
• Another example of computing the equations of Engel curves; the perfectly
complementary case.
• The ordinary demand equations are

m
x =x =
* *
p1 + p2
1 2

Income Changes and Perfectly Complementary Preferences - 2
m
x =x =
* *
p1 + p2
1 2
Rearranged to isolate y, these are:
Engel curve for good 1
Engel curve for good 2





Income Changes and Perfectly Substitutable Preferences - 1
• Another example of computing the equations of Engel curves; the perfect-
substitution case.
• The ordinary demand equations are…

• Suppose Then, and

and


Income Changes - 6
• In every example so far the Engel curves have all been straight lines.
• Q: Is this true in general?
• A: No. Engel curves are straight lines if the consumer’s preferences are
homothetic.

Homotheticity
A consumer’s preferences are homothetic if and only if
for every k > 0.
• That is, the consumer’s MRS is the same anywhere on a straight line drawn
from the origin.

Income Effects – A Nonhomothetic Example
• Quasilinear preferences are not homothetic.
• For example,

Quasilinear Indifference Curves
• Each curve is a vertically

shifted copy of the others.
• Each curve intersects both

axes.

Income Changes – Quasilinear Utility - 1



Income Effects - 1
• A good for which quantity demanded rises with income is called normal.
• Therefore a normal good’s Engel curve is positively sloped.

Income Effects - 2
• A good for which quantity demanded falls as income increases is called
income inferior.
• Therefore an income-inferior good’s Engel curve is negatively sloped.

Income Changes – Goods 1 & 2 Normal

Income Changes – Good 2 Is Normal, Good 1 Becomes Income Inferior - 1



Ordinary Goods - 1
• A good is called ordinary if the quantity demanded of it always increases as
its own price decreases.

Ordinary Goods - 2
• Fixed p2 and y.

Ordinary Goods - 3
• Fixed p2 and y.

Ordinary Goods - 4
• Fixed p2 and y.

Giffen Goods - 1
• If, for some values of its own price, the quantity demanded of a good rises as
its own price increases then the good is called Giffen.

Giffen Goods - 2
• Fixed p2 and y.

Giffen Goods - 3
• Fixed p2 and y.

Giffen Goods - 4
• Fixed p2 and y.

Cross-Price Effects - 1
• If an increase in p2
• increases demand for commodity 1 then commodity 1 is a gross
substitute for commodity 2.
• reduces demand for commodity 1 then commodity 1 is a gross
complement for commodity 2.

• A perfect-complements example:
m
x1* =
p1 + p2
• so . . .
 x1* m
=−  0.
 p2 ( p1 + p2 )2
Therefore commodity 2 is a gross complement for commodity 1.

• Increase the price of good 2

from p2′ to p2″ and . . .

• Increase the price of good 2

from p2′ to p2″ and the demand
curve for good 1 shifts inward.
Good 2 is a complement for
good 1.

• A Cobb-Douglas example:
bm
x2 =
*
( a + b ) p2
• so . . .
 x2*
= 0.
 p1
Therefore commodity 1 is neither a gross complement nor a gross substitute for
commodity 2.

Inverse Demand Function
• The inverse demand function is
the demand function viewing
price as a function of quantity.
• Same relationship, just
represented differently

Credits
This concludes the Lecture PowerPoint presentation for Chapter 6 of Intermediate Microeconomics, 9e
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CHAPTER 6

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

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• Then the ordinary demand functions for commodities 1 and 2 are . . .

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

• Then the ordinary demand functions for commodities 1 and 2 are . . .

Copyright © 2019 Hal R. Varian

• With p2 and y fixed, higher p1 causes smaller x1* and x2*.

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

• Then the ordinary demand functions for commodities 1 and 2 are . . .

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

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Answer: x1′ units.

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Answer: x1′ units.

The inverse question is:

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is the inverse demand function.

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Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

Copyright © 2019 Hal R. Varian

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Copyright © 2019 Hal R. Varian