Demand Functions

Demand Functions
In this lecture you will learn how to,

 Derive demand functions using diagrams.
 Derive Engel curves using diagrams.
 Derive demand functions and Engel curves

mathematically.
Where are we?
 In the last few lectures we have seen how to
solve for the consumer’s optimal bundle
given prices and income.
 If either prices or income were to change,
then so would the optimal bundle.
 In this lecture we shall derive demand
functions and Engel curves by, ceteris
paribus, changing price and income,
respectively.
What is a Demand function?
 If we hold Py and m constant and plot the
optimal demand x* as a function of Px we obtain
the Marshallian or Ordinary/Normal demand
curve of the consumer.
 Note that if Py or m changes then we obtain a
new demand curve.
Deriving a demand curve
We are given a set of preferences, m
y
and py and want to derive demand for X.
B.C.(p’’’)
Let px = p’ and find x*. This
B.C.(p’)
gives a point on the
B.C.(p’’)
demand function,
U=k
Decrease the price, px = p’’
x
pX and find the new x*. This
gives the next point on the
p’ Demand function demand function.
p’’ And so on, plotting the
p’’’
points along the demand
function.
x* x* x* x
Types of demand function
 The demand function for most goods is
downward sloping (i.e. demand falls when price
increases).
 The demand function can theoretically slope
upwards because:
 The good is a Giffen good (decrease in prices
decreases demand).
 Veblen effects – people want to signal they are rich
and can afford expensive goods.
 Imperfect information – the more expensive a good
the better it must be?
 Later, we shall look in more detail at different
types of demand function.
What is an Engel curve?
 If we fix Py and Px and plot the optimal
demand x* as a function of m we obtain the
Engel curve or Income Offer Curve of the
consumer.
 NB: as ‘own price’ changes the optimal choice
moves along the offer curve as against the
income offer curve, which is derived from
changes in income, ceteris paribus.
 Note that if Py or Px change then we obtain a
new Engel curve.
Deriving an Engel curve
We are given a set of preferences,
y
pX and py and want to derive the
B.C.(m’’’) Engel curve for good X.
B.C.(m’) Fix income, m = m’ and find
x*. This gives a point on the
B.C.(m’’) U=k Engel curve,
x Increase income to m = m’’

m
and find the new x*. This
m’’’
gives the next point on the
Engel curve.
m’’
Engle Curve
m’
And so on, plotting the
points along the Engel
x* x* x* x
curve.
Types of Engel Curve (part 1)
For a normal good
m
the Engel curve is For an inferior good
m
upward sloping. the Engel curve is
downward sloping.
Engel Curve
Engel Curve
x
x
m
For a luxury good a d%
Engel Curve
change in m causes a
more than d% change in x.
x
Types of Engel Curve (part 2)
An inferior good for high levels of

income
m
A normal good for intermediate
levels of income.
Engle Curve
A good could be a luxury
good for low levels of
income.
x
Homothetic preferences
If the demand for a good goes up by the same proportion
as income then we say the consumer has homothetic
preferences.
In this case the Engel Curve must be linear. For

m example, a doubling of m will double x.
This angle measures the proportion

of income spent on Good X.
Engle Curve
Cobb Douglas preferences are
homothetic because pXx = pYy.
Other examples are perfect
complements and substitutes.
x
Quasi-linear preferences
If the utility function has the form U(x, y) = f(x) + y then
we say the consumer has quasi linear preferences.
In this case the consumer has a ‘desired level’ of

x. Beyond this an increase in income does not
m change x. So, the Engel Curve is vertical.
The desired amount of good X.

Engle Curve
There are many goods that we only
want a fixed amount of, for
example, toothpaste.
x
The consumer must buy
something!
 The Engel curves of goods X and Y (and Z…)
must be interrelated.
 For example, it cannot be that all goods are
inferior.
 It also could not be that all goods are luxury
goods.
 Can good X and good Y both be normal?
The algebra of demand
functions and Engel curves
 The good news is that we already know how
to derive an expression for the demand
function and Engel curve.
 We just need to use the same techniques as
we went through on Monday last.
Another Example
The consumer wishes to
0.5 0.5
Max U ( x, y )  2 x y
subject to p x x  p y y  m; x  0; y  0
Draw the solution
The budget constraint is linear with equation y  m  p x x.
py
Preferences are convex. An indifference

y curve has equation y  (U  2 x 0.5 ) 2
The optimal bundle (x*, y*) may be

y* an interior, tangency solution.
But, it could also be

B.C. B.C.
U=k
a boundary solution!
x* x
Look for a tangency solution
 Let’s try the tangency condition
PX MU X

PY MU Y
 In this example
MU X  x 0.5 and MU Y  0.5 y 0.5 .
 So, we get
0.5 0.5
px x 2y
  0.5
 0.5 .
p y 0.5 y x
The tangency solution
2
 Rearranging we get x  p x 
y .
4  p y 
 Using the budget constraint gives
2
p y x  px   p 
m  px x     p x x 1  x .
4  p y  
 4 py 

 So,
4mp y mp x
x and y  .
p x 4 p y  p x  p y 4 p y  p x 
The solution
 Note that boundary solutions can be ruled out
– the solution must be interior. (How and
why?)
 We can see these preferences are
homothetic because the Engel curve is linear
4 py
x  m .
p x 4 p y  p x 
 Demand for both goods is normal.

Market vs individual
 We have been talking about deriving an
individual consumer’s demand curve.
 To derive a market demand curve we need to
sum all of the individual consumers
demands.
 So, if x1* is the demand of consumer 1 and
x2* the demand of consumer 2 and so on the
market demand is given by x1* + x2* + ….
Elasticity of demand
 Elasticity of demand is a measure of the
curvature of the demand function or Engel
curve. Usually it is calculated for a market
demand curve.
p x dx
 Price elasticity of demand =  p  .
x dp x
m dx
 Income elasticity of demand = m  .
x dm
Where to next
 Demand functions and Engel curves are some of
the most important things in microeconomics so
make sure you know what they are and how to
derive them.
 Next, we shall look in more detail at demand
changes.
 Further reading is …

Demand Functions

Uploaded by

Copyright:

Available Formats

Demand Functions

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Demand Functions

Uploaded by

Copyright:

Available Formats

Demand Functions

In this lecture you will learn how to,

 Derive Engel curves using diagrams.

 Derive demand functions and Engel curves

x Increase income to m = m’’

An inferior good for high levels of

In this case the Engel Curve must be linear. For

This angle measures the proportion

In this case the consumer has a ‘desired level’ of

The desired amount of good X.

Preferences are convex. An indifference

The optimal bundle (x, y) may be

But, it could also be

MU X  x 0.5 and MU Y  0.5 y 0.5 .

 Demand for both goods is normal.

You might also like