NOTES2B.201

# NOTES2B.201 - NOTES ON CONSUMER THEORY AND DEMAND CONT III The demand schedule Note something very important As the price of either good 1 or good

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NOTES ON CONSUMER THEORY AND DEMAND, CONT. III. The demand schedule Note something very important. As the price of either good 1 or good 2 changes ceteris paribus, the consumer's budget line will rotate. And if his income increases/decreases, his budget line will shift out/in in a parallel fashion. As a result, the market basket that the individual wishes to purchase will change. That is, the quantities of the two goods that he demands will change. Before going any further, let's be sure we're on the same page in regards to what the word "demand" means. The expression "quantity of good i demanded by the consumer" refers to the quantity of that good that the consumer wishes to purchase given prices and his income. The consumer's demand schedule for good i shows how the quantity of good i that he demands changes as the price of good i changes ceteris paribus. Let's "derive" a subject consumer's demand schedule for good 1 using one of the graphs up above. Suppose initially a price for good 1, a price for good 2, and an income for our subject. Denote the initial values of these three variables p1, p2, and Y respectively. Let AB be his budget line under those conditions. Suppose initially he wishes to purchase the market basket denoted x. Thus, at those prices and with that income the quantity of good 1 demanded by our subject is Q1 units and the quantity of good 2 demanded is Q2 units. Now, suppose that the price of good 1 falls ceteris paribus, i.e. the price of good 1 goes down but the price of good 2 and the consumer's income stays the same. Then his budget line is AC. Well, the market basket x is now below his budget line. That tells us that if he continues to buy market basket x he won't be spending his entire income. Because the price of good 1 is lower, he can buy more goods with the same income. And therefore we say that his real income has increased. So, for this reason, because his real income has increased, he would be inclined to buy a different market basket, a market basket on his new budget line, AC. In other words, the change in the price of good 1 would lead to a change in the quantity of good 1 (and possibly good 2) demanded because that decrease in price increases the consumer's real income. However, when the price of good 1 falls ceteris paribus, the consumer does not have to give up as much good 2 in order to increase his consumption of good 1. Let's think about that using a numerical example. Say initially the price of good 1 is \$ 8 and the price of good 2 is \$ 6. Then in order to purchase say, 3 more units of good 1 the consumer would have to stop purchasing 4 units of good 2 ( \$ 8 X 3 = \$24, \$ 6 X 4 = \$24 ). Well, suppose the price of good 1 drops to \$ 6. Then in order to increase his consumption of good 1 by 3 units, the consumer would now only

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## This note was uploaded on 04/16/2008 for the course ECON 2010 taught by Professor Aljamal during the Spring '06 term at Western Michigan.

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NOTES2B.201 - NOTES ON CONSUMER THEORY AND DEMAND CONT III The demand schedule Note something very important As the price of either good 1 or good

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