Intermediate Microeconomics Ch6 notes

Intermediate Microeconomics Ch6 notes - Ch 6 Demand The...

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1 Ch 6 Demand The last chapter explored how a consumer maximized utility subject to her budget constraint to determine the optimal choice. We has seen that her demand for each good depends on the prices and her income denoted by x i = x i (p 1 , p 2 , m) for i = 1, 2 . This chapter will examine how the quantity demanded of each good changes as the prices and income change. Studying how demand responds to changes in a parameter is known as comparative statics. The prices and income are parameters since they are not plotted on either axis in the ( x 1 , x 2 ) – space. As mentioned before, any change in a parameter leads the relevant curve (or line) to shift or rotate and thus causes demand to change. 6.1 Normal and Inferior Goods We now consider how a consumer’s demand for one good changes as her income changes while the prices are held fixed. Note that a rise in income only affects her BL. As shown in Panel A of figure 6.1, the demand for each good increases from X* to X*’ . Such goods are called normal goods (with 0 * > m x i ). If a rise in income results in a fall in the demand for one good (e.g., good 1, shown in Panel B of figure 6.1), such a good is called an inferior good (with 0 * 1 < m x ) that is usually a low-quality good. Normal goods for the poor may be inferior goods for the rich. 6.2 Income Offer Curves and Engel Curves We have seen that a rise in income shifts the BL outward in a parallel way so as to cause a change in demand. We can connect together the demanded bundles as we continuously shift the BL X * X *
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2 outward to construct the income offer curve (IOC, also called income expansion path). As shown in figure 6.2, the IOC may have a positive slope if both goods are normal goods, or a negative slope if one good is an inferior good (good 1 in this case). If focusing on good i , plotting demand x i against income m (with the prices held fixed) generates the Engel Curve . Corresponding to both IOCs in figure 6.2, the Engel curve looks like what is depicted in figure 6.3. 6.3 Some Examples (1) Perfect substitutes Consider the case if p 1 < p 2 so that the consumer buys only good 1. Her consumption of good 1 ( x * 1 = m/p 1 ) increases as her income rises. The IOC coincides with x 1 -axis, and the Engel Curve is a line with a slope of p 1 , as shown in figure 6.4 IOC IOC Engel curve m x i x 1 (.,.,m) x 2 (.,.,m) m Slope is p 1 m
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3 (2) Perfect Complements In this case, the consumer demands the same amount of each good ( x i * =m/(p 1 +p 2 )
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Intermediate Microeconomics Ch6 notes - Ch 6 Demand The...

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