Econ 281 Chapter5a - Chapter 5 The Theory of Demand Thus far we have studied supply and demand and their equilibrium In this chapter we will see

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1 Chapter 5 – The Theory of Demand Thus far we have studied supply and demand and their equilibrium In this chapter we will see how the demand curve arises out of consumer theory Shifts in demand will be dissected and consumer choices will be investigated further
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2 Chapter 5 – The Theory of Demand In this chapter we will study: Demand and Consumer Maximization Substitution and Income Effects Consumer Surplus Market Demand Network Externalities Labour and Leisure Choice CPI (Consumer Price Indexes)
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3 Y (units) X (units) 0 P X = 4 X A =2 X B =10 10 At a given income and faced with prices P x and P y, an individual will maximize their utility given the Tangency condition, resulting in a consumption of Good x as seen below: Demand and Optimal Choice
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4 Y (units) X (units) 0 P X = 4 P X = 2 X A =2 X B =10 10 When the price of x decreases, a consumer will maximize given the new budget line and a new amount of x will be consumed. 20 Demand and Optimal Choice
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5 Y (units) X (units) 0 P X = 4 P X = 2 P X = 1 X A =2 X B =10 X C =16 10 Price consumption curve 20 The price consumption curve for good x  plots all the utility maximization points as  the price of x changes.  This is the  individual’s demand curve for good x. Example:   The Price Consumption Curve
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6 Example:   Individual Demand Curve for X X P X X A X B X C The points along the price consumption curve produce the typically downward-sloping demand curve we are familiar with. P X = 4 P X = 2 P X = 1 U increasing
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7 Algebraically, we can solve for the individual’s  demand using the following equations: 1.  p x x + p y y = I 2.  MU x /p x  = MU y /p y  … at a tangency. -Solve (2) for y -Substitute y from (2) into (1) -Solve for x Deriving the Demand Curve
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8 Example: Finding a Demand Curve with an Interior  Solution Suppose that U(x,y) = xy.  MU x  = y and MU y  = x.  The prices of x and y are p x  and p y , respectively and  income = I. We have: 1.  p
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This note was uploaded on 03/14/2009 for the course ECON ECON 281 taught by Professor Priemaza during the Fall '08 term at University of Alberta.

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Econ 281 Chapter5a - Chapter 5 The Theory of Demand Thus far we have studied supply and demand and their equilibrium In this chapter we will see

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