Econ 4010 Lecture 4

# Econ 4010 Lecture 4 - 4 Individual and Market...

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<Lecture 4> 4. Individual and Market Demand Demand curve The demand curve is defined as the relationship between the price of the good and the amount the consumer is willing and able to buy, given constant levels of the other determinants – preferences, income, prices of other goods, and so on. This relationship is inverse, because as price gets higher, people want less of a particular product. In the diagram, the line shows a plot of the demand curve, say for food prices and quantity of food demanded. By convention, the demand curve displays quantity demanded as the independent variable (the horizontal axis) and price as the dependent variable (the vertical axis). (Price of Food, Units of Food demanded) => A: (\$20, 2)B: (\$10, 4) C: (\$4, 10)D: (\$2, 20) Maximizing Utility (P F = \$20) Maximizing Utility (P F = \$10) Maximizing Utility (P = \$4) The effect of a fall in the price of food Looking at the different prices has produced the different points on an individual's demand curve. By varying the price of food, other points could be found and an entire demand curve for one individual consumer constructed. Utility-maximizing condition results in a negatively sloped demand curve. Every point on the demand curve is utility maximizing point with different prices. 1

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Law of Demand: Other things being held constant, the lower the price of a good, the greater the quantity of it that will be demanded by purchases at any given time. Q1. Explain whether the following statements are true or false. a. The marginal rate of substitution diminishes as an individual moves downward along the demand curve. True. The consumer will maximize her/his utility by choosing the bundle on her/his budget line where the price ratio (P 1 /P 2 ) is equal to the MRS. As the price falls, the price ratio becomes a smaller number and hence the MRS becomes a smaller number. b. The level of utility increases as an individual moves downward along the demand curve. True. As the price of a good falls, the budget line pivots outwards and the consumer is able to move to a higher indifference curve. Q2. Derive the demand function from the utility function given below by using the Lagrangian method. U(X, Y) = log(X) + log(Y)
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Econ 4010 Lecture 4 - 4 Individual and Market...

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