1
Econ 306
Charles Hulten
Intermediate Micro
1106C Morrill
CLASS HANDOUT #1
ARC ELASTICITIES
Consider the following example in which there are two goods, Y and X, and
prices and income are P
X
= $10, P
Y
= $10, and I = $1000.
Faced with these
data, a consumer maximizes utility by choosing the point e
1
in the top figure
on the last page.
This is the tangency of the budget constraint and the
highest attainable indifference curve, and leads to X = 70 and Y = 30.
Suppose, now, that the price of X quadruples, so that P
X
= $40, P
Y
= $10, and
I = $1000.
This rotates the budget constraint from the original position, B
1
,
to the new position B
2
, and the consumer now chooses e
2
;
at this point X = 10
and Y = 60.
This information can be represented in terms of the following
table:
I
Y
X
P
Y
P
X
$1000
20
70
$10
$10
$1000
60
10
$10
$40
This information can be represented in terms of the following demand curves:
when the price of X quadruple, the consumer move up his demand curve for X
from e
1
to e
2
.
The demand curve for Y shifts outward, while the price of Y
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 Spring '06
 cramton
 Supply And Demand, Elasticity Elasticity Elasticity, Charles Hulten

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