Ch5-slides - Chapter Five The Theory Of Demand Chapter Five...

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The Theory Of Demand Chapter Five Chapter Five
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Chapter Five Overview 1. Individual Demand Curves 2. Income and Substitution Effects & the Slope of Demand • Applications: ¾ The Work-Leisure Trade-off ¾ Consumer Surplus 3. Constructing Aggregate Demand 1. Individual Demand Curves 2. Income and Substitution Effects & the Slope of Demand • Applications: ¾ The Work-Leisure Trade-off ¾ Consumer Surplus 3. Constructing Aggregate Demand Chapter Five
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Tobacco Industry In 1990s, Tobacco companies were in litigation trouble, paying billions of dollars. They cope it with raising the price for cigarettes. Small price increases generally do not cause most consumers to try to give up smoking, but they smoke few cigarettes per day. The demand for tobacco is inelastic. A 10% increase in price leads to a 4% (3.5% - 4.5%) decrease in sales. The price elasticity of demand is about -0.35 to -0.45.
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Is the set of optimal baskets for every possible price of good x, holding all other prices and income constant. The Price Consumption Curve of Good X: The Price Consumption Curve of Good X: Chapter Five Individual Demand Curves
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Y (units) X (units) 0 P X = 4 P X = 2 P X = 1 X A =2 X B =10 X C =16 10 P Y = $4 I = $40 P Y = $4 I = $40 Price Consumption Curve 20 The price consumption curve for good x can be written as the quantity consumed of good x for any price of x. This is the individual’s demand curve for good x. Chapter Five Price Consumption Curves
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X P X X A X B X C Individual Demand Curve For X Individual Demand Curve For X P X = 4 P X = 2 P X = 1 U increasing Chapter Five Individual Demand Curve
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¾ The consumer is maximizing utility at every point along the demand curve ¾ The marginal rate of substitution falls along the demand curve as the price of x falls (if there was an interior solution). ¾ As the price of x falls, utility increases along the demand curve. Chapter Five Individual Demand Curve
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X (units) Y*=I/P Y P X >P Y 0 Y (units) Chapter Five Example: Suppose U = x + y. Income, I, is spent only on x and y. Prices are p x and p y . When p x < p y , the price consumption curve is I/p x = x. When p x > p y , the price consumption curve is I/p y = y*. Between, it is x + y = I Example: Suppose U = x + y. Income, I, is spent only on x and y. Prices are p x and p y . When p x < p y , the price consumption curve is I/p x = x. When p x > p y , the price consumption curve is I/p y = y*. Between, it is x + y = I Price Consumption Curve
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X (units) Y*=I/P Y P X >P Y P X =P Y P X <P Y 0 Chapter Five Y (units) Price Consumption Curve
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X (units) Y*=I/P Y P X >P Y P X =P Y P X <P Y IC 1 IC 2 IC 3 0 Chapter Five Price Consumption Curve Y (units)
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The corresponding demand for x is: X = I/p x when p < p y I – y when p = > p X P X 0 P Y I/P Y -Y I/P X Chapter Five Demand Curve for “X”
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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.
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This note was uploaded on 07/17/2008 for the course ECON 501.02 taught by Professor Yang during the Winter '08 term at Ohio State.

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Ch5-slides - Chapter Five The Theory Of Demand Chapter Five...

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