lecture 2

# lecture 2 - LECTURE 2 DEMAND THEORY 1 Summary Descriptions...

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1 LECTURE 2 DEMAND THEORY

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2 Summary Descriptions Prices are assumed to be exogenously given to the consumers. The demand curve depicts the relationship between the demand for a given product and its price; other variables and parameters are suppressed. Consumers passively respond to prices ( price takers ), instead of actively setting prices (in the latter cases, a consumer who has market power is called a monopsonist). Demand curves are the result of the consumers' optimal choice.
3 Two Basic Features of Consumers Taste: utility function or ICs Income: economically feasible consumption set, or more practically, budget line. 1 1 2 2 : BL p x p x m + =

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4 Budget Line Solved Problem 3.1 (pp 63-64) A student entertainment committee for a college is given \$12,000 to bring in rock bands and speakers for the entire year. Rock bands typically cost \$4,000, and speakers typically cost \$1,000. Write the equation for the budget constraint of the committee. Assume that rock bands become more expensive and now cost \$6,000. write the new budget constraint. In terms of speakers, what is the cost of inviting a rock band to campus both before and after the increase in the price of rock bands? Draw a diagram representing the budget constraint before and after the change in the price of rock bands. Draw a diagram representing the change in the budget constraint of the committee if the college only gives it \$8,000 and if the prices are \$4,000 for rock bands and \$1,000 for speakers.
5 Budget Line Answer: BL: \$12,000=\$4,000×x r +\$1,000×x s BL: \$12,000=\$6,000×x r +\$1,000×x s Either the 4 or 6 speakers x s x r 12 3 2 0 \$12,000=\$4,000×xr+\$1,000×xs \$12,000=\$6,000×xr+\$1,000×xs x s x r 12 3 2 0 8

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6 Choice of Consumers Given tastes, income and prevailing prices in the market, how much of each good she wants to consume. Relative price Quantity demanded Q x1 Q x2
7 Price-Consumption Paths Price-Consumption Path → Demand Curves Changing relative prices

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8 Price-Consumption Paths Price-Consumption Path → Demand Curves Changing relative prices Deriving the Price-Consumption Path
9 Price-Consumption Paths Price-Consumption Path → Demand Curve Changing relative prices Deriving the Price-Consumption Path Deriving the Demand Curve: ( 29 1 1 2 , , x p p m

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10 Demand Curves Solved Problem 3.4 (pp 71-72) Bernie has preferences over egg rolls and sushi. His utility function can be expressed as u(e,s)=es, where e is egg rolls and s is pieces of sushi. The price of sushi is \$3 per piece, and egg rolls are \$2 each. Bernie has a total income of \$80. Of the following bundles, determine which is on Bernie’s demand curves for egg rolls and sushi: a) 25 egg rolls and 10 pieces of sushi b) 15 egg rolls and 10 pieces of sushi c) 20 egg rolls and 40/3 pieces of sushi.
11 Demand Curves Answer: Condition 1: Condition 2: For bundle a), (3)(10)+(2)(25)=80, but

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lecture 2 - LECTURE 2 DEMAND THEORY 1 Summary Descriptions...

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