Ch.5 Notes

# Ch.5 Notes - Intermediate Microeconomics Professor Yongmin...

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Intermediate Microeconomics Professor Yongmin Chen Topic 4. Individual Demand and Market Demand The Equilibrium of the Consumer: Review The consumer is in equilibrium, or her consumption choice is optimal, if any of the following is true: (1) Given the budget constraint, the consumer has chosen the commodity bundle that maximizes her utility. (2) The commodity bundle the consumer chooses is at the point where her indifference curve is tangent to her budget line. (3) The consumer's marginal rate of substitution of X for Y is equal to the price of X over the price of Y. (4) The ratio of the marginal utilities of any two goods is equal to their price ratio. Effects of Changes in Income When the consumer's income changes, her optimal choice of consumption will also change. We can analyze this in two steps: First, a change in income shifts the budget line. If there is an increase in income, the budget line will shift out; and if there is a decrease in income, the budget line will shift in. Second, after a shift in the budget line, the consumer finds a new consumption bundle at which her indifference curve is tangent to the new budget line. (See a graphical illustration in class.) This way, we can find out the relationship between the equilibrium quantity purchased of a good and the level of income. This relationship is usually referred to as the Engel curve. Example. The derivation of the Engel curve for a good. For most goods, when income is higher, the consumer will purchase more of them. Such goods are called normal goods. In other words, a normal good is one whose Engel curve has a positive slope. The opposite of the normal good is the inferior good. A good is called an inferior good if the consumer will buy less of it with higher income.

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Example. An inferior good. Example. True or false: If a good is an inferior good, consumers will prefer less of it to more of it. Example. Why should an investor be interested in the Engel curves of goods? Effects of Changes in Price When a commodity's price changes, the consumer's optimal choice of consumption will change too. Again, we can analyze this in two steps: First, a change in a good's price rotates the budget line. If it is a price increase, the budget line will rotate inward; and if it is a price decrease, the budget line will rotate
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Ch.5 Notes - Intermediate Microeconomics Professor Yongmin...

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