Principles of Economics- Mankiw (5th) 464

Principles of Economics- Mankiw (5th) 464 - tially, the...

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478 PART SEVEN ADVANCED TOPIC FOUR APPLICATIONS Now that we have developed the basic theory of consumer choice, let’s use it to shed light on four questions about how the economy works. These four questions might at first seem unrelated. But because each question involves household decisionmaking, we can address it with the model of consumer behavior we have just developed. DO ALL DEMAND CURVES SLOPE DOWNWARD? Normally, when the price of a good rises, people buy less of it. Chapter 4 called this usual behavior the law of demand. This law is reflected in the downward slope of the demand curve. As a matter of economic theory, however, demand curves can sometimes slope upward. In other words, consumers can sometimes violate the law of demand and buy more of a good when the price rises. To see how this can happen, consider Fig- ure 21-12. In this example, the consumer buys two goods—meat and potatoes. Ini-
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Unformatted text preview: tially, the consumers budget constraint is the line from point A to point B. The optimum is point C. When the price of potatoes rises, the budget constraint shifts inward and is now the line from point A to point D. The optimum is now point E. Quantity of Pizza 50 150 50 Demand (a) The Consumers Optimum Quantity of Pepsi Price of Pepsi $2 1 (b) The Demand Curve for Pepsi Quantity of Pepsi 150 B A B A I 1 2 New budget constraint Initial budget constraint Figure 21-11 D ERIVING THE D EMAND C URVE . Panel (a) shows that when the price of Pepsi falls from $2 to $1, the consumers optimum moves from point A to point B, and the quantity of Pepsi consumed rises from 50 to 150 pints. The demand curve in panel (b) reflects this relationship between the price and the quantity demanded....
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