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econ11_09_lecture4

# econ11_09_lecture4 - Lecture 3 Consumer Theory(contd Topics...

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Chaiyuth DB802 2011 1 Lecture 3: Consumer Theory (cont d) Topics 1.5 Properties of Demand Keywords: Relative prices, real income Substitution and income effects, Slutsky equation, Law of Demand

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Chaiyuth DB802 2011 2 1.5.1 Relative Prices and real income Relative prices of good x in terms of good y = units of good y foregone per unit of good x acquired. p x / p y = units of y / a unit of x Example. p x / p y = 3 means that to get a unit of x, we have to sacrifice 3 units of y. In other words, price of x is 3 times higher than of y.
Chaiyuth DB802 2011 3 1.5.1 Relative Prices and real income Real income: number of units of goods we could get from our money income. Reflect our purchasing power over a single good. Nominal income / price of good x = units of x. Marshallian demand is HD 0 in prices and income. No money illusion

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Chaiyuth DB802 2011 4 1.5.1 Relative Prices and real income Theorem 1.10: Homogeneity and Budget Balancedness Given u is continuous, st. increasing, and st. quasiconcave, x(p,y) is HD zero in all prices and income, and it satisfies budget balancedness, px=y for all (p,y) . Idea: as MU is positive, you will use up your money. For any (p,y), budget is binding.
Chaiyuth DB802 2011 5 1.5.1 Relative Prices and real income As for Homogeneity, we can use price of one good to be money unit. All things are compared to the price of this good. We call this good as numeraire. Say p n be numeraire; let t = 1/ p n x(p,y) = x(tp,ty) = x ( p 1 /p n , ... , p n-1 /p n , y / p n ) Demand depends on only n-1 relative prices, and real income.

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Chaiyuth DB802 2011 6 1.5.2 Income and Substitution Effects How consumers respond to a relative price change. Suppose the price of good 1 becomes cheaper, we will buy more of good 1. Very likely, but could this be only an answer? Let talk about few concepts on
Effect of a Price Change Food (units per month) Clothing (units per month) 4 5 6 U 2 U 3 A B D U 1 4 12 20 Three separate indifference curves are tangent to each budget line. Assume: I = \$20 P C = \$2 P F = \$2, \$1, \$.50 10 7 Chaiyuth DB802 2011

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