ch05 - Chapter 5 The Theory Of Demand 1 Chapter Five...

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1 The Theory Of Demand Chapter 5

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2 Chapter Five Overview 1. Individual Demand Curves 1. Income and Substitution Effects & the Slope of Demand Applications: The Work-Leisure Trade-off Consumer Surplus 1. Constructing Market Demand Chapter Five
3 Chapter Five Overview The Effects of a Change in Price Optimal Choice Demand Curve Chapter Five

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4 Individual Demand Curves In Chapter 4, consumer’s optimal basket was determined. Thus, we can tell – for a given income and prices of other goods – how much a consumer will demand of X for a given price of X. This is a point on the consumer’s demand curve. We can find more points on the demand curve for X by changing the price of X and determining how much of X the consumer will demand – prices of other goods and income are held constant. Chapter Five
5 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: Chapter Five Individual Demand Curves

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6 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 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
7 X P X X A X B X C 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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8 The consumer is maximizing utility at every point along the demand curve The marginal rate of substitution falls along the demand curve as the price of x falls (if there was an interior solution). As the price of x falls, it causes the consumer to move down and to the right along the demand curve as utility increases in that direction. The demand curve is also the “willingness to pay” curve – and willingness to pay for an additional unit of X falls as more X is consumed. Chapter Five Individual Demand Curve
9 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. (If this never holds, a corner point may be substituted where x = 0 or y = 0) Chapter Five Demand Curve for “X”

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10 We Have: 1. p x x + p y y = I 2. x/p y = y/p x Substituting the second condition into the budget constraint, we then have: 3. p x x + p y (p x /p y )x = I or…x = I/2p x Chapter Five Demand Curve with an Interior Solution Suppose that U(x,y) = xy. MUx = y and MUy = x. The prices of x and y are px and py, respectively and income = I.
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ch05 - Chapter 5 The Theory Of Demand 1 Chapter Five...

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