Lecture 6 - Lecture 6 Income and Substitution I Work less...

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Lecture 6 Income and Substitution I Work less, wear less, eat less, and we shall be a great deal wiser, healthier, and wealthier than by taking the course we now do. Brigham Young, Journal of Discourses, vol. 12, p. 122. The Economics Outline 1. Changes in Income 2. Changes in Price 3. Income and Substitution Effects The Mathematics Outline 1. Comparative Statics 2. Partial Derivatives Changes in Income A change in income will shift out the budget constraint and allow the individual to attain a higher level of utility. However, an increase in income does not necessarily mean that the individual will buy more of any given good. It is through changes in income that we define normal goods and inferior goods. Mathematically we have : If 0 , then x * I x i i is a normal good. [See Figure 5.1 in Nicholson] If 0 < then x * I x i i is an inferior good [See Figure 5.2 in Nicholson] Changes in Price A change in price will result in a change in the quantity demanded. To determine the magnitude of the change you would take the derivative, i i P x * . One would think that, at a minimum, you could say that 0 * < i i P x . This just says that the demand curve is downward sloping. However, it turns out that there are conditions under which the demand curve could be upward sloping. In other words, without knowing the specifics of the case I cannot tell if the derivative,
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Lecture 6 - Lecture 6 Income and Substitution I Work less...

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