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lecture7

# lecture7 - Professor Jay Bhattacharya Spring 2001...

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Professor Jay Bhattacharya Spring 2001 Econ 11--Lecture 7 1 Spring 2001 Econ 11--Lecture 7 1 Demand III Last lecture we covered: – Substitution and Income Effects – Slutsky Equation – Giffen Goods – Price Elasticity of Demand Spring 2001 Econ 11--Lecture 7 2 Substitutes and Complements We will now examine the effect of a change in the price of another good on demand. • Define x 1 and x 2 as “Gross Substitutes” if an increase in the price of x 2 leads to an increase in the demand for x 1 . > 0 2 1 dp dx Gross Substitutes Spring 2001 Econ 11--Lecture 7 3 Substitutes and Complements • Define x 1 and x 2 as “Gross Complements” if an increase in the price of x 2 leads to an decrease in the demand for x 1 . < 0 2 1 dp dx “Gross complements” Spring 2001 Econ 11--Lecture 7 4 Substitutes and Complements Gross Substitutes Gross Complements x 1 x 1 x 2 x 2 0 2 1 > dp dx 0 2 1 < dp dx Spring 2001 Econ 11--Lecture 7 5 Cross-Price Elasticity of Demand 1 2 2 1 12 x p dp dx = ε > 0 12 ε < 0 12 ε Gross Substitutes Gross Complements Why estimate elasticities rather than just the derivatives?—Elasticities are unitless. Spring 2001 Econ 11--Lecture 7 6 Hicksian Demand Functions Recall “Marshallian” Demand Functions hold income constant “Hicksian” or “Utility Constant” or “Compensated” Demand Function – Hicksian demand functions hold utility constant ( ) I p p f x , , 2 1 1 = ( ) U p p h x , , 2 1 1 =

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Professor Jay Bhattacharya Spring 2001 Econ 11--Lecture 7 2 Spring 2001 Econ 11--Lecture 7 7 Hicksian Demand x 2 x 1 x 1 p 1 Decreasing p 1 Spring 2001 Econ 11--Lecture 7 8 Hicksian vs. Marshallian Demand x 1 x 1 p 1 Hicksian demand curves are steeper for normal goods p 1 Hicksian demand curves are flatter for inferior goods D Hicksian D Marshallian D Hicksian D Marshallian Spring 2001
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