Copyright © 2019 W. W. Norton & Company CHAPTER 6 Demand This chapter is about using the model that was fully developed in Chapter 5. Copyright © 2019 W. W. Norton & Company

Properties of Demand Functions Comparative statics analysis of ordinary demand functions—the study of how ordinary demands x1*(p1, p2, m) and x2*(p1, p2, m) change as prices (p1, p2) and income (m) change.

Own-Price Changes – 1 How does x1*(p1, p2, m) change as p1 changes, holding p2 and m constant? Suppose only p1 increases, from p1′ to p1″ and then to p1‴.

Own-Price Changes – Fixed p2 and m – 1 p1x1 + p2x2 = m p1 = p1′ x1

Own-Price Changes – Fixed p2 and m – 2 p1x1 + p2x2 = m p1 = p1′ p1= p1″ x1

Own-Price Changes – Fixed p2 and m – 3 p1x1 + p2x2 = m p1 = p1′ These diagrams should be a mere reminder of what was discussed in Chapter 2. p1= p1‴ p1= p1‴ x1

Own-Price Changes – Fixed p2 and m – 4 p1 = p1′ x1*(p1′)

Own-Price Changes – Fixed p2 and m – 5 p1 = p1′ This slide connects the optimal choice bundle with a particular point on the Demand Curve. p1′ x1* x1*(p1′) x1*(p1′)

Own-Price Changes – Fixed p2 and m – 6 p1 = p1″ p1′ x1* x1*(p1′) x1*(p1′) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 7 x1*(p1′) x1*(p1′) x1*(p1″) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 8 p1 = p1‴ p1″ p1′ x1* x1*(p1‴) x1*(p1′) x1*(p1′) x1*(p1″) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 9 p1 = p1‴ p1‴ p1″ p1′ x1* x1*(p1‴) x1*(p1‴) x1*(p1′) x1*(p1′) x1*(p1″) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 10 Ordinary demand curve for commodity 1 p1 = p1‴ p1‴ p1″ p1′ x1* x1*(p1‴) x1*(p1‴) x1*(p1′) x1*(p1′) x1*(p1″) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 11 Ordinary demand curve for commodity 1 p1 = p1‴ p1‴ p1″ p1′ x1* x1*(p1‴) x1*(p1‴) x1*(p1′) x1*(p1′) x1*(p1″) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 12 Ordinary demand curve for commodity 1 p1 = p1‴ p1‴ p1 price offer curve p1″ p1′ x1* x1*(p1‴) x1*(p1‴) x1*(p1′) x1*(p1′) x1*(p1″) x1*(p1″)

Own-Price Changes – 2 The curve containing all the utility-maximizing bundles traced out as p1 changes, with p2 and y constant, is the p1-price offer curve. The plot of the x1-coordinate of the p1-price offer curve against p1 is the ordinary demand curve for commodity 1.

Own-Price Changes – 3 What does a p1 price-offer curve look like for Cobb-Douglas preferences?

Own-Price Changes – 4 What does a p1 price-offer curve look like for Cobb-Douglas preferences? Take: Then the ordinary demand functions for commodities 1 and 2 are . . .

Own-Price Changes – 5 and Notice that x2* does not vary with p1 so the p1 price offer curve is flat.

Own-Price Changes – Fixed p2 and m – 13 x1*(p1‴) x1*(p1′) x1*(p1″)

Own-Price Changes – Fixed p2 and m – 14 Ordinary demand curve for commodity 1 is x1* x1*(p1‴) x1*(p1′) x1*(p1″)

Own-Price Changes – 6 What does a p1 price-offer curve look like for a perfect-complements utility function?

Own-Price Changes – 7 What does a p1 price-offer curve look like for a perfect-complements utility function? Then the ordinary demand functions for commodities 1 and 2 are . . .

Own-Price Changes – 8 As As With p2 and y fixed, higher p1 causes smaller x1* and x2*. As As

Own-Price Changes – Fixed p2 and m – 15 p1 = p1′ m/p2 p1′ x1* x1

Own-Price Changes – Fixed p2 and m – 16 p1 = p1″ m/p2 p1″ p1′ x1* x1 x1

Own-Price Changes – Fixed p2 and m – 17 p1 = p1‴ m/p2 p1‴ p1″ p1′ x1* x1

Own-Price Changes – Fixed p2 and m – 18 Ordinary demand curve for commodity 1 is m/p2 p1‴ p1″ p1′ x1* x1

Own-Price Changes – 9 What does a p1 price-offer curve look like for a perfect-substitutes utility function? Then the ordinary demand functions for commodities 1 and 2 are . . .

Own-Price Changes – 10 and

Own-Price Changes – Fixed p2 and m – 19 p1 = p1′ < p2 x1

Own-Price Changes – Fixed p2 and m – 20 p1 = p1′ < p2 p1′ x1* x1

Own-Price Changes – Fixed p2 and m – 21 p1 = p1″ = p2 p1′ x1* x1

Own-Price Changes – Fixed p2 and m – 22 p1 = p1″ = p2 p2 = p1″ p1′ x1* x1

Own-Price Changes – Fixed p2 and m – 23 p2 = p1″ p1′ x1* x1

Own-Price Changes – Fixed p2 and m – 24 p1 price offer curve Ordinary demand curve for commodity 1 p1‴ p2 = p1″ p1′ x1* x1

Own-Price Changes – 11 Usually we ask “Given the price for commodity 1 what is the quantity demanded of commodity 1?” But we could also ask the inverse question “At what price for commodity 1 would a given quantity of commodity 1 be demanded?”

Own-Price Changes – 12 p1 x1* p1′ x1′ Given p1′, what quantity is demanded of commodity 1? Answer: x1′ units. p1′ x1′ x1*

Own-Price Changes – 13 p1 x1* p1′ x1′ Given p1′, what quantity is demanded of commodity 1? Answer: x1′ units. The inverse question is: Given x1′ units are demanded, what is the price of commodity 1? Answer: p1 p1′ x1′ x1*

Own-Price Changes – 14 Taking quantity demanded as given and then asking what must be price describes the inverse demand function of a commodity.

Own-Price Changes – 15 A Cobb-Douglas example: is the ordinary demand function and is the inverse demand function.

Own-Price Changes – 16 A perfect-complements example: is the ordinary demand function and is the inverse demand function.

Income Changes – 17 How does the value of x1*(p1, p2, m) change as y changes, holding both p1 and p2 constant?

Income Changes – 1 m′ < m″ < m‴ Fixed p1 and p2.

Income Changes – 2 m′ < m″ < m‴ Fixed p1 and p2. x2‴ x2″ x2′ x1′

Income Changes – 3 m′ < m″ < m‴ Income offer curve Fixed p1 and p2. Income offer curve x2‴ x2″ x2′ x1′ x1″ x1‴

Income Changes – 4 A plot of quantity demanded against income is called an Engel curve. Named after German statistician Ernst Engel (1821–1896).

Income Changes – Fixed p1 and p2 – 1 m′ < m″ < m‴ Income offer curve x2‴ x2″ x2′ x1′ x1″ x1‴

Income Changes – Fixed p1 and p2 – 2 m′ < m″ < m‴ Income offer curve m x2‴ m‴ Engel curve; good 1 x2″ m″ x2′ m′ x1′ x1″ x1‴ x1* x1′ x1″ x1‴

Income Changes – Fixed p1 and p2 – 3 Engel curve; good 2 m′ < m″ < m‴ m″ m′ Income offer curve x2′ x2″ x2‴ x2* x2‴ x2″ x2′ x1′ x1″ x1‴

Income Changes and Cobb-Douglas Preferences – 1 An example of computing the equations of Engel curves; the Cobb-Douglas case. The ordinary demand equations are

Income Changes and Cobb-Douglas Preferences – 2 Rearranged to isolate y, these are: Engel curve for good 1 Engel curve for good 2

Income Changes and Cobb-Douglas Preferences – 3 y Engel curve for good 1 Engel curve for good 2 x1* y x2*

Income Changes and Perfectly Complementary Preferences – 1 Another example of computing the equations of Engel curves; the perfectly complementary case. The ordinary demand equations are

Income Changes and Perfectly Complementary Preferences – 2 Rearranged to isolate y, these are: Engel curve for good 1 Engel curve for good 2

Income Changes – Fixed p1 and p2 – 4 m′ < m″ < m‴ x1

Income Changes – Fixed p1 and p2 – 5 m′ < m″ < m‴ x2‴ m x2″ m‴ Engel curve; good 1 x2′ m″ m′ x1 x1′ x1″ x1‴ x1′ x1″ x1‴ x1*

Income Changes – Fixed p1 and p2 – 6 Engel curve; good 2 m′ < m″ < m‴ m″ m′ x2′ x2* x2″ x2‴ x2‴ x2″ x2′ x1 x1′ x1″ x1‴

Income Changes – Fixed p1 and p2 – 7 Engel curve; good 1 Engel curve; good 2 x1′ x1‴ x1* x1″ x2′ x2″ x2‴ x2*

Income Changes and Perfectly Substitutable Preferences – 1 Another example of computing the equations of Engel curves; the perfect- substitution case. The ordinary demand equations are

Income Changes and Perfectly Substitutable Preferences – 2 Suppose p1 < p2. Then and and

Income Changes and Perfectly Substitutable Preferences – 3 Engel curve for good 1 Engel curve for good 2 x1* m x2*

Income Changes – 5 In every example so far the Engel curves have all been straight lines. Q: Is this true in general? A: No. Engel curves are straight lines if the consumer’s preferences are homothetic.

p p Homotheticity (x1, x2) (y1, y2) (kx1, kx2) (ky1, ky2) Û A consumer’s preferences are homothetic if and only if for every k > 0. That is, the consumer’s MRS is the same anywhere on a straight line drawn from the origin. p p (x1, x2) (y1, y2) (kx1, kx2) (ky1, ky2) Û

Income Effects – A Nonhomothetic Example Quasilinear preferences are not homothetic. For example,

Quasilinear Indifference Curves x2 Each curve is a vertically shifted copy of the others. Each curve intersects both axes. x1

Income Changes – Quasilinear Utility – 1 x2 x1 ~ x1

Income Changes – Quasilinear Utility – 2 x2 m Engel curve for good 1 x1 ~ ~ x1* x1 x1

Income Changes – Quasilinear Utility – 3 Engel curve for good 2 x2 x2* x1 ~ x1

Income Effects – 1 A good for which quantity demanded rises with income is called normal. Therefore a normal good’s Engel curve is positively sloped.

Income Effects – 2 A good for which quantity demanded falls as income increases is called income inferior. Therefore an income-inferior good’s Engel curve is negatively sloped.

Income Changes – Goods 1 & 2 Normal Engel curve; good 2 m‴ m″ m′ Income offer curve x2′ x2″ x2‴ x2* m x2‴ x2″ m‴ Engel curve; good 1 x2′ m″ m′ x1′ x1″ x1‴ x1′ x1″ x1‴ x1*

Income Changes – Good 2 Is Normal, Good 1 Becomes Income Inferior – 1 x2 x1

Income Changes – Good 2 Is Normal, Good 1 Becomes Income Inferior – 2 x2 Income offer curve x1

Income Changes – Good 2 Is Normal, Good 1 Becomes Income Inferior – 3 x2 m Engel curve for good 2 Income offer curve x2* m It is not possible for both goods to be inferior with well-behaved preferences. Engel curve for good 1 x1 x1*

Ordinary Goods – 1 A good is called ordinary if the quantity demanded of it always increases as its own price decreases. Another definition of an ordinary good is one which follows the Law of Demand.

Ordinary Goods – 2 Fixed p2 and y. x2 x1

Ordinary Goods – 3 Fixed p2 and y. x2 p1 price offer curve x1

Ordinary Goods – 4 p1 Û x2 x1* x1 Fixed p2 and y. p1 price offer curve Downward-sloping demand curve Û Good 1 is ordinary x1* x1

Giffen Goods – 1 If, for some values of its own price, the quantity demanded of a good rises as its own price increases then the good is called Giffen. Named after Scottish statistician and economist, Sir Robert Giffen (1837–1910). It is tough to come up with good examples of Giffen Goods. Asking the students leads to interesting possibilities. They often come up with items that are not really “goods” as much as they are investment vehicles like artwork or collectibles.

Giffen Goods – 2 Fixed p2 and y. x2 x1

Giffen Goods – 3 Fixed p2 and y. x2 p1 price offer curve x1

Giffen Goods – 4 p1 Û x2 x1* x1 Fixed p2 and y. p1 price offer curve Demand curve has a positively sloped part Û A Giffen Good has an upward-sloping Demand Curve (at least in part). Good 1 is Giffen x1* x1

Cross-Price Effects – 1 If an increase in p2 increases demand for commodity 1 then commodity 1 is a gross substitute for commodity 2. reduces demand for commodity 1 then commodity 1 is a gross complement for commodity 2. Using examples with actual combinations of goods would help here.

Cross-Price Effects – 2 A perfect-complements example: so . . . Therefore commodity 2 is a gross complement for commodity 1.

Cross-Price Effects – 3 p1 x1* Increase the price of good 2 from p2′ to p2″ and . . . p1 p1‴ p1″ p1′ x1*

Cross-Price Effects – 4 p1 x1* Increase the price of good 2 from p2′ to p2″ and the demand curve for good 1 shifts inward. Good 2 is a complement for good 1. p1 p1‴ p1″ p1′ x1*

Cross-Price Effects – 5 A Cobb-Douglas example: so . . . Therefore commodity 1 is neither a gross complement nor a gross substitute for commodity 2.

Copyright © 2019 W. W. Norton & Company Credits This concludes the Lecture PowerPoint presentation for Chapter 6 of Intermediate Microeconomics, 9e For more resources, please visit http://digital.wwnorton.com/intermicro9media Copyright © 2019 W. W. Norton & Company