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: lignOU MEC'-lOl
~ THE PEOPLE'S
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Indira Gandhi National Open University
School of Social Sciences ANALYSIS
Consumer Behaviour 1
I~....1I
.. Ignou
THEPEOPlE'S
MEC-IOl
~ UNIVERSITY Microeconomic
Indira Gandhi
National Open University
Analysis
School of Social Sciences
Block
1
CONSUMERBEHA~OUR
UNIT 1
Theory of Consumer Behaviour: Basic Themes 5
UNIT 2
Theory of Demand 24
UNIT 3
Theory of Demand: Some Recent Developments 73
•
---
Expert Committee
Prof. Bhaswar Moitra Prof. (}opinath Pradhan
Department of Economics School of Social Sciences
Jadavpur University Indira Gandhi National Open University
Kolkata New Delhi
Material Production
Mr. S. Burman. Mr. Tilak Raj AR (P) Mr. Yash Pal
D. R.( I)u bl ica tion) Ms.Ceet~ Sharma, Ms Pushpa Sharma Section Officer (Publication)
\11)1)1) IG'iOl. "IIe\\ Delhi i\lPPD, IG:\'Oli, New Delhi MPPD, IGNOU, New Delhi
November, 2018 (Reprint)
© III dim Gandhi Nationat University 2017
ISBN: 978-93-86375-06-3 .
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BLOCK 1 CONSUMER BEHAVIOUR
Introduction
Consumer's behaviour is analysed in the block. Building on the assumption that
consumers behave rationally arid maximise utility of consumption, Unit iattempts to
document the method of measuring utility either cordially or ordinary and seeks to
discuss the demand for commodity based on the premise of utility maximisation in the
presence of budget constraints.
Unit 2 extends the consumer choice and deals with demand curve. Approaches to
optimal choice of consumption and basic duality relations are discussed. In the process
it deals with analytical refmement in the utility and demand derivations with the aid of
indifference curve approach.
The last unit of block, (Unit 3), covers the recent developments in demand analysis
by including linear expenditure system, treatment of consumer's surplus and
inter-temporal consumption. After looking into the theory of price formation through
demand-supply analysis, it discusses the cobweb model and lagged adjustment
methods.
..
,..
UNITl THEORY OF COSUMER'
BEHAVIOUR: BASIC THEMES
Structure
1.0 Objectives
1.1 Introduction
1.2 The Basic Themes
1.3 Consumer Choice Concerning Utility
1.3.1 Cardinal Theory: An Introduction
1.3.2 Ordinal Theory: A Short Note
1.3.2.1 Indifference Curve Approach
1.3.2.2 Revealed Preference Approach
1.4 Introduction to Demand Analysis
1.5 Ordinal Theory: Indifference Curve Approach
1.5.1 Concept of Preference, Utility Function and Indifference Curve
1.5.2 Derivation of Indifference Curve and It's Properties
,
1.5.3 Utility Maximisation
1.5.4 Concepts of Income and Substitution Effects
1.5.5 Slutsky's Theorem
1.5.6 Compensated Demand Curve
1.6 Let Us Sum Up
1.7 Some Useful Books
1.8 Answers or Hints to Check Your Progress Exercises
1.0 OBJECTIVES
The objective of this unit is to relate how individual consumers take decisions
of consumption in a situation where market prices are given to them and they
can't influence the market prices by altering their consumption. This unit will
enable you to:
1.1 INTRODUCTION:
It is generally observed that market aggregate demand curve for a commodity
is downward sloping, given other things. Our problem is to investigate
___ economic rationality behind this for a commodity of all individual consumers.
The market demand basically depends on the characteristics of demand for a
commodity by individual consumers, and the demand for a commodity of an
individual consumer depends upon the behaviour of the consumer. Clearly, to
5
Consumer Behaviour
investigate economic rationality behind the law of demand, woeshall start with
the analysis of consumer behaviour.' '
1) Cardinal analysis
2) Ordinal analysis
1) Consumer is rational.
2) If the taste and preferences are given, the total utility of the consumer
depends on the quantity of consumption.
Implication! Let 'U' denote utility level of the consumer and let 'x' be the
consumption bundle. As 'x' increases (dlecreases) 'U' increases (decreases).
Therefore, marginal utilit~ is positive.
Consumer Equilibrium
According to our assumption for 'x' units consumption of the commodity,
gross utility obtained by the consumer is U(x).But for this, the consumer must
spend px.x units of money income if px be the price of the commodity 'x',
which is given to the consumer. Since from assumption 6, ~ represents fall in
utility due to one unit fall in money income, the net utility of the consumer is
given by N(x) = U(x)-x'px.x, where-X and px are given to the consumer. So
consumer's objective is to maximise N(x) by choosing 'x'. For that we take the
first derivative of N(x) and set that equal to zero, dN(x) =0. Or, we get
. ~
dU (x) ILp, = O. From this first order condition, we can derive the optimum
dx \
value of 'x' which is (say) x* = X*(Px,A).The second order condition for utility
xMUx (
I--------'---"t<o-------- x'px
x
x*
Fig. 1.1: Consumer Equilibrium in Cardinal Theory
........................ . .
2) Consider the utility function U (x) = log (x), let px = 2 and ~ 5. Derive
. the consumer equilibrium and check the second order condition .
............................ .
7
Consumer Behaviour
1.3.2 Ordinal Theory: A Short Note
In ordinal approach, utility is measured ordinally i.e., qualitatively (not
numerically or quantitatively). Alternatively, consumer can rank her
preferences according to the order she wants to compare but not in terms of the
different amount. It's a qualitative .measure and therefore more realistic
measurement of utility or satisfaction.
None of the commodity bundles are not preferred i.ed-'consumer can choose
any commodity bundle. So choice set of this consumer is specified by the
commodity set 'X'.'
9
Consumer Behaviour Meaning and definition of indifference curve: Different combination of goods
Xl and X2 along which consumer is indifferent (or consumer has same level of
utility) give a curve in commodity-commodity plane known as indifference
curve. Therefore, along the indifference curve utility or satisfaction remains
unchanged.
Graphical Presentation
x
2 \ II
.~
0
x '
2 ~ a
m IV
• od
a • (! 1CoCUJ
o
o x
1
x
1
Fig. 1.2: A Typical Indifference Curve
Consider any commodity bundle denoted by point A in "the above figure which
consist XOI and X02 amount of good I and good IT respectively and from which
consumer obtains particular level of .utility, say Uo. We compare the
commodity bundle 'A' with other commodity bundle in the commodity space.
For that we divide the entire commodity plane into four phases from 'A'.
Consider any point in phase I say ~, where we have large quantity of both x,
and X2 compared to point 'A'. Again, if we consider any point say 'a' in
horizontal line' in phase I, we have larger quantity of x, with same quantity of
X2 compared to point 'A'. Similarly, for any point 'b' in vertical axis, we have
larger X2 with same x.. That means in phase I including the borderlines, we
have larger quantity of at least one commodity and no less quantity of any
other commodity compared to 'A'. Thus, we have larger utility in phase I .
including the borderlines compared to 'A'.
By similar logic, we have lower consumption of at least one good and no larger
consumption of any other 'good in phase III including the borderlines compared
10
to point 'A'. Hence, we have lower level of utility in phase III including the Theory of Consumer
Behaviour: Basic
borderlines compared to 'A' by the axiom of non-satiation for all goods.
Themes
Mathematical Presentation
Consider the utility function V = V(Xj, X2). Differentiating totally, we get the
following:
Econoniic meaning
All goods are non-satiated i.e., larger (lower) consumption .leads to lager
(lower) utility. Hence, for given X2,as xi increases,utility increases. Thus, to
maintain same level, utility must be reduced, which is possible by reducing X2.
Hence, as x, increases, X2 must decreases in order to" maintain 'same level of
utility. That is why indifference curve is downward sloping.
11
Consumer Behaviour
X
2
~
2
X
2
0
X
2
1
X
2
IC(tJ )
1
IC(tJ
1
0 xO X X
1 1 1
. Explanation: Since all goods are non-satiated, larger consumption of any good
leads to larger utility. Thus, a commodity bundle, which consists of larger
quantity of at least one good and' no less consumption of any other goods, gives
larger utility compared to any other commodity bundle. Consequently, higher
indifference curve represents higher consumption of at least one commodity
and no less consumption of any other commodity.
X
2
C(UJ
1
ICeD: )
o X
1
Equation (a) is known as consumer budget constraint. Let U = U(XI, X2)is the
utility function of the ~onsumer. Therefore, consumer must solve the following
maximisation problem(UMP):
,
subject to XI> 0
X
2
A.
x*
2
x
1
Now suppose that the line segment AB represents the budget line. Along AB
PIXl+P2X2=Mholds. Let initial indifference curve of the consumer is o. In le 13
Consumer Behaviour
ICo, there are .many points along that indifference curve such that
PIXI + p2X2 ~ M holds, Therefore, utility maximising consumer will spend
more as she .moves to higher indifference curve (say ICI). In ICI there are still
such points along the indifference curve such that PIXI + P2X2 ~ M holds, so
again consumer spends more. This process will continue as long as consumer
reaches an indifference curve where for no point along the indifference curve
PIXI + P2X2 ~ M holds and at least one point of the indifference curve is on the
budget line. At that point, we' have consumer equilibrium, C(XI, X2) =
(XI*(M,P['P2), x2*(M,PI,P2))(inFigure 1.5.3 point 'e' is the equilibrium point).
Not that at equilibrium, slope of the indifference curve is equal to the slope of
the budget line. Therefore, at equilibrium we have
2) Slope of the indifference curve is equal to the slope of the budget line.
Mathematical Presentation
dL(XI,X2) dU(XI,X2)
= A,PI =0 ------------- (fi)
dxs dxs
.',
dL(XI,X2) dU(XI,X2)
= A,p : =0 ------~------(f2)
dX2 dX2
=i«: = M -
dL(XI,X2)
PIXI - P2X2 =0 ------------- (f3)
dU(XI,X2)/dU(Xl,X2) / N
----'------'--= pi px . ote
dU(Xl,X2)/dU(XI,X2) .>
IS t he s1ope 0 f t he
~.~ ~ ~
indifference curve and pi / p: is the slope of the budget line. So, at equilibrium
we have a slope of the indifference curve that is equal to the slope of the
budget line. Again, from equation (f3) we get M = PIXl+P2X2, so budget
equation holds with equality sign.
1) Defme indifference curve in one sentence. What are measured in the axes
of the figure to draw an indifference curve?
.........................................................................................
\
.........................................................................................
14
..................................... ..•.-
, .
2) If U(Xl, X2) = 10XI°.3X20.7,M=200, Pl~5 and P2=2, set up the Lagrange Theory of Consumer
Behaviour: Basic
nction an d deri
functi . Iest form 0 f dU (XI, X2) / dU (XI, X2)
enve th e SlITlP = pi / pz . Themes
. dXI dX2
........................................................................................
........................................................................................
. . .
3) If U(Xl, X2)= lOxt5x2o.s, M=lOO, Pl=2 and P2=4 calculate the consumer
equilibrium .
......................................................................................... ,
Own Substitution Effect: Change in demand quantity for a good (say x.) due to
change initsown price under constant real income (in terms of utility) is called
substitution effect for that good and can be written as (dxi)[7, pj •
dPi
Income Effect: Income effect for a good (say xi) represents change in demand
.quantity for th~t good for a change in r~al income. So income effect = ( dxi )Ji ,
dM
which is positive for a normal good, negative for inferior good and zero for
neutral good.
Income Effect For A Price Change: For given money income, as price of any
one good change one unit then real income (M/Pi) changes for which demand
for the good changes by income effect. It is known as income effect for a price
change. Thus, income effect for a price change = -Xi( dXi ). Note that income
. dM
effect and income effect for a price change have opposite sign and different
magnitude.
,
o B x' C c x
I
I
At initial prices and money income, budget line is AB and according to the
condition of the equilibrium eo is the initial equilibrium point. The consumer
gets Uo level of utility. Suppose at constant income and pz, PI decreases (say by
one unit). Consequently, the intercept of the budget line (Mlpz) remains
unchanged but absolute slope of the budget line (PI/PZ) decreases. The new
budget line becomes flatter with the same intercept. It is denoted by AC line.
New equilibrium can be achieved at any point on the new budget line AC (and
therefore own price effect can take any algebraic sign). Suppose the
equilibrium takes place at point el. Hence, as PI decreases, for given pz and M,
demand for good I increases from XIO to XII. This is the own price effect for XI
and here it is negative. A part of this change is due to change in real income
(since for given pz and M as PI decreases, real income increases) and another
part is originated at constant real income. To decompose these effects, we
reduce money income (M) of the consumer in such a way that real income
helps her in procuring the optimal consumption bundle before the price change.
After such a readjustment of M, intercept of the new budget line AC, i.e.,
(Mlpz) decreases with the same slope (PI/PZ) for given p.and Pz- Hence the new
budget line shifts parallely downwards. Note that now consumer is to purchase.
the original bundle with new prices. After the shift, she can move to a new
indifference curve as well.
We already know from the first order conditions of utility maximisation that,
dL(Xi,X2)
. = M - PIXI - P2X2 = 0 ------------- (c)
dA
( Adp I
VI2 -PI] ,
dx. == I Adp 2 V22 -p2 / ID I
\ -dM +dpI +dP2 -p2 0
where, I D I~ U 21
VII
Vn
-PI]
-P2 an d V ij =
d-V(Xi,Xj)
?
.
°
(
° dXidxj
-Pi
°
Or, we can write,
where Dij is the co-factor of, the i'" row and column of the determinant IDI. r
For income effect we know dpr=dp-=G, therefore we have from equation (h),
dx! = -D3IdM or ( dXI )jJ = pzV 12- plV 22 (i)
IDI' dM IDI
Now for own price effect we have dlvl=dpi=O. So from equation (h) we get,
(dXI)
- __
M,p2= (dXI)__
- U,p2-XI (dXI)_
-- p, i
W hi Ch IS t he SIuts k'y s equation.
.
dXI dpl dM .
Demand curve for a good showing the relationship between demand quantity
for that good and its own price given other things and given real income is
known as compensated demand curve along which real income is constant
(real income is defined by the ratio between money income and price level).
Along the demand curve price of that good changes, so money income should
be proportionately adjusted or compensated such that real income is constant.
That is why the corresponding demand function and demand curve is known as
compensated demand function and compensated demand curve.
There are two different approaches to the measurement of real income, viz.,
18
Derivation of compensated demand curve Theory of Consumer
Behaviour: Basic
Themes
Hicksian compensated demand function for Xl is given by XI=XI(PI, P2, U),
where Hicksian compensated demand curve for a good represent the
relationship between price of that good with its own demand quantity for given
prices of other goods and real income in terms of utility.
Figure A
0 xl
I x
P FigureB I
I
rP
I
t:f
I
cl
o X I ~ x
I
Plot this XIO and PlO in Figure 1.7B. Suppose, for given utility and P2, PI
decreases to PII. Therefore, absolute slope of the budget line decreases, i.e.,
expenditure line become flatter. Since utility is constant, the indifference curve
remains the same as before. Therefore, expenditure is minimised Jar given
\ utility at point el i.n Figure 1.7A, as indifference curve is downward sloping
strictly convex to' the origin. So compensated Hicksian demand for good I
increases to XII plot Pll and XII in Figure 1.7B. By joining all such pair of PI
and XI in Figure B, we have a downward sloping curve in PI-XI plane, for given
P2 and utility. This downward sloping demand curve is the Hicksian
compensated demand curve. This is shown in the above Figure 1.7B.
19
Consumer Behaviour
Check Your Progress 3
l) Define compensated demand curve in one sentence. What are measured
in the axes of the figure to draw a compensated demand curve in Hicksian
approach?
........................................................................................
.............................................................................. .- .
........................................................................................
2) What is the sign of the slope of the compensated demand curve? Can the
compensated demand curve take positive slope?
......................................................................................... -
.................................. : ~ .
................................................................ , .
21
Consumer Behaviour
Inferior Good A good for which demand decreases when
income rises and increases when income falls.
Varian, Hal (1992), Microeconomic Analysis, W.W. Norton & Company, Inc.,
New York.
dU(xl=
dx
l/x, A.-=5 and p,
".
= 2, therefore at equilibrium l/x = 10 or, x* =
2
1110. Second order condition is satisfied because a uax2(x) = -1/ X2 < 0 at
22 equilibrium. •
Check Your Progress 2 Theory of Consumer.
Behaviour: Basic
1) See Sub-section 1.5.1 Themes
dU(XI,X2)
---- = 3Xl-0.7X20.7 an d dU(XI,X2)
= 7Xl'0.3X2-0.3,t h ererore
c.
dXI dX2
dU(xI,x2)ldU(xI,x2)
= pi I" P? =>
3/7 -0.4
Xl
0.4'
X2 = 5/2 , or
dXI dX2
Xl = (6/35)4x2 .
dU(XI,X2) 'dU(XI,X2)
----'-I = pIIp: => XI_\X2 = 1, or Xl = X2------ (I).
dXI - dX2
23
UNIT 2 THEORY OF DEMAND
Structure
2.0 Objectives
2.1 Introduction
2.2 Preference and Utility
2.2.1 Three Building Blocks
2.2.2 Basic Axioms
2.2.3 Lexicographic Preference Relation
2.2.4 Quasi-concavity of Utility Function
2.2.5 A Note On Ordinality of Utility Function
2.3 Indifference Curve and Budget Set
2.3.1 Slope and Curvature of Indifference Curve: -Mathematical Derivation
2.3.2 Properties of Indifference Curve
2.3.3 Properties of Budget Set
2.4 Utility Maximisation Problem (UMP)
2.4.1 Mathematical Derivation of UMP
2.4.2 Diagramatic Representation of UMP
2.4.3 Properties of Walrasian or Ordinary Demand Function
2.4.4 Properties of Indirect Utility Function
2.5 Expenditure Minimisation Problem (EMP)
2.5.1 Mathematical Derivation ofEMP
2.5.2 Diagramatic Representation of EMP
2.5.3 Properties of Hicksian Demand Function
2.5.4 Properties of Expenditure Function
2.5.4.1 Re-deriving some Standard Results by Using Shephard's Lemma
2.5.5 Decomposition of Price Effect
2.5.6 Ordinary Demand and Compensated Demand Functions
Duality Relations
2.6.1 Basic Duality Propositions
2.6.2 Basic Duality Relations
2.6.4 Slutsky Equation
2.7 Let Us Sum Up
2.8 Key Words
2.9 Some Useful Books
2.10 Answer or Hints to Check Your Progress
2.11 Exercises and Answers/Hints
2.0 OBJECTIVES
After going through this unit, you will be able to:
• understand the basic axioms of preference relation;
• determine the optimal choice of consumption through two different
approaches (Utility Maximisation Problem (UMP) and Expenditure
24 Minimisation Problem (EMP);
Theory of Demand
.!.) learn .to derive four. different functions of consumer choice i.e., Indirect 'L.:f'r-i ,.,;" .• l;~tf;S·~J{~
2.1 INTRODUCTION ,.
, I
Commodity 2
Consumption Set
.• x,
Consumption Bundle
• XI
~-------------------- Commodity 1
2) Strict Preference (»: Xl > X2 <=> Xl ;::-;X2and not X2 ;::-; Xl' Xl >
x2is read as Xl is preferred to X20r Xl is strictly preferred to X2'
3) Indifference (- ): Xl X2 ~ Xl ~ Xz and Xz ~'Xl'
26
the consumer can always rank finite number of consumption bundle in Theory of Demand
t------LCS (X) I
=
Commodity I
Fig. 2.2: Upper Contour Set and Lower Contour Set
27
MbnOtotriCity)is~rmoreTes1irictilive:Jlss\.unptio:owhereas strong rnonotonicity is a
weaker assumption, which is used to derive more robust results. Thus, strong
~IWt9,~cjt10f?:J'I~es;:~~ . 9E<JW~~t¥{?vu: ?~t}~1 ~thr.~ ~a~,fou~d. ~o~otonic~ty
of preference relaiioii elIJIllilates the possIfnhfy of indifference curves to bend
up~atij1('Be~lF-i~ureliJ3JiiY-.. 1:)1' nc,rl(,(fIlJ2H():l '3riJ IJ)" r • j ~~ l ','
-,
b !; ...t;
1')1 '!i enoronorn ei 'f (10 r-« (Oi'r;b1 '.' "ll" 'I j
t: - - ~ilL,f!(lIIS151'jb vf')"jI:)ml~fh ':fIf. 2< Ibnud x b le ~ ?nWj,n) =r V'
( -r «
S'
b ,: \. ~.\ il -I"
" .' ~ - ~ c';,,,J ,;" 'IV ~ _) ,;,J:;pjnJIlod'U'
Fig. 2.4: Local Non-Satiation -< I{ <-:::.. '( ,.. _
commodities may be bad and in that case consumer 'wGuKi prefer fuss-of ithem
(like garbage or noise). Thus local non-satiation is a,'Y~akt.f J§S!ll?Qti9-9-) <than
strong monotonicity and monotonicity) that also allows consumer to prefer less
to more (see Figure 2.4).
Non-satiation says that consumers are never fully satisfied. For any bundle XO
and any E > ,0 there exists another bundle Xl E X where 11xO-xli <
E and Xl > xO. This, with continuity, ensures that indif;fer.~rltsets are
indifference curves -theycannot have any "thick" regions to/hem.j
z:
nO.Jgi~)lS:}H:a'lj1:~.YI~i·~{frqB1:g;'J"~iz<h.I €..~.~
, ,. ,. , , !" .. . 1 •.• Commodity 'AI
f If <"jUt J:J1 t}. H ! n ~f. r1~~L;tJ ~rd l,.-l ~JL.1JO .~nr1~Dl0
'! -, L~'\.;{..'-~o .UlUL ..J 5:)fl~Yl'!)L~1"l(1 ql
" ;.: ,<:('5JI:} 1'-'li'f '~::)i!: J]i'l\ OG'~ Eig:;2•.s,l.,.C,~J)Y.~~t3S·i);ilqh;
21./10\1: gnign.G11£ nerfW
j>f' P
.""
, W::'I'f!;:;"~J:)fd;j!.ni 1cl .rn '}d t ::4mn :nVll (J N!iG c:'l'1HOl j,.;-Jl :;dl ersqrnoo
f11· .."J l.:1
'j"A~"" Iq ..:.)
,. C'! J U-J,-,.[J
IJJ'.) -.)(1
Co' '.,.
';i '....
',.
,j, ) "I ...
/·'r'
{ <"'r
,jHj" 1,' or
",.1
~ ,~tlqp~
2.,," bru
u, abro W'
r». 1~,,",
,,,," ~C
•
Not feasible
-:
~------------------~~~----~l
Fig. 2.5(c): Non Convexity
Otherwise, y z x.
y>-x
II
------------------.~--------------~~----~~----
·:y
y>-x
··
III •
1
Fig. 2:6: Lexicographic Preference (consumer biased toward commodity 1)
A function f(x) is quasi-concave (see Fig. 2;7), if for all x' and x",
31
L ~~
i· f; ;: '( r : \\ _.
Consumer Behaviour f(x) f .)
, f
f(x)
:::.. 'c!: !'n'~i. { c: .'
l(x")I---------~
f(x)I---------,,?
\..-
,-\ <
.1 (J • cJ• ~,(
x
X- 1
x~ <'A X i
" J
I
\/1 /' r II
i) Quasi-Concavity is a w aker assumption as we know' any concave
function is a quasi concave function but not the other way round i.e., any
quasi.concave functio~y..noJ.be_nece.s.S.ariLy. om:Jl'Y~ " ., . J
ii) Qll.a~iQ;l!\~~¥iWI"~11S1Pf;i0rpm~lmPhqp.yI1iM1CjI~W.§lhl·' ~jit}'1ar4.'!l1tir-tO
any
monotonic transformation.
?t, ''101 D'dlId ,;r nIT!' Imo" ',ri, L"i.> )!rCl1;190'JJ5[ ~i ,:J[i'}'j ;t~nq eLl', .':
2~2.5<;ArNdte)oliiOrtlj.Iialit~ dffldtility~Fllnctipn T. ITL)rir .l Ojbomrl~O
,.,.; nII:..liJbf'; JJl!!l~fl1 1) ~, ,~)ft"lOtJf" ",'j[-,)IT!t'IY'f,,()") 'to 50;1 'JGJ ~; sr.:: ,G:lL -{:; r
)VydBY, ,u~tlbtqr)~dW9~WRa!rhOHF~pr,J'J~9.a'i~r;fh~1 OJRf C?f{l1~m?e ~~~jen~9r(\0
rh~
reflectvth~ 11I~ ferenct; ,Q~X&"iQysbundLe~_do matter b}.ltpot the nUI~ber It;5elf
~u~bi;js~~~ ',',10
w~;;tltipl~liU5th~ vr~p';~s~~t't1:~
.~~ilitY
'nu~~t~~J~vb:~~'
i~ just( a~'arbiPr~y,~I~~rg~;n~~t~
;{(,~'tt·th~tk\~yi,t"ak.!e ~'sgum:{m;~t.yli~
if
" VJ1J)r':J ,'l:()') 10 ~J( , , e' )![O'tifi ut , .~, 't cr, '3ti)i1 J.l ~o j~}l1i>li'; VlI '")1l ,x' -: -( 1
33
Consumer Behaviour au au
du = -x
ax
+ -y
ay
(2.2)
dx
I
u == constant = -
ax
-
au
MUx
-<0
MUy
............ (2.3)
ay
To show the convexity of the indifference curve, we have to see its curvature.
That is, the second order derivative of the equation concerned with the
,Z
indifference c~rve is positive, i.e., d ~
dx
> O.
au au
Since we have U = U(x,y), let -a
x
= tl = MUx and -
ay
= /1 = MUy, such
that, dy
dx
I(u = constant) = _11.
fz
Differentiating equation (2.2) with respect to
(w.r.t.) x, we get,
As, ~RS -
_ (MUx)
(MU ) ~ MRS - ,-
_ dy
dx
Iu = constant or, dMRSI _
dx - -
dZy
dxZ < O.
y
Thus, it shows the assumption of diminishing MRS ,i.e., dM RSId x < O. If the
consumption of x increases (along the indifference curve) the consumer has to
substitute y for x (to keep the utility constant along the indifference curve) and
that makes y relatively attractive at the margin, such that for each additional
unit of x she will be willing to substitute lesserunits of y.
34
Theory of-Demand
2.3.2 Properties of Budget Set
Budget Set is a set of all possible consumption bundles (like x and y) which for
a given income (M) and prices of the commodities (Pt> pz) defines the feasible
region of consumption i.e., B = {x, P1X + Pzy ::; M}, Xi ~ 0, i = 1,2. Y:
" Thus, if AB is the budget line, then diagrammatically the budget set includes
the area of the triangle along with the line AB. Any point on the budget set
rep esents a commodity bundle which is feasible for the consumer (i.e., total
expenditure for the two commodities is less than equal to the given income).
See Figure 2:8.
M A
P;.
.
Fig. 2.8: Budget Set
• Bounded Set: Consider the budget set B = {x, y : P1X + PzY ::; M},
Xi ~ 0, i = 1,2, and define a upper fixed points (x(y)) and a lower fixed
point (K , ~), such that for all, x and 'y E B E R2 : (i) L::; x ::;x and (ii) y >
X2 ·······r··········
. · ·
. .
.,
~ ~ ~ __ ~ __ --.X,
, • Closed Set - the budget set B is a closed set since it includes all its
boundary points. If we take any point on the boundary of budget set and -I'
draw a circle (however small) some points will lie on the set itself and
some outside, then those points are called the boundary points. A closed set
35
Consumer Behaviour is a set which includes all the boundary points. A boundary point is a point
such that if a circle is drawn centering that point some points will lie inside
the set and some points outside the set (see Figure 2.10).
eO e I
(You may check on yourself after drawing a budget set. The line AB includes
all the boundary points and it is part of the set B.).
The closedness and boundedness of the budget set are critical assumptions,
without which there will be no solution. See Figures 2.11 a, band c for the
budget set violating any of these assumption.
.r. x,
A .
.10.1 !\ ~=oo
r----------= B ~
~=O
~,
~ B
X,
o Xl M
~
Fig.2.11a: Budget Line when Xl is a free Fig. 2.11b: Budget Line when X2 is a
goods PI = 0 free goods P2 = 0
i\
---~o~------------- .c,
Suppose the budget set is not closed.' Then B = {X,Y:PIX + pzY < M},
Xi ~ DJ i - 1; 2. Let us assume x' is an interior point represents a bundle,
which is an equilibrium solution. Then (x' + E) represents another bundle (E
> 0, but very small) which yields a greater utility (due to strong monotonicity).
Thus, x' can't be equilibrium solution. Since (x' + E) is also not a boundary
36 points (it can't be equilibrium solution either). One can define another interior
bundle (x* + E + 0) (where 0 is negligibly small but positive), which is still a Theory of Demand
part of the budge set, which gives the consumer higher utility (due to strong
monotonicity). Hence equilibrium solution cannot be
defined if the boundary
points are not included (i.e., B should be a closed set).
• Convex Set - The budget set is a convex set. If you take any two arbitrary
points on the budget set and join them together, the corresponding points on
the line will also part of the set. (See Figures 2.12a,b,c).
t
A
x
B B
Fig. 2.12c: Convex Set
Note that convexity of the budget set ensures the existence of solution.
............................................................................................
............................................................................................
37
Consumer Behaviour 2) Suppose two distinct consumption bundles Xl and X2 achieve the exact
same maximum utility level for a consumer, given prices and
income (p, y). Does it imply that this consumer does not have a strictly
quasiconcave utility function?
3) If a person consumes only two goods then can both of them be inferior
goods.
4) A person with income y facing prices p uses the choice rule: Xl(P; y) =
o and X2(P,Y) = L to choose consumption bundles in R~. For any
P2
P E R~+ and y E R+, is this choice rule-a valid Marshallian demand of a
utility maximising consumer?
.............................................................................................
ec au(.)
ay = ---ay - AP2 = 0 (2.7)
aL
aA = M - P1X - P2Y == 0 (2.8)
au(.)
au(.)
where = (MUx) and (Ml!x) _
au(.)
ax
au(.)
ay (MUy) ~ MRSx,y = at(.) = (MUy)
ay
Solving equation (2.8) and (2.9) we get the equilibrium values of x, y and A as
a function of (Pv P2, M). Thus,
x* = x*(PvP2,M) (2.10)
39
Consumer Behaviour .. lid
positive y s ope or upwar
d ·1 .
s opmg VIZ.,
OX(Pl,P2,M)
0
> 0 ' iJY(Pl,P2,M)
0
> 0
Pl P2
(implying direct relationship between price and quantity demanded).
Plugging the equilibrium values of x*,y* in the utility function V(x, y) we get:
oU(.)
oM
[Note that from the FOCs (equations (2.5) and (2.6) we get o~;.) =
A P1 and oU(.)
oy
= A P2' Again differentiating the budget constraint [P1X +
ox oy
P2Y = M], W.r.t. M we get: [P1 oM + P2 OM] = 1]
Thus, the Lagrangian multiplier A can be interpreted as the marginal utility of
income.
From the budget equation [P1X + P2Y = M], we get the important condition
[P1 ~ + P2
oM
Oy]
oM
= 1. This condition is called the Engel Aggregation. So with
some minor manipulation we get
Thus, the weighted average of the income elasticity of demand for all
commodities is unity, where the weights are the respective proportion of
income spent on commodities.
consumption and hence attain higher utility. There are two points at Cl and C2
points, where P1X + P2Y = M. However neither Cl and C2 is equilibrium. At
Cl we see slope of the indifference curve is steeper than the slope of the budget
constraint i.e., MRSx,y = ((aU(.))jax)j((aU(.))jay) > Pl ::::} (au(.))jax) >
- ~ ~
(au(.))jay)
pz
That is marginal utility of per rupee spent on commodity x is greater that the
marginal utility of per rupee spent on commodity y. So a rational consumer at
the point Cl will increase her purchase of x in order to increase her utility.
Similarly you can check at C2, exactly the opposite happen i.e., (au(.))jax) <
Pl
(au(.))jay) and is just the reverse of the earlier result. So both Cl and C2 are not
pz
the equilibrium. Now let us consider the next higher indifference curve Ul
which is just tangent to the budget constraint AB at the point Eo. Thus at EOI
oU(.)
OX
ou(.)
= Pl
pz
::::} (au(.))jax)
Pl
= (aU(.))jay)
pz
. If one rupee is given to a consumer
'
~ ,
and is asked to consume commodity x or y then marginal utility for per rupee
spent on commodity x is exactly equal to the marginal utility for per rupee
spent on commodity y. That means E is the point of equilibrium where the law
of equi-marginal utility holds and the rational consumer has no incentive to
deviate from the point E and at the equilibrium
i) The budget constraint holds with equality.
ii) The slope of the indifference curve is equal to the slope of the budget
constraint.
M
~
D
PlO 1----...:: _
I
P I
PI~
PI)
2
XI XI XI
Fig. 2.13b: Derivation of Walrasian Demand Curve
x. = ate.) = ~:~x>.
au(.)
~ Ell + E12 + 171 = 0, where Ell = Own price elasticity of' demand,
E12 = Cross price elasticity of demand and 171 = Income elasticity of
demand ..
1) v(PlI P21 M)= U(X*(Pi1 P21 M), Y*(Pil P21 M)) is a continuous function.
Take the indirect utility function v(Pv P21 M) and fmd that it is continuous
function in P and M. That is, small change in Pil P2 and M will cause a
small change in utility. It follows from the fact the utility function
U(X*,y*) and ordinary demand functions (x*(Pv P2IM), Y*(Pil P21 M))
are continuous functions and preferences are convex.
ii) (pap:
-,
M)
1_, 2_,_
= - Y*(Pv P2, M) (2.15)
aM
0= aV(P1,P2,M) + aV(Pl,P2,M) h
1(Pv P2, u*)
apl aM
0= aV(Pl,P2,M) + aV(Pl,P2.M) *( M)
apl aM x PI, P2,
av(pvP2,M)
apI
- X*(Pv P2, M ) = -"'a-V~(p-I.o-,
P';;;"'2-'
M----)
aM
[By Shephard's Lemma: We can show ae(p~,p2' u*) = hI (Pv P2, U*), (see
PI
Section 2.6), where hI (.) is the compensated demand function for
commodity 1, (to be done in the next section under EMP)]. Again by duality
relation hI (pv P2' U*) = X*(Pv P2, M)
Check Your Progress 3
1) What is homogenous function of degree zero?
............................ ; .
45
Consumer Behaviour 1
4) If a consumer has utility function (Xli X2) = ""14, what would be
-+-
Xl Xz
consumer's Marshallian demand function for each good.
1
5) If a consumer has utility function U(Xll X2) = ""14, find consumer's
-+-
Xl Xz
indirect utility function.
tu: au(.)
ax = Pl - f.1-;;;- = 0 (2.17)
ec au(.)
ay = Pz - f.1--ay = 0 (2.18)
:: = Cv - U(x,y)) = 0 (2.19)
au(.)
curve= Pi =slope of the budget constraint. [As already stated the utility
pz
function U(x,y) is a function of (x,y), the marginal functions a~;.)and a~;.)
are also the functions of (x,y)].
Solving equations (2.19) and (2.20) we get the equilibrium values of x, y and f.1
as a function of (Pv pz, V). With these equations we can solve for another
category of demand function, called the Hicksian or the compensated demand
function. Thus, from equations (2.19) and (2.20) we get the equilibrium values
of x, y and A. as a function of (Pv pz, V)Thus, giving
x* = hl*(pvPz, V) (2.21)
Equations (i21) and (2.22) are called the Hicksian or the compensated
demand functions. If the utility function U (x, y) is strictly quasi-concave then
the optimal solutions hl * and h2 * are unique. Hicksian or the compensated
demand functions captures the substituti:on effect and it is always negative (i.e.,
the Hicksian demand functions are always downward sloping irrespective of
the nature of commodity i.e., whether a normal commodity or a Giffen
commodity) => the slope is negative =>
ahl((pvpz, V) . ahZ((pVP2' V)
.
a P: < 0, a P2 <0
e(pv pz, V) is called the expenditure function. e(pv Pz. V) is the minimum
expenditure in equilibrium that supports the V level of utility at the given
prices (Pvpz).
47
Consumer Behaviour
2.5.2 Diagramatic Representation of EMP
Let us now explain the EMP diagrammatically (see Fig. 2.14). Here the
consumer's objective is to minimise the expenditure. Let us have a family of
iso-expenditureIine represented by B1, B2, B3 and so on. So a typical consumer
will always want to achieve the lowest possible iso-expenditure line. to .
minimise her expenditure. However she cannot do so as she is constrained by
the utility constraint (V), i.e., she has to attain at least (V) level of utility while
minimising her expenditure. The feasible region of consumption for the EMP
thus consists of points above the indifference curve (U)including those along
the curve.
Let us consider the two points at C and D, where B3 intersects the (V).
However neither C nor D is equilibrium. At C slope of the indifference curve
au(.)
(au(.))jax)
~. PI
= (au(.))jay)
P2
. .
Thus, If one rupee
.
IS
.
given to a consumer and
.
is asked to consume commodity x or y the marginal Utility for per rupee spent
on commodity x is exactly equal to the marginal utility per rupee spent on
commodity y. That gives E as the point of equilibrium where the law of equi-
marginal utility holds and the rational consumer has no incentive to deviate
from the point E. At the equilibrium:
i) the utility constraint holds with equality.
ii) The slope -of the indifference curve is equal to the slope of the iso-
expenditure line.
T
Theory of Demand
49
:,;i~0;'
Consumer Behaviour iii) No excess utility: U{hl *(Pv P2, V), h2 *(Pv P2, V)} = V~t:,,;f
•..
' ~ '\
Proof: This property follows from the continuity property of the V(.) :lu.,tiction.
Let us prove by contradiction. -r!'
Suppose not, i.e., suppose {hl *(Pv P2, V), h2 *(Pv P2, V)} is the optimal.bundle
of EMP but {hl *(Pv P2, V), h2 *(Pv P2: V)} > V ;'
~ U{hl *(Pv P2, V), h2 *(Pv P2, V)} * U. ;'i"\;,
Consider a bundle {h~ (Pl' P2, V), h~ (Pv P2, V)}, that is, slightly smaller th~
the optimal bundle {hl *(Pl' P2, U), h2 *(Pv P2, U)}, on all dimensions. .
By continuity, if the bundle {h~ (Pv P2, V), h~(Pl' P2, V)} is' sufficientltpl~ser
to the bundle {hl *(Pv P2, V), h2 *(Pv P2' V)}, > ,
{Plh~ (Pv pz, V) + p2h~(pv P2, V)}} < {Plhl *(Pv pz, V) + P2h2 *(Pld?,:a,V)}
. ;"1t'.
= e(pv P2, V), the bundle {h~ (Pl, P2, V), h~ (Pv P2, V)} achieves V at a'lower
costs.
Hence it contradicts the assumption that {hl *(Pv P2, V), hz *(Pv P2, V)} is the
expenditure minimising bundle.
Consequently, if {hl*(pVP2' V), h2*(PV P2, V)} is the optimal bundle under
EMP, the constraint always binds in the EMP and
U{hl*(PvPz,V),h/(pVP2'V)} = V.
and ht (pv P2, U) is continuous function in (pv pz, V), it follows that
e(pv P2, V) is continuous function in Pv pz, and V.
Proof: Suppose there exists two levels of utility U', U", such that U" >
U', for a given price vector (p = Pv P2)'
Let x' vector (z ' = x~, x~) solves EMP for the given prices OWd.:t\ltility
level (PVP2, U') and x" vector (x" = x;, x;) solves for 'the EMP for the
given prices and utility level (Pv P2, U''), so that e(pv P2, U') = P ~: and
··e(PVP2' U") = px".
We have to show e(pv P2, U'') > e(pv P2, U') ~ P x'~ > P x' which
we will prove by contradiction. Suppose x' vector solves EMP for the
given prices and utility level (PVP2, U') and x" vector sol~es for t,he'EMP
for the given prices and utility level (pv P2, U'') but P x" :::; P x' > O.
U(x") > U(x} > U(x) ~ U(x) > U(x) ..... (a),
since U" > U' (by assumption. a being a fraction, xbundle is closer to
that of x").
Combining (a) and (b) we can claim x is the optimal bundle which solves
EMP. It contradicts the fact that x' solves EMP for the given prices and
utility level (Pi' P2, U).
Therefore we can claim that if x' vector solves EMP for the given prices
and utility level (Pv P2, U) and x" vector solves for the EMP for the
given prices and utility level (PVP2, U') then p x" > P x' must hold.
e(pv P2, U') > e(Pl' P2, U).
We have to show e(p', U) ). e(p, U) ~ e(p~, p~,u) > e(pv P2, U).
Let x vector (x=xv X2) solve EMP for the given prices and utility level
(pv P2, U), such that e(pv P2, U) =px.
Let x' (x' = x~, xD solves EMP for the given prices and utility
level (p~,p~, U), such that e(p~,p~, U) =p'x'.
iii) e(pv P2, lJ) is homogenous function of degree one in (pv P2)
/
Proof: Consider two price vectors: fp' = p~, pD and {p" = p~', p~'} at
the given utility lJ:
51
Consumer Behaviour Let us consider another price vector p = (p1, Pz), where, p = {A (p') +
(1 - A)(p")}, where 0:::; A :::; 1. Let h(p, [j) be the vector of optimal
solution from EMP with(p, [j). {where, h(p, [j) = hi (p, [j), hz (p, [j)}.
We have to show that e(p, [j) = p h(p, [j) 2:: A (p')h(p', U) + (1-
A)(p")h(p", U)
This is because
b) h(p, [j) is not the expenditure minimising bundle at price vector p",
rather h(p", U) is the optimal in EMP for (p", U) ~ (1-
A)(p")h(p, [j) 2::(1 - A)(p")h(p", U)
Combining (a) and (b) we get-the result.
Proof: By definition e(pv pz, [j) = I. p.h, (Pi' pz, [j) = Pi hl (Pv pz, [j) +
pzhz (Pi' pz, [j)
From the duality U{hl (Pvpz,[j),hz (PvPz,[j)} = [j (see Section 2.6 for
duality relations)
Now substituting it in the equation (2.6) we get ae(~l,p2,[J) = hi CPl1 PZI U).
Pl
S·mu'1ar 1y, we can sh ow t h at ae(Pl,P2'U)
ap2 = h,Z CPl1 PZI U-) .
i) Proo f : Su bsti
stituuon ffect iISnegative
. elect . ==> ahi«PVP2,[J) ::; 0 i = 1 2
1 1
api
==> ae(Pl,P2,[J) _
- h 1CC Pil PZI U-) 'Clor l• -- 1.
apl
2 - -
. ... iJ e«pVP2'U) ah1«P1,P2,U) 0
Differentiating WIth respect to Pi' a 2 - a <.
P1 P1
Since the expenditure function e(Pl1 P21 rJ} is concave in prices (Pl1 P2)'
Hence the substitution effect is negative.
ii) Proof: Cross substitution effects are same:
a hi «PVP2, [J) ahj«PVP2,[J) , ,
,1,J=1,2
, apj a Pi
From' the Shephard's Lemma'. ae(p;,P2,[J)
Pi
= hi (Cp 11 P2, U-), l' = 12
1 •
So we have
(a) ae(Pl,P2,[J)
apl
= h CC
1 Pl1 P2,
U-) and (b) ae(Pl,P2,[J)
ap2
= h CC
2 Pl1 P21
U-)
By Young's theorem the second order cross partial derivatives are equal,
that is,
a h2 «PVP2,[J)
ap1
53
Consumer Behaviour"
2.5.5 Decomposition of Price
Own price effect captures the change in quantity demand (ceteris paribus) due
.. . Th . ff . aX(Pi.pz,M) ~ d
to th e. ch ange m Its own pnce. us own pnce elect IS ror goo s
--!)~--
op;
ay(pi,pz,M)) .
x and (a for goods y. Movement along the ordinary demand curve
pz
raptures the own price effect. Price effect can be decomposed into Substitution
'Effect and Income Effect.
Own Substitution Effect is the effect of the change in own price of x (i.e., Pi)
on the quantity demand of x, for a given level of utility. Movement along the
compensated demand curve captures the own substitution effect.
. . a hi ((Pi,PZ,iJ) ax(pi,pz,M) 11 -. '
Income Effect: Income Effect for a good (say,x) represents achange in quantity
demanded due to the change in income (M), for the given prices. So income
ffect iIS capture d b-y ax(pi,pz,M)
elect aM . Thee si
SIgn can b e positrve,
.. . . or zero
negative
according to the different characterization of the commodity. So if the income
ax(pvpz,M) . . . . . ax(pi,pi,M}
effect aM > 0, the commodity IS a normal good, If It IS aM < 0,
t he commo ditv
ity is an im feri
IS an enor goo d an d 1if iIt IS
. ax(pvpz,M)
aM °
=, th e commo d"ity IS
perfectly income elastic.
Income effect for a price change works through the change in real income
which changes the purchasing power of a consumer and therefore her demand.
For a given money income as the price of one good changes (say, Pi), the
. f~ c. . ' . {
mcorne elect ror a pnce change IS -
ax(pi,pz,M)
aM
C'
x P1, P2, . Note t hiat M)}
income effect and income effect for a price change have opposite sign and
different magnitude.
Consider good x being normal good. Suppose there is a fall in price of x from
(Pi) to Pi' (so Pi < Pi'), prices of other commodity and income (P2' M)
remaining unchanged. The change in demand of x due to the change in price is
the whole own price effect. The fall in price of x (for a given income of the
consumer) implies an increase in real income, as with the same nominal
income consumer can buys more x or y or both. In order to capture the
substitution effect, (according to the Hicksian principle), let us introduce a
compensated change in income in such a way (in opposite direction to the price
change) which enable the consumer to attain the initial utility (/1) at the new
lower price Pi'. Let AB (see Fig. 2.14a and b) be the initial budget line (having
the slope = Pl) and the tangency point with the indifference curve 11 defines
, ~ .
the initial equilibrium atE. Now the change in price will lead the budget line 'to
rotate outward from AB to AC. The new equilibrium defined at the tangency
point with the higher indifference curve 11' and the budget line AC is E'.
Movement from E to E' captures the price effect.
54
.,
Theory of Demand
X{ B E c y
PE
~ y
r-;-
u..
•...
e--
•...,, SE
•...
o
•..., Fig. 2.14b: Decomposition of Price Effect (Inferior Commodity)
o
~ 55
Consumer Behaviour' 2.5.5 Decomposition of Price
Own price effect captures the change in quantity demand (ceteris J!!lribus) due
oX(Pl.Pz,M) ft d
to the change in its own price. Thus own price effect is --;----- or goo s
. uPl
X and (OY(P;~z'M)) for goods y. Movement along the ordinar.y demand. cu~e
captures the own price effect. Price effect can be decomposed into Substitution
Effect and Income Effect.
Own Substitution Effect is the ~ffect of the change in own price of x (i.e., P1)
Consumer Behaviour Let DE be the income compensated budget line, which will capture the initial
I
new ratio l2.: but tangent to the initial indifference curve 11, so that the
Pz .
consumer is as well as before with the new price. The new tangency point with
the income compensated budget line DE and the indifference curve 11 is E".
Movement froms to E" , captures the own substitution effect.
Note that for a fall in price of x (i.e., P1), there is an increase in demand for
x through the price effect. The is because the commodity is a normal
commodity, the (price effect is negative i.e., PE < 0). Moreover, while we
look at the decomposition of price effect, we see both the income effect and
substitution effect moves in the same direction with the price effect leading to
an increase in demand due to a fall in price of x (i.e., P1)' .
However if the commodity is not a normal commodity, the price effect can be
positive, negative or even zero (i.e.,PE > 0 or PE < 0 or, PE = 0). As we
know irrespective of the nature of commodity (be it normal or inferior) the
substitution effect is always negative to the price change (i.e., demand
increases due to the fall in price and viceversa), but the income effect can be
. OX(Pl,Pz,M)). . .
negative or zero ( a .. :::; 0 depending upon whether the commodity IS \
. M
inferior or perfectly income inelastic. So the income effect in prices can be
. . . oX(Pl,Pz,M) ( -) .
POSItIve or zero I.e., {~ . x Pv P2, M 2:: O}. In such cases the
aM
substitution effect (SE) and income effect (lE) move in opposite direction and
price effect is the net of these two. Thus, the price effect can be negative,
positive or zero, depending upon whether the absolute magnitude of
substitution effect is greater, equal or less that the income effect.
i)
SE (= ah1((pi,P21 V)< 0)
apl
aX(pVP2'M)
ii) ( aM > 0)
. ax(pv P2' M) .. -
hence the lE = -( aM. X(Pl' P2' M) < 0
. oX(Pvpz,M) )
So lE and SE move in the same direction and PE (= = SE
, °Pl
« 0) + lE {< O} < 0 '
. . ox(Pvpz,M)
For a commodity not normal (i.e.,
_ aM ~ 0), we will have:
i) SE (= .ah ((pVP2'
ap1
1 V) < 0).
ii) (aX(Pl,P2,J11) < 0) Hence the lE = {_(aX(Pl,pz,M) x(p pM)} >0
aM - . aM v 2, -
-e-:
,
..•...
Consequently, lE and SE move in opposite. directions and hence the PE o
or
,
depends on the net effect of these two. There are three cases: o
w
56 ~
, ,,}l -'.
inelastic. ,.
2) Suppose lE> O. If ISEI = IIEL it follows that PE =0 and SE and lE are
equal in magnitude (in absolute value) and the effects outweigh each
other. So the net effect on PE = O. It is a case of perfectly price inelastic
commodity (represented by vertical
..,.J
demand curve) . I_ .L ." ..•
ii) Since the substitution effect is always negative irrespective of the nature
of the commodity, the compensated demand function are' always
. "-1"'1y s ope'd,'he.;','
OCHnegat'l:ve " (ajtl((PI,P2,[J)
- a < 0),. ,
_ ' PI
x/ x
57
Consumer Behaviour iii) For a normal good, both the ordinary demand functions and the
compensated demand functions are negatively sloped but as the former
captures the entire price effect it is flatter than the later.
iv) For an inferior good, while the compensated demand functions are
negatively sloped, the ordinary demand functions can negatively sloped,
vertical or positively sloped depending upon whether ISEI > IIEI , ISEI =
IIEI or ISEI < IIEI .
Ordinary dd function
• d, (Perfectly price Inelastic good)
P·It
. I
d, d)
\ /' Ordinary dd function
\N \ (Giffen goods)
\ \ /1
~/
.. ,,,,, .... ".~'''''
' ~.. co~~ensated Hicksian dd function
/
~/ ~ ~ .
X "n x
• I
58
3) What are the properties of expenditure function?
,- Theory of Demand
i) x* = x*(PvP2,M)
i) x* = h1*(PVP2' U),
ii) y* = h2 *(pv P2' U)
These two are called the Hicksian or the compensated demand functions.
We also derived the expenditure function e(pv Pz, U), by plugging the
equilibrium values of x*and y* in the expenditure equation E = P1X + pzy.
59
Consumer Behaviour
2.6.2 Basic Duality Relations .,
Following are the four duality-relations: .
-
We have seen that, generally, if the price of a commodity goes down, .we buy
more of it. This downward movement of the demand is due to two effects:
Wh~t Eilg~.,rStu1tskY' managed 'to' 'dd 'was tb 'ftnd"ah equation 'that decumpo~e-s
this-effect that is based on Hicksian and Marshallian demand curves.
.li'!
From the duality relation: h1 ((PlI P2: U)f== X(P:,P2,'e(pVP2' U))
t
, t
_ '{ ('\,.=
-:,' -Ji'
I
n e-' [J . n- • if
,(PV,P2.' ,-~Pv P2, ))'~l' .(Rv P2',. (PvP2! )))
ai } t lr ((p" p.J{lfi)iJ
,,'... ~.:.,':Jiv
P,)
- ap1 ae(.) 1 V z» •
In aIwo commodity framework there .are four, sets .of Slutsky equations
(showing the decomposition of price effect into income and substitution effect),
, \ aY(Pl.P2,M)
IV}
apl
ah (C ) (2.38)
... ' , 2 PVP2,U . ..2, PvP2,l! .. .. '. . .
apl ap2 /
_ [~2~(~;t2"~) iJ~e~~{.~2:~! .
S- 2 - 2 -' (2.39)
a e((pvPz,u) . a"e((PVP2,U.) \.... " .
_. -- ap1.-P'2-, __ .__ ilPi· -- .. --,.~- ----_~._. .
qTl .,.·r~r~ •...r .~-.1" v"' •••.
ae(n. "'~~~ l J~, U.J! .s ~
'Sihce we knuw1Jy-SITep'lrnrd'~~t;ennna;-~a ":.!dfL -=-hrt('Pl;PZ;tf}-;i-=-'l-;2-'
Pi
" ". iJ~eC(pil,Pi;iJ) H(JIt"t{(P1l,P1,fl), .~ ~a2f!((Pi,:P2'iV)tJf}i:l~(}[hi~('P~r;p2-,iJ0!. , '} srlT
~)I,;', ,iopfJJ j l~jfIjiJ(. ·(jp~1\,).}WFJ 'yjf ·.cJp¥nC'f.l, .'J1Tli iOpF' ~).n.:. ' I
I )!"Qp.iP~ ':).11 T,)rj1 iJPzilIiywfl (J] 8 ~Jbnua n~i~lq hns H . I J'j .;.' - I i :',: 'I
61
"
..........................................................................................
•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• i •••••• ; •• ;, ••••••••••••••••
.................................................... ,' , .
.................................................... ,' .
2.7 LET US SUM UP
The consumption bundle is the set of goods and services that the consumer
would like to consume. Axioms of the theory of consumer choice help making
the assumption that a consumer can make a choice between any two bundles-
the assumption of complete preferences. The consumer prefers one to another
or is indifferent between the two. W.: refer to this as complete preferences.
Consumers are able to make comparisons and choices. We assume that
consumers' preferences are transitive preferences. If a consumer prefers
Bundle A to Bundle B and prefers Bundle B to Bundle C, then the consumer
prefers A to C if preferences are transitive. We assume that there is
nonsatiation for at least one good.
Consumers try to make the choices that maximise their satisfaction given their
limited resources. A consumer's budget constraint shows the possible
combinations of different goods she can buy given her income and the prices of
the goods. The slope of the budget constraint equals the relative price of the
goods.
62
An increase 'in income shifts the budget constraint outward. A change in the Theory of Demand
The substitution effect is the change that arises because a price change
encourages greater consumption of the good that has become relatively
cheaper. It is represented by a movement along an indifference curve. When'
the substitution effect is removed the income effect is the residual effect in the
change in consumption that arises' because of a lower price makes the
consumer better off in terms of increased affordability. It is represented by a
movement from a lower indifference curve to a higher one.
1) What, are the four basic duality relations through which equilibrium
consumer choice are solved?
••••••••••••••••• i • ~ ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
.............................................................................................
Consumer Behaviour
"" "'~~ .•. -•. :. ,I.. ._~'~,':.~i!
Centinuous Function A. .functioncfor :(which. sufficientl y.~t;naij
l' ,_ t,,:,
. tr" '; ';,1 changesin -J,bejoput, ~~_~1j,ltil1,wh,it:r;flr~ly, SIA~nl
, changes in the output.
."\F~:,,,J :J..
.r)~~·,r;l'.'1',<~}:."l·f" f11"•..1.
__ .~ ..••- •.._1Q._
~ uh
n »-: _c· ~ ~ (
f.
.(;~;~l~)·j:.-·I-,-"lj -:J1
<"
jr:"J •.",' J!'~.r 1
~J f. • : "!:hnUinCYJ
.:·fi'-:'i.·'~J{f~.fH f-\ ' .--.,
Bomogenous Punction •.1\ ,0'f'!'" Afunction, which. satisfies -thej 1:! : fW"?1O:
~'Jl hJ, ..>fL k:JG /T ,2bnflg 0'1/1 ~rh', aQlldition!(tx, t:y} :;:;::t1f{Xiiy)~jJoJ:.sQme',IL'
20Jh)Ji') .. I:iJilj'2fiC,} u r, (~'Hll ;,'" integern.· ""'"j/ C'!, le 'i 'I',
3) No. Engel aggregation, Lf=l Si"Yli = 1 and income shares are non-
negative.
4) Yes.
5) You can get your answer by substituting the Marshallian demands that
you round into the definition of indirect utility which is
v(p,m) = U(x1(p, m), X2(P, m)) and
. m
V ((Pv Pz , m)) = -----.1 "11·
"2 ']
4P2 +P1 +""P1 Pi
The expenditure function has the same properties as the cost function.
2) Ordinary demand functions are derived from the utility maximisation
problem and capture the entire price 'effect, which can be decomposed
into substitution effect and income effect. Whereas the compensated
demand functions are derived from the expenditure minimisation
problem and capture only the substitution effect.
3) i) e(pv Pz, U) is continuous function in Pv Pz, and U.
Since.efp., Pz. U) = {Pi hi * (Pi' Pz. U) + pzhz * (Pv Pz. U)}, . and
hi *(Pv Pz, U) is continuous function in' (Pv Pz, U), so it follows
that e(pv Pz, U) is continuous function in Pv Pz, and U.
From above it can be said that the same bundle which solves the utility
maximisation problem (UMP) with given prices and income
(Pv Pz, M) where M = e(pv Pz, U), solves the ,expenditure
\minimisation problem (EM:P) with given prices and 'target utility level
v(PvPz,M) = U.
aY(Pl,pz,M)
ii)
apz
ay(pvpz,M)
iv)
apl
66
3) Since the expenditure function e(Pl1 P2, U) is concave functon in Theory of Demand
·2- .
0 e((P1/PZ1U).. ...
( Pl, P2 ) , (JPf < 0, 1 = 1, the first principal mmor 51 < 0 and
the second principal minor 52 = S ~ O. Such a feature generates the
negative definite matrix.
av
apl 4y(2Pl+PZ)-Z 2y
d) use Roy's identity, xi (p, y) = - av =-
2(2Pl +PZ)-l
- -~-
(2Pl +pz)
ay
and similarly, x~(p,y) = (2P;+Pz)
4y(2Pl +pz)-z 2y
d) Use Roy's identity, x;(p,y) =
2(2Pl +P2r1
Let the price of good x be given by px, let the price of good y be given
by py, andlet income be given by M.
a) What is the slope of the consumer's indifference curve at the
consumption bundle, (1,1) ?
b) Derive the consumer's generalized demand function for goods x
and y.
Y
MRS
2x
Solving the first two equations for A and equating the expressions,
24xy4 48x2y3
we have A = -- = . We can simplify and solve for y,
Px Py .
Px
yielding y . 2X . Substituting this expression into the budget
Py
equation, we have.
O = M - Pxx - --2xpx Py
Py
=M - 3
Pxx.
68
.~
Solving for x, we have the generalized demand function for x, Theory of Demand
M
X = -. Plugging (2} into (1), we get the generalized demand
3px
M
2( 3P)PX 2M
for y, y = ---''-''---
Py 3py
ADS.:
a) There are two related approaches. Both approaches require the simple
derivation of the first order condition for maximising utility subject to a
budget constraint: MU(x) /MU(y) = P(x)/(P(y) i.e, Y / X = 10/15 = .67,
or Y = .67 X and X = 1.S Y.
69
Consumer Behaviour
Slutsky derivation of substitution and income effects: "hypothetical"
increase in M of Rs.2,499.95 to M = Rs.12,499.95. The pure substitution
effect related to X is 500 - 416.67 = 83.33 and the real income effect is
then the "residual" of 416.67 - 333.33 = 83.34.
70
UNIT 3 THEORY OF DEMAND: SOME
RECENT DEVELOPMENTS
Structure
3.0 Objectives
3.1 Introduction
3.2 Recent Developments in Demand Analysis: Linear Expenditure Systems
3.3 Theory of Consumer Surplus
3.4 Theory of Inter-Temporal Consumption
3.5 Elementary Theory of Price Formation: Demand-Supply Analysis
3.6 Cobweb Model
3.7 Lagged Adjustment in Interrelated Markets
3.8 Let Us Sum Up
3.9 Key Words
3.10 Some Useful Books
3.11 Answers or Hints to Check Your Progress Exercises
3.0 OBJECTIVES
In this unit, we will discuss some of the recent development in demand
analysis. First, we will look at an important implication of utility maximisation
exercise viz., linear expenditure system. Then we move on to another important
theory in consumer behaviour called consumer surplus, where we introduce
three different types of definition with their graphical interpretation. In the next
section, we introduce a more advance theory of consumer behaviour where
consumers present decision depend on her future concerns. The price
determination in the market is covered next. Then we move on to explaining a
dynamic model called Cobweb model," which will explain the dynamic stability
p. operty <l( the equilibrium of Demand-Supply analysis. Finally, we will
discuss a model related to lagged adjustment in interrelated markets.
that allow empirical estimation have been developed. In this section we present
one of such exampies. .
with the domain ql>YI and q2>Yz.The y's may be interpreted as m;;'-7n nn
subsistence quantities and are positive. The a's are also positive. Applying '·h,..,
.positive monotonic transformation U' = U/(al+a2) we get,
Subject to ql>O
q2>O
y ~ psq, + p2Q2
We set Lagrange function of the above maximisation exercise as
Z = ,8lln(ql- YI)+ ,821n(q2- Y2) + A(Y- plql- p iq z)
and set its first partial derivatives equal to zero (we assume interior solution of
this maximisation problem):
,
c
.
-e-
c
u,
~
72
Theory of Demand:
Some Recent
AP2=0 Developments
az
-= y- plql- p iq: =0
aA
It can be easily verified that the second order condition for the maximisation is
satisfied. By evaluating the above three equation one can also find out that the
marginal utility of income is decreasing.
Solving the above equations for optimal quantities gives the demand functions,
Multiplying the first equation of the abovetwo demand functions by PI and the
second by P2 we get the expenditure functions
which are linear in income and prices, and thus suitable for linear regression
analysis.
In this section, we discuss the basic concept of consumer surplus and its
derivation. A consumer normally pays less for a commodity than the maximum
amount that she would be willing to pay rather than forego its consumption.
Consumer surplus therefore in crude sense is the difference between what
consumer willing to pay and what she actually pays. Several measures of such
consumer's surplus have been proposed. We will discus three of them.
Attention is limited to a consideration of the good under investigation and a
composite commodity called "money", with consumption quantities of q and M
respectively. Let the distance OA in Figure 3.3.1 represents the consumer's
income. She achieves a tangency solution at point D on indifference curve h. If
she were unable to consume Q, she would be at A on the lower indifference 73
Consumer Behaviour curve I,. She would have to be given an income increment of AB dollars to
restore her to indifference curve h. This increment, called compensating
income variation, is denoted by c, and provides a measure of consumer's
surplus.
o q
74
Theory of Demand:
Some Recent
Developments
o q
It can be shown that c ~ s ~ e. The strict inequalities hold for the case pictured
in Figure 3.1 as a consequence of the income effect. If the consumer were to
'pay more to consume the good, her demand would decline because of her
lower effective income, and the area under the demand curve would exceed the
amount that she would pay rather than forego consumption of the good. Figure
3.2 depicts a case in which the income effect is zero throughout. A
perpendicular such as the line through D and E connects points with the same
marginal rate of substitution. The indifference curves are "parallel" with a
constant vertical distance between a pair of indifference curves. In this case
AB=AC and the three measures of consumer's surplus are the same.
Consumer Behaviour consuming income y this year is thus forgoing consumption of y (1 + r) next
year.
Wealth, W, in the present, is defined as the present value of current and future
income. The consumer's budget constraint is that she cannot spend more than
her wealth, i.e.,
0
X2
XI + -- = XI 0 + --X2 = W ----------------- (a)
. l+r l+r
X ~;
2 X2 ,X2 T.if?
Xl+--= xr +--= 1"1'
1 +r 1+r
0f---_---'Ii:
X
2
o
o x
1
x
1'
The model is depicted in Figure 3.4. The budget line has slope dXI = -(1 + r),
.' ~2
the price of X1 in terms of X2, and passes through the endowment point A, (X10,
0
X2 ). An increase in the interest rate represents an increase in the price of the
present consumption, and has the effect' of rotating the wealth .constraint
clockwise through A.
76
Theory of Demand:
assuming strict interior solution, producing the first order conditions Some Recent
Developments
dL = U (XI, X2) _ A =0 (b. I)
dXI dXI
U(XI,X2) A
-- =0 ------------~----- (b.2)
dX2 U+r)
-dL = XI +--
X2
= XI ° +--
X20
=0 --------------- (b.3)
dA 1+ r l+r
U(XI,X2)
----
Equation (c) says that the consumer's marginal value of present consumption,
U(XI,X2) U(XI,X2) .
Ul1U2 (where UI =. and U2 = ), equals the opportumty cost
dXI dX2
of present consumption, in terms of future consumption forgone. It will
1
simplify the algebra if we let p = --, the price of future consumption.
(1+ r)
Assuming the sufficient second-order conditions hold, the first-order conditions
can be solved for the Marshallian demand functions
XI = XI M ( p,XI °,X2 0)
an,d X2 = X2 M (
p, XI 0 ,X2 0)
We can gain greater insight into the model by deriving the Slutsky equation,
separating out the substitution effect and the wealth (income) effect.
Minimise
subject to
U(Xl, X2) = UO
The Lagrange function for this problem is then
Assuming the first and sufficient second-order conditions hold, the implied
first-order equations can be solved for the Hicksian demands
77
Consumer Behaviour
and
eo
XI
* (p,U 0
)=XI
u +p (vX2 -X2 0)
Xi u (p,U 0
) == Xi M (p,XI *
(PiU 0
),X2) 0 for 1. = 1, 2,
producing the famous Slutsky equation
M V
dXi _ dXi (0 V )(dXiM )
--=--+ X2 -X2 --0
dp dp dXi
If the interest rate increases, the price of future consumption, p, decreases. This
produces a pure substitution effect towards less present and greater future
V
..........................................................................................
78
Theory of Demand:
3.5 ELEMENTARY THEORY OF PRICE Some Recent
Developments
FORMATION : DEMAND-SUPPLY ANALYSIS
In this section, we discuss the elementary theory of price formation. Demand
curve in the market is derived from the aggregate consumer demand and supply
curve is derived from the aggregate firms supply. Since market demand curve
for a good is the sum total of demand for that good of all individual consumers
and since demand curve for a good for an individual consumer is derived from
its utility maximisation, so along the demand curve consumer's optimizing
behaviour is always fulfilled. That means each point on the demand curve
represents that consumers are willing to purchase the corresponding demand
quantity with corresponding price.
o q
Clearly, at the point of intersection between market demand and supply curve,
exchange will take place between consumers and producers, as both of them
simultaneously fulfilled their optimizing behaviour. Corresponding price and
aggregate quantity are short run equilibrium price (say Po) and aggregate
If',mtity (say qo) respectively, which is shown in Figure 3.5.
..-·
t"-
u,
It is assumed that for any excess demand (or excess supply) prices will increase
e-'
..-· (or decrease). According to this behaviour of the market, price adjustment in
·
'\'""
o disequilibrium will take place QYa mechanism, which is known as auctioneer
"';"
U
mechanism.
u.J
~
79
Consumer Behaviour Suppose there is an invisible referee who controls the market price according to
the above behavioural assumptions. Producers supply their quantity on the
basis of existing market price. Suppose, the referee initially specifies a
particular price on the basis of which producers and consumers specify their
supply and demand respectively. Then suppose the referee observed that supply
quantity is larger than the demand quantity i.e., we have excess supply of the
commodity.
If producers fail to supply their entire supply quantity at the existing price, then
according to the behavioural assumption, the referee specifies a lower price of
that commodity. Producers will be discouraged and will supply lower quantity
and consumers will be encouraged and will demand higher quantity. Thus, in
both ways excess supply of the commodity decreases. Suppose it is observed
that demand quantity is larger than the supply quantity in aggregate. We have
excess demand for that commodity. The referee again specifies a larger price
level. Hence, producers will increase their supply and consumers will decrease
their demand. Thus, in both ways excess demand for that commodity goes
down. This process will continue till the referee specifies a particular price at
which corresponding. demand and supply quantities are equal. That means
supply quantity offered by the producer is demanded by the consumer at the
corresponding price. So, both consumer and producer fulfilled their optimising
behaviour simultaneously. The exchange of commodity will take place at this
price and quantity. These price and quantity are the equilibrium price and
quantity in the market respectively.
• Both demand and supply functions depend on time, where time is a discrete
...-
o
I
...-
matter (in that sense it is a dynamic model). U
I
UJ
• Supply quantity at any time, t, depends on previous period's price and ~
80
Theory of Demand:
S, = c -rd Pt-1 ------------------ (i) Some Recent
Developments
But demand quantity at any time, t, depends on the price at that time
D, = a + b P, ----------------- (ii)
• Behaviour of the market is such that as soon as supply quantity comes into
the market, entire quantity is demanded at that period by adjusting price so
that market is clear in each period. Thus, at any time, t, St = D, --------(iii)
Since demand and supply functions are linear, a, b,.c and d are constant. On the
basis of these we now analyze dynamic equilibrium and stability.
a+ b P, = C + d P,
or, (a-c) = (d-b) P,
or, Pe=(a-c)
(d -b)
This is the equilibrium price, which is assumed to be positive such that initially
equilibrium exists. Now we find the time path of price from behavioural
assumptions.
Dt = S,
or, a + b P, = c + d 1\-1
or, b P, - d Pt-1 = (e-a)
,
d (c-a) . .
or, Pt - - Pt - I = ---------------------- (IV)
P b
P, = Pp + Pc ---------------- (v)
To fmd out Pp we put P, = Pt-I = P (say) into the equation (iv), and have
• P(I- d) = c-a
b b
- b-d c-a
or, P(-);::::-
b b
- a-c
or, P=--=Pe
d-b
X
I d I-I = 0
--x
b
or,
d
Of, x="-
b'
Here Po, Pe, d and b all are known and for each level of time price can be
determined from equation (vii).
°
(otherwise it is dynamically unstable). This requires (d y -7 as t -7 00 (since
b
then only P, -7 Pe as t -700 where Po - P, is constant and does not change over
d '
time). Now (-r -70 as t -700 only when
b
d
I"-kl
b
This is the condition for dynamic stability (as in this case we have convergence
to equilibrium from any disequilibrium over time). That means absolute slope
't,
dPI 1
of the demand curve 1-1=1-1 should be lower than the absolute slope of the
dDI b
dPI 1 ,
supply curve 1-1=1-1 , i.e., demand curve should be flatter than supply curve
dSI d
for dynamic stability.
82
Theory of Demand:
Some Recent
When 1d L....-1 then we have divergence from equilibrium over time (from Developments
b
equation (viij) we have dynamically unstable equilibrium, and at that situation
d
When 1-1= 1, we have neither convergence to equilibrium nor divergence
b
from equilibrium (from equation (viil). So it is also dynamically unstable. At
that situation I..!..I=I~ 1i.e., slope of the demand curve is equal to the slope of
b d
the supply curve in absolute sense.
If (d) > 0, then we have monotonic time path of price from equation (vii). If
b
(d) < 0, then we have cyclical time path of price from equation (vii).
b
Case 2: Suppose demand curve and supply curve are upward sloping i.e., dc-O
d
and bc-O hence (-) > 0 .
b
1 1
Case E: If 1-1=1-1 then demand and supply curve are coincide if their
b d
intercepts are also same then we have infinite number of equilibrium
and there is no need for dynamic stability analysis or demand and
supply curve are parallel to each other (when intercepts are not equal)
then equilibrium does not exist. Hence, there is no need for stability
analysis in this case.
Case~: !
If 1.!.. kl 1then we have mono tonic convergence to equilibrium. It's a
b d
dynamically stable equilibrium.
1 1
Case H: If 1-1=1-1 then demand and supply curve are coincide if their
b d
intercepts are also same then we have infinite number of equilibrium
and there is no need for dynamic stability analysis Or demand and
supply curve are parallel to each other (when intercepts are not equal)
then equilibrium does not exist. Hence, there is no need for stability
analysis in this case.
Case I: !
If I .!..I>I Ithen we have monotonic divergence from equilibrium. It's
b d
a dynamically unstable equilibrium.
[Note: At time (t-l) if E (Pt-I»O, then price should increase in the next period
according to the behavioural assumption i.e., Pt>Pt-1 i.e., (P, - Pt_I»Owhich is
captured by equation (iii) with the restriction that K>O]
The time path of price is represented by the first order linear non-homogeneous
difference equation since by assumption a, b, c, d and K are constants. Solution
of the time path of price (Pt) consists of a particular solution (Pp) and a
complementary solution (Pc). Thus,
P, = Pp + Pc ------------- (vi)
To find out Pp, we put, P, = Pt-I = P' (say), into the difference equation of price
and get
[Note: In fact, here the inter-temporal price is equal to static equilibrium price
where equilibrium does not change over time].
To find out Pc, w.e put P, = x', into the homogeneous part of the difference
equation of price and get
x=[I+K(b-d)]
85
, "
.Consumer Behaviour It is the characteristic rout. Therefore, complementary solution is Pc = m x','
where m is any unknown integral constant. So from equation (vi) we have r-:
which automatically holds when demand curve is downward sloping [i.e., b<O]
and supply curve is upward sloping [i.e., dc-O]. Equilibrium is dynamically
unstable when demand curve is upward sloping and supply curve is downward
sloping (as bo-O and d<O so b-ed does not hold)
When both demand and supply curves are upward sloping, the Walrashian
dynamic stability requires bedor, (!) > (~). That means I! 1>1~ 1 [since de-O
. b d b d
and bo-O and price is measured in vertical axis]. So, the supply curve is flatter
than the demand curve. Otherwise, it would be dynamically unstable.
When both demand and supply curves are downward sloping, the Walrashian
dynamic stability requires b-ed or (!) > (~). That means I! 1<1~ I [since d<O
. b d b d
and b<O].. Hence, the demand curve should be flatter than the supply curve.
Otherwise, it is dynamically unstable.
86
Theory of Demand:
3.8 LET US SUM UP . Some Recent
Developments
1) Hint: Set up the Lagrange function and solve the first order condition,
assuming interior solution exists.
L = q/l.q2J2 +A(Y-Plql-P2q2)
MPDDIIGNOU/P.O.7K1November 20 18 (Reprint)
'.
ISBN : 978-93-86375-0~3