Background

to Demand
 Introduction

 In this lesson, we will take a more detailed look at

consumer demand, and try to understand the reasons
behind the consumer’s behavior – why s/he buys more
when price falls all others held constant, and vice versa.

 There are two main approaches to analyzing consumer

behavior:
 The Marginal Utility Approach
 The Indifference Approach

 We will assume that consumers behave “rationally” – they

weight the relative costs and benefits of the alternatives
they could spend their money on.
 The Rational Consumer
 A rational consumer is a person who attempts to get the
best value for money from his or her purchases.

 The main aim of the consumer is to maximize his/her

satisfaction from the unlimited incomes they have.
 That’s you to ensure that the benefits of what you are
buying are worth the expense to you.

 Sometimes people may buy things irrationally out of habit

or impetuously, with little or no thought about the price
and quality.

 However, in general, people behave in a rational way.

Caveats on the Rationality Assumption

 First, don’t confuse irrationality and ignorance.

 Behaving rationally, does not mean that you have perfect
knowledge/information
 Have ever been disappointed and feel cheated after buying something?
 Nonetheless, you behaved rationally based on information you had. You
only believed wrongly and paid for your ignorance
 Second, the term ‘rational’ does not imply any moral
approval
 As economists we cannot make judgements about what people’s
goals should be.
 We cannot say which ones are morally right or wrong
 We can, however, look at the implications of people behaving
rationally in pursuit of those goals.
 The Marginal Utility Theory
 Utility is the sense of pleasure, or satisfaction, that comes from
consumption.
 How do you measure utility?
 We do not have utility meters to measure and compare utilities
 Economists used an imaginary unit of satisfaction from the consumption
of a good called, Util –1 util corresponds to one-unit of satisfaction

 Utility is subjective in that the utility that a person derives from

consuming a particular good depends on that person’s tastes or
preferences (likes and dislikes) for different goods and services.
 Utility is in the mind of the consumer, and consumers change
their minds. Their tastes change; their circumstances change;
their consumption patterns change.
 We generally assume simply that tastes are given and are
relatively stable. Different people may have different tastes but a
given individual’s tastes are not constantly in flux
 Total Utility

 Total Utility (TU) is the total satisfaction a person derives

from all those units of a commodity consumed within a given
period of time.
 In other words, Total utility is the total utility a consumer
derives from the consumption of all of the units of a good or a
combination of goods over a given consumption period, ceteris
paribus.
 Thus if you drink 10 bottles of coke, total satisfaction from the
10 bottles is the total Utility.
 Marginal utility

 Marginal utility is the additional satisfaction

derived from consuming one extra unit of the
commodity within a given time period.
 Put differently, Marginal utility is the
change in total utility resulting from a one-
unit change in consumption of a good.
 Total and Marginal Utility

Units of Water
Consumed Total Marginal
(glasses) Utility Utility
0 0 -
1 40 40
2 60 20
3 70 10
4 75 5
5 73 -2
 Jo-Nuellah’s utility from consuming Coke (daily)
16

14

12

10
Utility (utils)

0
0 1 2 3 4 5 6
-2

Packets of crisps consumed (per day)

 Ollie's utility from consuming crisps (daily)
16

14 TU
12
Packets TU
10 of crisps in utils
Utility (utils)

0 0
8 1 7
2 11
6 3 13
4 14
4 5 14
6 13
2

0
0 1 2 3 4 5 6
-2

Packets of crisps consumed (per day)

 Ollie's utility from consuming crisps (daily)
16

14 TU
12

10
Utility (utils)

0
0 1 2 3 4 5 6
-2

Packets of crisps consumed (per day)

 Ollie's utility from consuming crisps (daily)
16

14 TU
12

10
Utility (utils)

0
0 1 2 3 4 5 6
-2 MU
Packets of crisps consumed (per day)
 Ollie's utility from consuming crisps (daily)
16

14 TU
12 DTU = 2

10 DQ = 1
Utility (utils)

6
MU = DTU / DQ

0
0 1 2 3 4 5 6
-2 MU
Packets of crisps consumed (per day)
 Ollie's utility from consuming crisps (daily)
16

14 TU
12 DTU = 2

10 DQ = 1
Utility (utils)

6
MU = DTU / DQ = 2/1 = 2

0
0 1 2 3 4 5 6
-2 MU
Packets of crisps consumed (per day)
 Total and Marginal Utility curves.

You Must notice the following about the TU and MU Curves

 The MU curve slopes downwards, this illustrates the
concept of diminishing marginal utility
 The TU curve stars from the origin, implying that zero
consumption yields zero utility.
 The Marginal utility is zero when TU reaches its
maximum.
Law of Diminishing Marginal Utility

 The more of a good an individual consumes per

time period, other things constant, the smaller
the increase in total utility from additional
consumption.
 The law of diminishing marginal utility states
that as more and more units of a particular
good is consumed, the extra satisfaction
derived from extra units consumed declines.
 This applies to all consumption
Q Jo-Nuellah eats five slices of pizza one evening but
admits that each slice of pizza doesn't taste as good as
the previous one. This suggests that for Jo-Nuellah

A. The TU from pizzas is past

its maximum point.
B. The MU of a slice of pizza
is negative.
C. The MU is still rising but
by smaller amounts.
D. The MU is positive but
declining.
E. The TU is positive but
declining.
 The optimum level of consumption

 Since utility cannot be measured (in utils), how do we

determine how many units of a good should we consumed
in order to maximize our total satisfaction?
 We can measure utility with money
 Thus, utility becomes the value that people place on their
consumption
 Marginal utility becomes the amount of money a person would be
prepared to pay to obtain one more unit (MU=P)

 To know how many units of a good to consume, if a

consumer is acting rationally, we introduce the concept of
CONSUMER SURPLUS
 Consumer Equilibrium:
One Commodity Case

 Consumer Surplus: consumer surplus is the

excess of what a person would have been
willing to pay for a good (i.e. The utility) over
what that person actually pays.

 Marginal consumer surplus is the difference

between what a consumer would be willing to
pay for one more unit of a product (MU) and
what the person actually pays (P).

 Thus: MCS = MU - P
 Consumer Equilibrium:
One Commodity Case

 Total consumer surplus is the sum of all the

marginal consumer surpluses obtained from all
the units of a good she consumes.
 it is the difference between the total utilities
from all the units a consumer consumes and
the total expenditures. THUS
 Consumer surplus
MU, P

Total
consumer
surplus
P1

Total
consumer MU
expenditure

O Q1 Q
 Utility maximization Rule

 A rational consumer attempts to maximize

consumer surplus.
 A rational consumer would buy an
additional unit of a good as long as the
perceived dollar value of the utility of one
additional unit of that good (say, its
marginal dollar utility) is greater than its
market price.
 Utility maximization Rule

 The equilibrium occurs where:

 MU = P

 If MU>P, the consumer must buy more since

the surplus is positive

 If MU < P, the consumer must buy less since

the consumer surplus is negative.
 Q Rational consumer behaviour is where a
person consumes the amount of a good that

A. maximises the total utility

from the good.
B. maximises the consumer
surplus from the good.
C. minimises the amount spent
on the good to achieve a
given level of utility.
D. maximises the marginal
utility from the good.
E. equates the marginal utility
with that from other goods.
 Q An individual’s consumer surplus
will tend to fall as:
A. the market approaches
equilibrium.
B. the market supply curve shifts
to the right.
C. marginal utility increases at
higher prices.
D. the individual’s demand curve
becomes more price elastic at
the optimum level of
consumption.
E. the individual’s demand curve
becomes less price elastic at the
optimum level of consumption.
Marginal utility and the demand curve
 maximising consumer surplus: P = MU

 Individual's demand curve for any good is the

same as their marginal utility curve for that
good, where utility is measured in monetary
terms.

 This is shown in the figure below:

 Deriving an individual person’s demand curve
MU, P

Consumption at Q1
a where P1 = MU
P1

MU = D

O Q1 Q
 Deriving an individual person’s demand curve
MU, P

Consumption at Q2
a where P2 = MU
P1
b
P2

MU = D

O Q1 Q2 Q
 Deriving an individual person’s demand curve
MU, P

Consumption at Q3
a where P3 = MU
P1
b
P2

P3
c

MU = D

O Q1 Q2 Q3 Q
 Multiple commodity rule:

 Limitations of the one-commodity version

 marginal utility affected by consumption of other
goods
 marginal utility of money not constant

 Optimum combination of goods

 the equi-marginal principle
 MUA/MUB = PA/PB
 Multiple commodity rule:

If the price of good a falls such that

MUA/MUB > PA/PB
The consumer would buy more of good A and less of
other goods
If the price of good a rises such that
MUA/MUB < PA/PB
The consumer would buy less of good A and more of
other goods
Background to Demand

Indifference Analysis
 Indifference analysis

 In the indifference analysis, we do not measure

utility, we merely measure satisfaction by
ranking various combinations of goods in order
of preference. In other words, it assumes that
consumers can decide whether they prefer one
combination s of goods to another.
 Assumptions of Consumer Behaviour
 Baskets or bundles is a collection of goods or
services that an individual might consume.

1. Complete: Preferences are complete if the

consumer can rank any two baskets of goods.
Thus, the consumer can always do one of these:
 A preferred to B
 B preferred to A
 indifferent between A and B
Assumptions of Consumer Behaviour
2. Transitive:
 Preferences are transitive if a consumer who
prefers basket A to basket B, and basket B to
basket C also prefers basket A to basket C.

3. More is better less. basket with more of at

least one good and no less of any good is
preferred to the original basket. Thus, there is
non-satiation.
 Indifference Curve
 An indifference curve is a set of points,
each representing a combination of some
amount of good X and some amount of
good Y, that all yield the same amount of
total utility.

 Indifference curve shows all the

various combinations of two goods
that give an equal amount of
satisfaction or utility to a consumer.
Constructing an indifference curve

Pears Oranges Point

30 6 a
24 7 b
20 8 c
14 10 d
10 13 e
8 15 f
6 20 g

Combinations of pears and

oranges that Clive likes
the same amount as
10 pears and 13 oranges
 Constructing an indifference curve
30
28
Pears Oranges Point
26
30 6 a
24
24 7 b
22 20 8 c
20 14 10 d
18 10 13 e
Pears

8 15 f
16 g
6 20
14
12
10
8
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Constructing an indifference curve
30 a
28
Pears Oranges Point
26
30 6 a
24
24 7 b
22 20 8 c
20 14 10 d
18 10 13 e
Pears

8 15 f
16 g
6 20
14
12
10
8
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Constructing an indifference curve
30 a
28
Pears Oranges Point
26
b 30 6 a
24
24 7 b
22 20 8 c
20 14 10 d
18 10 13 e
Pears

8 15 f
16 g
6 20
14
12
10
8
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Constructing an indifference curve
30 a
28
Pears Oranges Point
26
b 30 6 a
24
24 7 b
22 20 8 c
20 c d
14 10
18 10 13 e
Pears

8 15 f
16 g
d 6 20
14
12
e
10
f
8
g
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 The Slope of Indifference curve
 The indifference curves are negatively sloped
and thus have negative slopes.
 The negative slope of the indifference curve is called
the Marginal Rate of Commodity Substitution.
 The MRS shows the amount of one commodity that
a consumer is prepared to give up in order to
consume one more unit of another commodity and
still maintain the same level of satisfaction
 The MRS declines as one moves down on an IC.
This concept is called Diminishing MRS
 Deriving the marginal rate of substitution (MRS)
30 a
DY = 4 MRS = 4
26 b

DX = 1 MRS = DY/DX
Units of good Y

20

10

0
0 67 10 20
Units of good X
 Deriving the marginal rate of substitution (MRS)
30 a
DY = 4 MRS = 4
26 b

DX = 1 MRS = DY/DX
Units of good Y

20

Diminishing marginal
rate of substitution

MRS = 1
c
10
DY = 1 d
9
DX = 1

0
0 67 10 13 14 20
Units of good X
 Q The marginal rate of substitution is:
A. the total amount of utility
received by a consumer from
consuming one product
relative to another.
B. the amount by which demand
falls as price rises.
C. the ratio of the extra amount
of one product needed to
compensate for the loss of a
unit of another.
D. marginal utility divided by
the price of the product.
E. the degree of convexity of a
given indifference curve.
 Indifference Map

 an indifference map is the collection of Indifference

curves corresponding to different levels of
satisfaction
 An indifference map
30

The further out the curve, the

higher the level of utility
Units of good Y

20

An indifference curve shows all

combinations of X and Y that
give a particular level of utility.
10

I5
I4
I3
I2
0 I1
0 10 20
Units of good X
 Properties of Indifference Curves

 Property 1: Higher indifference curves are

preferred to lower ones.
 Property 2: Indifference curves are downward
sloping. This reflects the law of
diminishing MRS.
 Property 3: Indifference curves do not cross
The impossibility of two indifference curves crossing
30

A consumer cannot be
indifferent between a
and both b and c
Units of good Y

20

a
10
c
I2
b
I1
0
0 10 20
Units of good X
 Q Indifference curves cannot intersect
because this would imply that:

A. the consumer has 20% 20% 20% 20% 20%

imperfect information.
B. the ratio of the marginal
utilities had risen.
C. both prices and income
have fallen.
D. the consumer is not a
rational agent.
E. the marginal rate of
substitution had become
negative. A. B. C. D. E.
 The budget constraint
 The budget constraint shows all combinations
of goods that just exhaust the consumer’s
resources.
 That is, the set of baskets that the consumer
may purchase given the limits of the available
income.

PxX + PyY = I
 The budget constraint
 Two goods available: X and Y

I= GHȻ10
Px = GHȻ1
Py = GHȻ2
 Budget Line :
 1X + 2Y = 10
 Or
 X + 2Y = 10
 The budget Line
Y

I/PY •
Budget line

•C
Slope -PX/PY

•
I/P X
X
 A budget line
30 a

Units of Units of Point on

good X good Y budget line

0 30 a
Units of good Y

20 5 20
10 10
15 0

10 Assumptions

PX = £2
PY = £1
Budget = £30

0
0 5 10 15 20
Units of good X
 A budget line
30 a

Units of Units of Point on

good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10
15 0

10 Assumptions

PX = £2
PY = £1
Budget = £30

0
0 5 10 15 20
Units of good X
 A budget line
30 a

Units of Units of Point on

good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10 c
15 0

c Assumptions
10

PX = £2
PY = £1
Budget = £30

0
0 5 10 15 20
Units of good X
 A budget line
30 a

Units of Units of Point on

good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10 c
15 0 d

c Assumptions
10

PX = £2
PY = £1
Budget = £30

d
0
0 5 10 15 20
Units of good X
 Effect of an increase in income on the budget line
40

30
Units of good Y

20

Assumptions

10 PX = £2
PY = £1
Budget = £30

0
0 5 10 15 20
Units of good X
 Effect of an increase in income on the budget line
40

Assumptions

PX = £2
30 PY = £1
Budget = £40
Units of good Y

n
20

16
m

10 Budget
= £40
Budget
= £30
0
0 5 7 10 15 20
Units of good X
Effect on the budget line of a fall in the price of good X
30
Assumptions

PX = £2
PY = £1
Budget = £30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
Effect on the budget line of a fall in the price of good X
30
Assumptions

PX = £2
PY = £1
Budget = £30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
Effect on the budget line of a fall in the price of good X
30
Assumptions

PX = £1
PY = £1
Budget = £30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
Shift in the Budget Line from A fall in Price of
Y
X

M/PY •
Initial Budget line
New Budget line

Slope –PX/PY

Slope –P*X/PY

M/PX
•
M/P*
X
X
 Shift in the Budget Line from A Rise in Price
Y
of X

M/PY •
New Budget line

Initial Budget line

Slope –P*X/PY

Slope –PX/PY

M/P*X
•
M/P X
X
Shift in the Budget Line from A Fall in Consumer
Income
Y

M/PY •
New Budget line

M*/PY Initial Budget line

Slope –PX/PY

Slope –PX/PY

M*/PX
•
M/P X
X
Shift in the Budget Line from A Fall in Consumer
Income
Y

M*/PY •
Initial Budget line

M/PY New Budget line

Slope –PX/PY

Slope –PX/PY

M/PX
•M*/P X
X
 Q If the price of both goods doubles and
also income doubles, the budget line will:

A. not change. 20% 20% 20% 20% 20%

B. shift outward parallel to

the previous budget line.
C. shift inward parallel to
the previous budget line.
D. become steeper, crossing
the mid-pint of the
previous budget line.
E. become less steep,
crossing the mid-pint of
the previous budget line. A. B. C. D. E.
 Consumer Equilibrium

 A consumer is in equilibrium when, given

personal income and price constraints, the
consumer maximizes the total utility or
satisfaction from her expenditures.
 In other words, a consumer is in equilibrium
when, given her budget line, the person reaches
the highest possible indifference curve. This
occur at the point where the consumer’s budget
line is tangent to the highest indifference curve.
 Consumer Optimum
Y

•A D

• Optimal Choice

E
•
• C
IC
•
B
BL
0 X
69
 Finding the optimum consumption
Points r, s, u and v
give a lower level of
r utility than point t.
s
Units of good Y

Point t gives
the maximum
level of utility
Y1 t

u I5
I4
v I3
I2
I1
O X1
Units of good X
 Consumer Equilibrium
 At the point of equilibrium, the slope of the IC
(MRS) must be equal to the ration of the two
Prices(Px/Py)
 That is MRS = Px/Py
 “The rate at which the consumer would be
willing to exchange X for Y is the same as the
rate at which they are exchanged in the
marketplace.”
Income Consumption Curve and Engel Curve
 Income consumption curve is the locus
of point of consumer equilibrium
resulting when only the consumer’s
income is varied.
 The Engel curve shows the amount of a
commodity that the consumer would
purchase per unit of time at various
levels of income. The Engel curve is
derived from Income consumption
curve
 Effect on consumption of a change in income
Units of good Y

B1 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

I2
B1 B2 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

I4
I3
I2
B1 B2 B3 B4 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

Income-consumption curve

I4
I3
I2
B1 B2 B3 B4 I1
O
Units of good X
Deriving an Engel curve from an income-consumption curve

Bread

I3
I2
I1
B1 B2 B3

CDs
Deriving an Engel curve from an income-consumption curve

Bread Income-consumption
curve

I3
I2
I1
B1 B2 B3

CDs
Deriving an Engel curve from an income-consumption curve

Bread Income-consumption
curve

I3
I2
I1
B1 B2 B3

CDs
Income (£)
Deriving an Engel curve from an income-consumption curve

Bread Income-consumption
curve
Qb1 a
I3
I2
I1
B1 B2 B3
Qcd1 CDs
Income (£)
Deriving an Engel curve from an income-consumption curve

Bread Income-consumption
curve
Qb1 a
I3
I2
I1
B1 B2 B3
Qcd1 CDs
Income (£)

Y1 a

Qcd1
Deriving an Engel curve from an income-consumption curve

Bread Income-consumption
Qb2 curve
b
Qb1 a
I3
I2
I1
B1 B2 B3
Qcd1Qcd2 CDs
Income (£)

Y2 b
Y1 a

Qcd1Qcd2
Deriving an Engel curve from an income-consumption curve

Bread Qb3
c
Income-consumption
Qb2 curve
b
Qb1 a
I3
I2
I1
B1 B2 B3
Qcd1Qcd2 Qcd3 CDs
Income (£)

Y3
c
Y2 b
Y1 a

Qcd1Qcd2Qcd3
Deriving an Engel curve from an income-consumption curve

Bread Qb3
c
Income-consumption
Qb2 curve
b
Qb1 a
I3
I2
I1
B1 B2 B3
Qcd1Qcd2 Qcd3 CDs
Income (£)

Engel curve
Y3
c
Y2 b
Y1 a

Qcd1Qcd2Qcd3
Deriving an Engel curve from an income-consumption curve

Bread Qb3
c
Income-consumption
Qb2 curve
b
Qb1 a
I3
I2
I1
B1 B2 B3
Qcd1Qcd2 Qcd3 CDs
Income (£)

Engel curve
Y3
c
Y2 b
Y1 a

Qcd1Qcd2Qcd3
 Effect of a fall in the price of good X
30
Assumptions

PX = £2
PY = £1
Budget = £30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30
Assumptions

PX = £2
PY = £1
Budget = £30
Units of good Y

20

10

B1 I1
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30
Assumptions

PX = £1
PY = £1
Budget = £30
Units of good Y

20

10

B1 I1
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30 a
Assumptions

PX = £1
PY = £1
Budget = £30
Units of good Y

20
k
j

10 I2

B1 I1 B2
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30 a The price–consumption curve shows how
consumption is affected by a change in the
price of one of the two goods

Price-consumption curve
Units of good Y

20
k
j

10 I2

B1 I1 B2
0
0 5 10 15 20 25 30
Units of good X
Deriving a demand curve from a price-consumption curve

As the price

Expenditure on
all other goods
of X falls, so
a the budget
line swings
outwards.

I1
B1

Units of good X
Deriving a demand curve from a price-consumption curve

Fall in the

Expenditure on
all other goods
price of X
a b

I2
I1
B1 B2

Units of good X
Deriving a demand curve from a price-consumption curve

Further falls in

Expenditure on
all other goods
the price of X
a b

I2
I1
B1 B2

Units of good X
Deriving a demand curve from a price-consumption curve

Further falls in

Expenditure on
all other goods
the price of X
a b
c d

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a b Price-consumption
c d
curve

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a b Price-consumption
c d
curve

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X

P1 a
Price of good X

Q1 Units of good X
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a b Price-consumption
c d
curve

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X

P1 a
Price of good X

P2 b
P3 c
P4 d
Demand

Q1 Q2 Q3 Q4 Units of good X
 Indifference analysis

 The effect of changes in price

 the price–consumption curve
 deriving the individual's demand curve

 Income and substitution effects of a price change

 a normal good
Units of good Y Income and substitution effects: normal good

f
I1
I2
I3
I4
I5
B1 I6
QX1
Units of Good X
 Income and substitution effects: normal good

Rise in the price

of good X
Units of good Y

f
I1
I2
I3
I4
I5
B2 B1 I6
QX3 QX1
Units of Good X
 Income and substitution effects: normal good

Substitution effect
of the price rise
Units of good Y

g
h

f
I1
I2
I3
I4
I5
B2 B1a B1 I6
QX3 QX QX1
2 Substitution Units of Good X
effect
 Income and substitution effects: normal good

Income effect of
the price rise
Units of good Y

g
h

f
I1
I2
I3
I4
I5
B2 B1a B1 I6
QX3 QX2 QX1
Income Substitution Units of Good X
effect effect
 Q The substitution effect will be bigger:
A. the more similar the two goods are
to each other and hence the more
convex the indifference curves are.
25% 25% 25% 25%
B. the less similar the two goods are
to each other and hence the more
convex the indifference curves are.
C. the more similar the two goods are
to each other and hence the
straighter the indifference curves
are.
D. the less similar the two goods are
to each other and hence the
straighter the indifference curves
A. B. C. D.
are.
 Indifference analysis

 The effect of changes in price

 the price–consumption curve
 deriving the individual's demand curve

 Income and substitution effects of a price change

 a normal good
 an inferior good
 Income and substitution effects: Inferior (non-Giffen) good
Units of good Y

I1

I2 B1

QX1
Units of Good X
 Income and substitution effects: Inferior (non-Giffen) good

Rise in the price

of good X
Units of good Y

f
h

I1

B2 I2 B1

QX3 QX1
Units of Good X
 Income and substitution effects: Inferior (non-Giffen) good

Substitution effect
of the price rise
g
Units of good Y

f
h

I1

B2 B1a I2 B1

QX2 QX1
Substitution effect Units of Good X
 Income and substitution effects: Inferior (non-Giffen) good

Income effect of
the price rise
g
Units of good Y

A positive income
effect: a rise in price
f partially offsetting the
fall in consumption.
h

I1

B2 B1a I2 B1

QX2 QX3 QX1

Substitution effect Units of Good X
Income effect
 Indifference analysis

 The effect of changes in price

 the price–consumption curve

 deriving the individual's demand curve

 Income and substitution effects of a price change

 a normal good
 an inferior good
 a Giffen good (a special type of inferior good)
Units of good Y Income and substitution effects: Giffen good

I1

I2 B1
QX1
Units of Good X
 Income and substitution effects: Giffen good

Rise in the price

of good X
Units of good Y

I1
h

B2 I2 B1
QX1QX3
Units of Good X
 Income and substitution effects: Giffen good

Substitution effect
g of the price rise
Units of good Y

I1
h

B1a
B2 I2 B1
QX2 QX1QX3
Substitution effect Units of Good X
 Income and substitution effects: Giffen good

Income effect of
g the price rise
Units of good Y

A positive income
I1 effect that is bigger
than the negative
h substitution effect. A
rise in price causes a
rise in consumption.

B1a
B2 I2 B1
QX2 QX1QX3
Substitution effect Units of Good X
Income effect
 Q If the income and substitution effects of
a price change work in the same direction,
the good whose price has changed is:
20% 20% 20% 20% 20%
A. a normal good.

B. an inferior good.

C. a Giffen good.

D. a normal or inferior good,

but not a Giffen good.

E. an inferior or Giffen good,

but not a normal good.
A. B. C. D. E.
 Indifference analysis

 The effect of a change in price on the demand

for other goods

 The usefulness of indifference analysis

 superiority of using ordinal measures

 limitations of indifference analysis