Transcript No Slide Title

ESC Toulouse Microeconomics
Topic 3: Demand
Motivation & Overview
• Focus switches from market to individual
demand
• Greatest pleasure given limited income
– utility function / budget constraint
• What happens when prices or income
changes?
– comparative statics
Preferences
• Represent preferences using utility function
– U=U(x,y)
x and y are two goods
• Indifference curves
– all points on a given indifference curve
represent same utility
– U  U(x 1 , y1 )
Quantity
of good
y per
period
Qy1
1
2
Qy2
U U
0
Qx1
Qx2
Fig 3.3 An indifference curve for the goods x and y
Quantity of good x
per period
Preferences II
• Properties of indifference curves
–
–
–
–
slope downwards
smooth
continuous
convex
• curves bowed towards origin
Budget constraint
• Can only afford to buy limited amounts of
goods
– represent affordable combinations using budget
constraint
– position depends upon ratio of good prices and
income
Qy
M2
Py1
M2
M1
Py1
M2
0
Fig 3.6 A set of budget constraints
M3
M1
Px1
M1
Px2
M2
Px1
Qx
Utility maximisation
• Maximise utility subject to budget
constraint
• Most north easterly indifference curve
possible
• Point of tangency between budget constraint
and indifference curve
Qy

*
Y
Q

~
U U
U U

U U
0
QX*
Fig 3.7 Utility maximization subject to a budget constraint
Qx
Efficient Budget Allocation
• Marginal utility
– MUx
– increase in utility from one more unit good X
• Slope of indifference curve
– minus MUx / MUY
Qy
Qy1
Qy
Qy2
U U
Qx1
Fig 3.8a
Qx2
Qx
Qx
Qy
*
Qy
slope   U / Qx

U / Qy
U U
*
Qx
Fig 3.8b
Qx
Efficient Budget Allocation II
• Slope budget constraint
– minus Px / PY
• Efficient allocation
– MUx / PX = MUY / PY
• Equalise marginal utility per Franc spent
Qy
*
Q y1
slope

Px
Py
*
Q x1
Fig 3.8c
Qx
Change in Price
• Fall in price
• Budget constraint swings outwards
• Relative prices change
– substitution effect
• Real income increases
– income effect
Qy
m
Py2
Y1
a
b
Y2
U2
U1
0
X1
Figure 3.9 A fall in the price of good x
X2
m
Px1
m
Px2
Qx
Qy
d
Y1
Y2
a

c
Y3
0
b

X2
X1
X3
SE
IE
Total effect
Fig 3.10 The substitution and income effects of a fall in the price of good x
Qx
Change in Price II
• Normal good
– increase in income leads to higher consumption
• Inferior good
– increase in income leads to lower consumption
– income and substitution effects opposed
• Giffen good
– income effect outweighs substitution effect
Qy
m
Py1
Y2
Y1
U2
Y3
U1
0
X1
X2
X3
Fig 3.11 A fall in the price of good x, where good x is an inferior good
Qx
Qy

Y2

Y1
U2

Y3
U1
0
X2 X1
X3
Fig 3.12 A fall in the price of good x, where good x is an Giffen good
Qx
Team Tasks 3 - Demand
• What happens to demand for your organisation’s good
when its price is increased?
• What happens to demand for your organisation's good
when income increases?
• Under what circumstances will the demand for your
organisation’s good fall when its price falls?
• Are there are any advantages in your organisation
producing an inferior good?