Individual DemandBest Affordable BundleFigure 3.1 Optimal Consumption BundleSome other examples: Perfect SubstitutesPerfect ComplementsIncome ChangesFigure 3.2 Income Expansion PathNormal GoodsNormal and Inferior GoodsPrice Consumption PathPrice-Consumption PathIndividual Demand CurveSlide 14Income and Substitution EffectsThe resulting DemandIncome and Substitution Effects Work in Opposite DirectionsFigure 3.13 Giffen GoodCompensating for Price Changes: “over compensation”Individual DemandIndividual DemandHow Does the Best Affordable How Does the Best Affordable Bundle Change when the Prices or Bundle Change when the Prices or the Income Change the Income ChangeBest Affordable BundleBest Affordable BundleAn interior solution to the constrained An interior solution to the constrained (smooth) utility optimization problem (smooth) utility optimization problem satisfies:satisfies: IxPxPPPxxMRS*22*1121*2*12,1;,Figure 3.1 Optimal Figure 3.1 Optimal Consumption BundleConsumption BundleSome other examples: Some other examples: Perfect SubstitutesPerfect SubstitutesIf the goods are perfect If the goods are perfect substitutes, so that the substitutes, so that the MRS is constant no MRS is constant no matter how much of matter how much of each one of the goods each one of the goods the consumer has, the the consumer has, the best affordable bundle best affordable bundle may contain only one may contain only one of the goods.of the goods.xx11xx2221PP55 55,212121PPxxxxuPerfect ComplementsPerfect ComplementsIf the goods are perfect If the goods are perfect complements, so that a complements, so that a consumer uses, say, 5 consumer uses, say, 5 units of good units of good yy for every for every unit of good unit of good x, x, the best the best affordable bundle will affordable bundle will always contain a fixed always contain a fixed proportion of goods proportion of goods independent of the ratio independent of the ratio of prices.of prices.xxyy },5min{, yxyxu Income ChangesIncome ChangesIncome Expansion Path Income Expansion Path traces the traces the changes in the composition of the best changes in the composition of the best affordable bundle as the income changesaffordable bundle as the income changesThe Engel CurveThe Engel Curve is the relationship is the relationship between the income and the amount of a between the income and the amount of a good consumedgood consumedFigure 3.2 Income Figure 3.2 Income Expansion PathExpansion PathNormal GoodsNormal GoodsAs the consumer’s income increases, the quantity demanded increasesNormal and Inferior Normal and Inferior GoodsGoodsA good is inferior if the quantity demanded falls with the consumer’s incomePrice Consumption PathPrice Consumption PathHolding income and price of the second Holding income and price of the second goodgood fixed, the Price Consumption Path fixed, the Price Consumption Path for good for good oneone is the set of best affordable is the set of best affordable bundles as the price of this good varies.bundles as the price of this good varies.Price-Consumption PathPrice-Consumption PathIndividual Demand CurveIndividual Demand CurveThe individual demand curve is the The individual demand curve is the relationship that shows how much of a relationship that shows how much of a good the consumer wants to purchase good the consumer wants to purchase when the price of this good varies and when the price of this good varies and the rest of the prices and the income are the rest of the prices and the income are held constant.held constant.Income and Substitution Income and Substitution EffectsEffectsThe resulting DemandThe resulting DemandIncome and Substitution Income and Substitution Effects Work in Opposite Effects Work in Opposite DirectionsDirectionsFigure 3.13 Giffen GoodFigure 3.13 Giffen GoodCompensating Compensating for Price for Price