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# Contents

**I Preferences and choice 1
**

1 2 3

1 Preference relations 1.1 Utility Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Choice Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2 Consumer choice 4 2.1 The consumption set . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.2 Competitive Budgets . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.3 Demands Functions and Comparative Statistics . . . . . . . . . . 7 2.3.1 Wealth eﬀect . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.3.2 Price eﬀects . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.3.3 Implications of homogeneity and Walras’ law for price and wealth eﬀects . . . . . . . . . . . . . . . . . . . . . . . . 10 2.4 The Weak Axiom of Revealed Preference and the Law of Demand 11 2.5 The Weak Axiom of Revealed reference and the Law of Demand 11

Part I

**Preferences and choice
**

1 Preference relations

X :={set of mutually exclusive possible alternatives } Deﬁnition 1.1. Preference (technically binary) relations are deﬁned over the set X and denoted by ⌫ 1. Strict preference relation : x y () x ⌫ y but y 6⌫ x 2. Indiﬀerence relation ⇠ :x ⇠ y () x ⌫ y and y ⌫ x Deﬁnition 1.2. The preference relation ⌫ is rational1 if it satisﬁes : 1. Completeness : 8x, y 2 X we have that x ⌫ y or y ⌫ x or both. 2. Transitivit y: 8x, y, z 2 X , if x ⌫ y and y ⌫ z =) x⌫z. Completeness and transitivity are very strong assumptions, think how diﬃcult it is to compare between options we do not know in real life. Proposition 1.1. if ⌫ is rational, then:

1 Also

known as weak order

1

3. e.) it requires the following additional assumtion: Deﬁnition 1. Thus ⌫ associated with u(. d) be a metric space. Deﬁne u(x) = |. which is closer to continuty of a function on Rn is Deﬁnition 1. .3. since x % x =) x 2.1. Properties that are preserved under monotonic transformations are called ordinal. x is both irreﬂexive ( x 6 y) x) and transitive ( if x y and y z =) 2. since we know we are not dealing with inﬁnity 2 Think 3 See of lexicographic preferences and the jump experienced by a sequence of bundles De la Fuente page 329 2 . x is weakly preferred to any element in this set. if 8x. An alternative deﬁnition. a function that counts the number of elements in .(y ) ✓.(x).) that represents ⌫ =) ⌫ is transitive and complete Rationality is necessary. if % on X is rational. an ! a and bn ! b. if 8x 2 X the sets B (x) = {y 2 X : y y } and W (x) = {y 2 X : y x} are closed in (X. Cardinal properties are preserved under any transformation.) is an ordinal property.(x)| . any strictly increasing function f : R ! R. We say ⌫ is continuous. but not suﬀucient. If x y ⌫ z =) x y 1.g. for ⌫ to be representable by a function u(. then it can be represented by a utility function. The proof shows that if there is u(. Continuity of rational preferences3 (weak order). . Proof. A function u : X ! R is a utility function representing ⌫ (preference relation).4.(x).1 Utility Functions Deﬁnition 1. ⇠ is reﬂexive and transitive 3.(y )| |. x ⌫ y () u(x) u(y ) Notice that a utility function representing ⌫ is not unique. d). In fact2 . in fact.(x) 6= .2. Continuity of preferences an % bn . then a % b Proposition 1.(x) = {y 2 X : x % y }. Let (X.5. Deﬁne the lower contour set of x 2 X as . Let X be a ﬁnite set. Proposition 1.(x)| () u(y ) u(x) . diﬀerences in utility meaure between alternatives are cardinal properties.(x) =) |. v (x) = f (u(x)) is a new utility function representing the same ⌫ . y 2 X . ⌫ can be represented by a utility function only if it is rational Proof.

if x and y are feasible.2 Choice Rules Deﬁnition 1. But c(B 0 ) could contain other elements. x has been revealed as “weakly preferred” to y . {x. z }) = {x. B is a collection of non-empy subsets of X .10. 2. x 2 C (B ) and y 62 C (B ). Fact 1. then for any B 0 2 B with x. 2. Deﬁnition 1. y. % ) = {x 2 B : x % y. y }. Given a choice structure (B. z }. c2 ({x.9. we have x 2 C (B ). Using the previous deﬁntion. under B . Choice behavior es represented by a choice structure (B. y 2 B . Note: According to this deﬁnition. C (·)) over the set of options X. Example: X = {x. and any non-empty B ✓ X . y }) = {x}.1. it cannot be that y is chosen but not x. we must also have x 2 C (B 0 ). so be careful with notation such as x 2 c(B 0 ). 8B 2 B. c1 ({x. z }} 1. 4 Consider C2 in example 1.8. We may have a choice rule that satisﬁes WARP but that does satisﬁes completness in the deﬁnition of rational preferences4 . C (·)) the revealed preference relation %⇤ is deﬁned by 1. c2 ({x. 1.t x. Weak Axiom of Revealed Preferences (WARP) A choice structure (B. then y cannot be revealed preferred to x”. because this implies x is an element of the chosen set.1 of MWG or come up with your own idea ! 3 . y } =) y %⇤ x!! Clearly. y. 2. 8y 2 B }. y }) = {x}. c1 ({x. According to deﬁntion 1.1. y. but then c2 ({x. y }) = {x}. hence for any other B 0 . y.6.C. C (·)) satisﬁes WARP : If for some B 2 B with x. y }. y 2 B . z }) = {x. A preference maximizing behavior has the following choice structure: C ⇤ (B.7. x %⇤ y () there is some B 2 B s. z }) = {x}. ⇤ : If 9B 2 B s. y 2 B 0 and y 2 C (B 0 ). C (·) is a choice rule (correspondence) that chooses a nonempty set of elements C (B ) ⇢ B.t x. z }) = {x. Deﬁnition 1. it is possible to restate WARP as: “If x is revealed at least as good as y . B{{x. y. Deﬁnition 1. C2 (·) does not satisﬁes WARP. y. Deﬁnition 1. y }) = {x} =) x ⇤ y . Example: c2 ({x. Note: Choice rules are selecting sets. y }. c2 ({x. Consider a rational preference %. y 2 B and x 2 C (B ) .8 c2 ({x.

C (B ) = C ⇤ (B. Walrasian Budget Set: The set of consumer subject to physical AND economic constrain. this % is the only preference raltation that does so. Suppose 9B 2 B s. WARP is satisﬁed. If % is rational =) (B. Proposition 1. y 2 B 0 where y 2 C ⇤ (B 0 . Consumption set: The set of consumer choice subject to physical constraints. 2. Theres is a rational preference relations % that rationalizes C (·) relative to B. y % z . by transitivity x % y % z =) x % z .4. 8z 2 C ⇤ (B 0 . %). To verify WARP holds. 4. In words. let B 0 2 B . Commodities: The objetct of choice.D. it is a choice structure where the underlying rule is %. %) contains all elements that are weakly preferred to 8z 2 B 0 and x % y . Furthermore. 1. x. 2 Consumer choice 1.In words. Market economy : it is a setting in which the goods and services that the consumer may acquire are available for purchase at known prices.2 of MWG. Hence. %). 5 This Some basic ideas and implicit deﬁntions used freely in this chapter are: is proposition 1. Proof. Comparative Statics: The study of Walrasian demand response to changes of exogenous parameters/constrains such as prices and wealth. If (B. Notice that x must also be feasible. C (·)) is a choice structure5 that 1. %) =) x 2 C ⇤ (B 0 . Thus. by the deﬁnition of C ⇤ (B. %) satisﬁes WARP. %). %)8B 2 B. 5.5. Proposition 1. 4 . Consumer: the most elementary decision making unit to the study of consumer demand. 2. it is implied that x % y 2 B . the proof is on page 13. y 2 B and x 2 C ⇤ (B. C ⇤ (·. B includes all subsets of X of op to three elements. the proof states that given that the set C ⇤ (B 0 . 2. with x. %) . that is. 8z 2 B 0 . Then. it must be the case that x 2 C ⇤ (B 0 . %). 6. 3.t.

6. price-taking behavior.w = {x 2 RL + : p · x w} is the set of all feasible consumption bundles for the consumer who faces market prices p and has wealth w. 7 L Deﬁnition 2. Consumption set: RL ◆ X = {x 2 RL : xl 1. L} An importan feature of our consumption set is that it is convex.w . 0. Price vector p = 4 . Deﬁnition 2.. The budget hyperplane determines the upper boundary of the budget set.. Convex set (strict convex) if 8x.. 5 2 R and p >> 0.3. 5 . In sum.1. Deﬁnition 2. Commodity vector ( or commodity bundle) x = 4 . 8 l = 2. . The Walrasian or competitive budget set Bp. x0 2 A.. L). 1] =) x” 2 A (x” = ↵x + (1 ↵)x0 . x” = ↵x+(1 ↵)x0 . Deﬁnition 2.5. Deﬁnition 2. given p and w. the consumer’s problem consists in choosing a consumption bumdel x 2 Bp. ..2 There are a few implicit assumptions throughout this section and they are: completeness of markets.2. The set {x 2 RL : p · x = w} is called the budget hyperplane. 7 L Deﬁnition 2. 1) =) x” 2 A. 6 Check 3 p1 6 . 52R . ↵ 2 [0.4. . xL The consumption set6 2 For simplicity we assume that the number of ommodities is ﬁnite and equal to L (indexed by l = 1m. pL Competitive Budgets 2 page 19 of MWG to see a mix of continuous and discrete boundles and combinations.. ↵ 2 (0. 2.1 3 x1 6 .2.

6 .The following graph shows the geometric relationship between p and the budget hyperplane.

↵w) = x(p. we have p · x0 = p · x = w. 7 see 8 page proof on page 22 MWG 22 MWG if you cannot come with your own example 7 . The consumer’s Walrasian ( or market. 2. because for any x0 that lies on it.p w/p1 x1 The price vector p is orthogonal to the budget hyperplane. when this is so. w and ↵ > 0.w is a convex set7 . Hence p · x = 0 for x = (x0 x). any x 2 x(p.3 Demands Functions and Comparative Statistics Deﬁnition 2. w). we refer to it as a demand function. Think of the consequences of diﬀerent tax rates for diﬀerents wages and the trade of eﬀect of consumption and lesiure8 .7. Note: The budget constrain needs not be a straight line.8. The Walrasian demand correspondence x(p. w) is homogenous of degree zero. then consumption should stay the same. The walrasian budget set Bp.1. or ordinary ) demand correspondence x(p. w)is single-valued. w) assigns a set of chosen consumption bundles for each pair (p.x2 p w/p2 x ∆x={x'-x} x' Bw. This says that if prices and wealth change by ↵. In principle it could be multivalued. Deﬁnition 2. w) for any p. w) might be chosen. Lemma 2. When x(p. if x(↵p.

8x 2 x(p. . 2. w ) 6 x2 (p. w) = 6 6 4 R . we say the demand is normal. w) 2. w)/@ w 0 we say commodity l is normal.2 Price eﬀects Deﬁnition 2.10. . 3 @ xL (p. If @ xl (p.3. Price eﬀect is deﬁned as @ xl /@ pk .3.9.1. we can normalize the leel of one of this L + 1 independen variables at an arbitrary level. This assumption does not preclude savings. but for Giﬀen goods @ xl /@ pk > 0 8 . If @ xl (p. A common normalization is to set come pl = 1 w = 1.w) · · · @ p1 @ pL 9 Generally it is that @ xl /@ pk < 0.11. Fact 2. For a ﬁxed price p ¯.w) @w 7 7 72 7 5 2. w) : w > 0}. 6 6 In matrix notation the weatlh eﬀects are reprsented as: Dw x(p. Ep as the wealth (income) expansion path. 2 3 x 1 ( p1 .9 In matrix notation it is: 2 @ x (p. Wealth eﬀect is deﬁned as: @ xl (p. Its image in RL p.w ) · · · @ x@ @ p1 pL 6 7 . This reduces the efective level or arguments in x(p. . is known ¯ = {x(¯ + . w) to L. The walrasian demand correspondence x(p.. p) is homegeneous of degree zero and that it satisﬁes Walras’ law. w) satisﬁes Walras’ law if 8p >> 0 and w > 0.1 Wealth eﬀect Deﬁnition 2. Througout this section. 4 5 @ xL (p.w) @w @ x2 (p.w) 3 1 1 (p. 6 7 . Walras law says that the consumer fully expends his wealth. L 2 @ x1 (p. we have p · x = w. w) = 6 7 .w) @w . w) formally has L + 1 arguments. w)/@ w 1. w). w) is called consumer’s Engel function. w)/@ w < 0 we say commodity l is inferior. it is assume that the correspondence x(w. Note: A convinient implication of being homegeneous of degree zero is that. xL (p. 4 5 . w) 7 6 7 x(p.w) @ xL (p. If every commodity is normal. although x(p. the function of wealth x(¯ p.Deﬁnition 2.

.w) x2 ⇤⇤ Figure 2.1: Shows the income (wealth) expansion path for a given price vector p..x1 Bp.w**) Ep x(p.w) x2(p**1.w** w**>w*>w x(p...w) x2 Figure 2.2: Demand of x2 for ﬁxed p1 . p1 9 .w*) Bp.w* x(p. p⇤ 1 .. p2 x2(p1..w) x2(p*1.

w) = @ x@ pk xl (p.k (p.L @w In matrix notation Dp x(p. The previous result can be restated by a simple manipulation yielding: L X "l. then 8p and 8w: L X @ xl (p. 2..3: An oﬀer curve as p2 changes. ↵w) x(p. w) w = 0.w (p. w) = 0. w) = 0 Note: The result follows inmediately from homogeneity of degree zero.w) w/p2 x(p1. w)p + Dw x(p.w) w/p1 x1 Figure 2.x2 w/p"2 d w/p'2 x(p1.p2. w) is homegeneous of degree zero. If the Walrasian demand function x(p. respectively. set ↵ = 1.and "l.w) pk w l (p.3 Implications of homogeneity and Walras’ law for price and wealth eﬀects Proposition 2. .3. w) = 0 and then.w) x(p1.w) .p2'. 10 .p2". w ) = @w xl (p. l = 1..k (p.w ) where "l.L k=1 @ xl (p. simply diﬀerentiate x(↵p. w) + "l.1. l = 1.w (p. w) k=1 @ pk pk + @ xl (p.. .w) are the elasticities of good l with respect to price pk and elasticity of good l with respect to wealth.. holding p1 constant.

w) and he experiences a price change to p0 . w) = w ( the equality comes from Walras’ law). If the Walrasian demand function x(p.w) law. Slutsky wealth compensation w = p · x(p.. Whenever price changes are accompanied by a Slutsky wealth compensation. w0 ) w” and x(p0 . w) satisﬁes Walras’ L P l (p.3 can be derived by diﬀerentiating p · x(p.12. respectively. In words. then it must be that the bundle x(p. w). w). w0 ) : If p” · x(p0 . 2.9 and fact 2. w)10 satisﬁes the weak axiom of revealed preference (WA) if the following property holds for any two price-wealth situations (p.13. This must be the case.4 The Weak Axiom of Revealed Preference and the Law of Demand In this section. homogeneous of degree zero and satisﬁes Walras.w ) law for all p and w: pl @ x@ + xk (p. w) over x(p0 . w”) > w0 . w) is unnafordable at prices p0 and wealth w0 .Proposition 2. w). w0 ). then for all p and w: pl @ xl@ = 1 or in matrix notation p · Dw x(p. 0 In words. The Walrasian demand function( see deﬁnition 2. w) is aﬀordable.5 The Weak Axiom of Revealed reference and the Law of Demand Deﬁnition 2. w) satisﬁes Walras’ L P (p..1 to understand this) x(p. 2. L or in matrix Pk notation p · Dp x(p. w) = w 1. with respect to the vector p and scalar w respectively. w”) =) p0 · x(p”. law. Similarly.2 and 2. if for given prices and wealth (p.2 and 2. k=1 Note 1: Proposition 2. w0 ) 6= x(p. Deﬁnition 2. w) is single valued. w0 ) is aﬀordable and x(p . l=1 Proposition 2. because he could aﬀord x(p0 . we refer to them as compensated price changes. w0 ) with (p. w) + x(p. if our consumer choses x(p. . w) and (p0 .3.3 are also known as Cournot and Engel aggregation. 10 It is assumed that x(p. w) = 0. x(p0 . k = 1. w) is unique througout this section 11 . Note 2: Proposition 2. Another interpretation is that our consumer reveals that he prefers x(p. it is implied that x(p. w0 ) 6= x(p”.2. If the Walrasian demand function x(p. w) yet he decided to not to get this bundle. then the Slutsky wealth compensation is the minimum ammount necessary such that the orginal bundle x(p. w)T = 0T .. where p = (p0 p).

x(p”.w' x(p". x(p” .w” .x2 Bp'.w") Bp'. x(p0 . our consumer violates WA ( Wearl Axiom) because under Bp0 . w”) is the preferred. x(p”.w') Bp". under the diﬀerent Walrasian Budget sets. On the lower left panel The deﬁnition is satisﬁed with equality. yet he does not chose it. 12 . only one of the options is available at a time.w" x(p'.w' x(p". under Bp”.w" x(p". w0 ) is aﬀordable.w") Label x1 x1 x1 Bp'. On the lower right panel.w') x(p".w' x(p".w' x(p'.w") x2 x2 x1 Bp".w') Bp'. when x(p0 .w') Bp'.w") x(p'. our consumer chooses x(p”.w') Bp". w0 ) is available . similarly.w0 . w” ) is not.w" x(p'.w" x(p'. w”) under both circumstances.4: On the left panel.w" Bp". w”) is available and he does not chose it. On the bottom panel.w' Bp".w") x2 Figure 2. On the right panel.

13 . the ﬁnal intersect is w /p1 . Moreover. according to our deﬁnition.w) w'/p2 Bp'. x(p.w) Label Bp'.w .5: Under Bp. hence.w . w < 0 . the displacement is parallel from Bp0 .w w'/p'1 w/p1 x1 w/p'1 Figure 2.w w'=p'. in a way such that x(p.w' x(p. w) is chosen. The latter. After a price reduction from p to p0 .w to Bp. as shown in the graph. 0 Notice that the initial displacement is to the point w/p1 . but after slutsky’s 0 0 weatlh compensation.w(p. real wealth increases.x2 w/p2 Bp. w) is still aﬀordable.

moreover. Bp0 . w0 ) x(p. Then we have ↵w0 + (1 ↵)w00 > ↵p0 · x(p0 . w0 ) x(p. see graph below) 11 Notice the notation has been slighted reverted to accomodate for the following proof. ((= ) This direction uses fact 2. w) =) p0 · x(p. p0 · x(p0 .w0 and Bp00 . Assume we have p0 · x(p00 . (p0 p) · [x(p0 . By contradiction. w0 ) = w and x(p0 .13 ( =) ) For x(p. Expanding our expression (p0 p) · [x(p0 . both bundles are aﬀordable under either price-wealth scheme. w) > w0 holds () 8(p. Thus. w0 ) = (p0 . -p · [(x(p0 . w0 ) = w = p · x(p. w0 ) = [↵p0 + (1 ↵)p00 ] · 00 x(p .z (homogeneous of degree zero) and satisﬁes Walras’ Law. w0 ) > w. w) to a new price-wealth pair (p0 . w0 ) x(p. w)] 0. Consider the ﬁrst term.w00 are both convex (see lemma 2. For our second term. Suppose that x(p. w). w) does not have to be aﬀordable under both cases. w) = ↵)p00 · (x(p. w0 ) =) px(p0 . w)] = 0. w0 ) x(p. w0 ) = [↵p0 + (1 ↵)p00 ] · x(p00 . w0 ) < w00 . of Proposition2. w00 ) < w0 and p00 · x(p0 . 1) for which [↵p0 + (1 ↵)p00 ] · x(p0 . Clearly. Hence our ﬁrst term p0 · [(x(p0 . w0 ) x(p. with strict inequality whenever x(p. w) = w. w0 ) + (1 ↵)p00 · x(p0 . So. w 0 ). w) = w0 12 and by Walras Law. Proof. we have (p0 p) · [x(p0 . p0 · x(p. w0 ) (we assumed this in the ﬁrst line of the proof) . w00 ) and denote p = ↵p0 + (1 ↵)p00 and w = [↵p0 + (1 ↵)p00 ] · x(p0 . w0 ) w ) < 0. w) [↵p0 + (1 (Notice that the new x(p. we have p0 · x(p. w). w ) aﬀordable with (p0 . the Weak Axiom implies that 0 if p x(p.2. 12 This makes the initial bundle x(p. w0 ) x(p. w0 ). w0 ) x(p. That is. w)]. w00 ) and x(p0 . w) + (1 14 . w) = ↵p0 · x(p. given that p0 is a compensated price change (see deﬁnition2. w)]) = 0. w)]. w0 ) 6= x(p.2: that the WA holds () it holds for all compensated price changes13 . w0 ) x(p. The argument is by contradiction. 13 It is also obviating the trivial case when WA holds with equality ↵)p00 ] · x(p. w0 ) + (1 ↵)p00 · x(p0 . w)11 . w)] = p0 · [(x(p0 .d. w) satisﬁes the WA () the following property holds: For any compensated price change from an initial situation (p. w0 ) 6= x(p. w)]. w) > w0 whenever p · x(p0 . w0 ) w and x(p0 . w)] = (p · x(p0 . w) = x(p. p0 · [(x(p0 . w0 ). w) 6= x(p.13). w) and 8(p0 . The following proof will us this fact: Fact 2. x(p00 . w0 ) x(p. w00 ). using the fact that the intersection of two convect sets is convex: Choose ↵ 2 (0. w)] p · [(x(p0 . suppose x(p. w0 ) sit on the intersection of these sets (they’re both aﬀordable in either case). Thus. Now. we know p0 · x(p. w) (Walrasian demand function) is h. -p · [(x(p0 . w) 6= x(p0 . this fact is only a special case of the deﬁnition.4. w0 ) = w0 .1). In addition. Walras’ law dictates that p · x(p. w)). w) 6= x(p0 . Then x(p. p · x(p0 .Proposition 2. ↵w0 + (1 ↵)w00 > ↵p0 · x(p0 . clearly. w) w0 and x(p.

+ @y dxn @ xn y = f (k.14. Finally.w) Bp. either p0 · x(p. Which can be intepreted as a form of law of demnds: Demand and price move in opposite directions.w'' x(p'.. w) < w00 . Deﬁnition 2.w') x1 Figure 2. w) · dp (2. w) p) is a diﬀerential compensated price change. w)] 0 is p · x 0. w) 6= x(p00 . Then we have x(p. (p0 p) · [x(p0 . A short notation for (p0 p) · [x(p0 . w0 ) x(p. 00 14 Remark 2. Then how it is possible to build a new walrasian budget set Bp. p · x(p00 . That’s where the contradiction comes from.4 has the following implications: Let (p. w)] 0 ⌘ p · x 0 is also known For the case in which x(p. + @ f (·) dxm . l) =) dy = f kdk + f ldl 15 . The diﬀerential change in demand induced by this compensated price change is dx = Dp · x(p. Suppose p00 · x(p. w) does not have to be available under both budgets. w) · dp (analogous to ( w = x(p... w)dp + Dw x(p. w) < w0 or p00 · x(p. w00 ) are aﬀordable under either budget. x(p. .1.. if y = f (x . w00 ). Therefore.1) 14 The i.For @ xm @y dx1 @ x1 + .e y = other case is identical and shown on page 32 of MWG.. w)dw16 =) by using dw = x(p.. w00 ) = w (compensated price change) and p00 · x(p. dw = x(p..w'') Bp''. x ) its total diﬀerential is dy = 1 n) = 15 Under @ f (· ) dx1 @ x1 + . w) is diﬀerentiable propostion 2.x2 Bp'. w) be our starting point and let dp be a diﬀerential change in prices. w) < w0 . w) < w .w .w' x(p.w x(p''. w0 ) and x(p00 . because this new setting obeys WA. the selected bundle x(p. w0 ) as Compensated Law of Demand15 . Compensated law of demand there is no giﬀen goods 16 For example.6: The graph shows howx(p0 .

.3) (2. w)dp + Dw x(p. w)T ]dp Using form the last expresion into dp · dx 0 =) dp · [Dp x(p. the compensated law of demand holds.x1 x2 Bp. w) @ xl (p. . w) where the (l. w) @ pk @w (2.w) Bp'. w)[x(p. w) 6 7 .w' x(p'.15. w)T ]dp 0 The expression inside brackets is equivalent to 2 3 S11 (p. w) + xk (p. w' )u nd e Bp. w)x(p.x(p. w) + Dw x(p. 16 . . because our consumer will either chose x(p. Equation 2.w x(p.6) Deﬁnition 2.w rW A x(p..w) x2 x1 Figure 2. SL1 (p.5) slk (p. .5 is also known as Slutsky of substitution matrix. w) + Dw x(p. . w) · · · SLL )p.w w'=p'. w) = (2. The right panel shows that under WA without compensated price change. w) · dp] ⌘ [Dp x(p. . k )th entry is @ xl (p.7: The left panel shows that under compensated price change and WA. w) · · · S1L (p.w) Al lo wa b le lo c at io n sf or x( p'. w) or a point that was not available before.2) (2. our consumer is free to chose any point on the line Bp0 .w (for L = 2) and it might be possible that p1 # and x1 # without additional restrictrions.6 is also known as substitution eﬀect.w) Bp'. Equation 2. that dx = Dp x(p. S (p. w)x(p.4) (2. w) = 4 5 .

6. An implication of being negative semideﬁnite implies sll (p. 17 This 18 does not be symmetric under our current assumptions. note that the change in demand for good l if wealth is left unchanged is (@ xl (p. If a diﬀerentiable Walrasian demand function x(p.4. if @ xl (p. Proposition 2.3. w)dpk (dw due to change in pk ). w) 0. w) measures the diﬀerential change in the consumption of commodity l (substitution to or from other commodities) due to a diﬀerenital change in the price of commodity k when wealth is adjusted so that the consumer can still just aﬀord his original consumption bundle. slk (p. w) = @ xl (p. w)/@ w < 0 17 . Thus according to the previous deﬁnition S (p.2. Thus a good can only be Giﬀen a (p. To see the latter. w) is always singular ( rank less than L). homegeneity of degree zero and weak axiom. w)p = 0 for any (p.w)0. w). w) 0. For the consumer to be able to just aﬀord his original consumption bundle welath must vary bu the amount xk (p.Remark 2. The sum of this elements is therefore exactly slk (p. w)dpk ]. but for L = 2 it holds. The substitution with respect to its own price si nonnegative18 . Remark 2. w)/@ pl ) + [@ xl (p. The result of the previous derivations is: Proposition 2. The eﬀect of this weatlh change on the demand for good lis then (@ xl (p. Remark 2. then at any (p. w). w)/@ pl ) > 0 =) @ xl (p. Then p · S (p. homogeneous of degree zero and satisﬁes Walras’ law. w) satisﬁes v·S(p. the Slutsky matrix17 S (p. Suppose the Walrasian demand function x(p. w)/@ w) [xk (p. In particular sll (p. w) satisﬁes Walras’ law.5. w) and S (p. w)dpk . w) is diﬀerentiable. w) only if it is inferior. w)/@ w] xl (p. w)/@ pl ) dpk . 8v 2 RL .