Varian9e Chapter

Chapter 6
Demand
Properties of Demand Functions
 Comparative statics analysis of
ordinary demand functions -- the
study of how ordinary demands
x1*(p1,p
p2,y)
y) and x2*(p1,p
p2,y)
y) change as
prices p1, p2 and income y change.
Own Price Changes
Own-Price
 How does x1*(p1,p2,y) change as p1
changes holding p2 and y constant?
changes,
 Suppose only p1 increases, from p1’
to p1’’ and then to p1’’’.
’’’
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1x1 + p2x2 = y
p1 = p1’
x1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1x1 + p2x2 = y
p1 = p1’
p1= p1’’
x1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1x1 + p2x2 = y
p1 = p1’
p1=
p1’’’ p1= p1’’
x1
Own Price Changes
Own-Price
Fixed p2 and y.
Own Price Changes
Own-Price
Fixed p2 and y.
p1 = p1’
x1*(p1’)
p1
Own Price Changes
Own-Price
Fixed p2 and y.
p1 = p1’
p1’
(p1’))
x1*(p x 1*
x1*(p1’)
p1
Own Price Changes
Own-Price
Fixed p2 and y.
p1 = p1’’
p1’
(p1’))
x1*(p x 1*
x1*(p1’)
p1
Own Price Changes
Own-Price
Fixed p2 and y.
p1 = p1’’
p1’
(p1’))
x1*(p x 1*
x1*(p1’)
x1*(p1’’)
p1
Own Price Changes
Own-Price
Fixed p2 and y.
p1’’
p1’
(p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’)
x1*(p1’’)
p1
Own Price Changes
Own-Price
Fixed p2 and y.
p1 = p1’’’
p1’’
p1’
(p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’)
x1*(p1’’)
p1
Own Price Changes
Own-Price
Fixed p2 and y.
p1 = p1’’’
p1’’
p1’
(p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’’’) x1*(p1’)
x1*(p1’’)
p1
Own Price Changes
Own-Price
Fixed p2 and y. p1’’’
p1’’
p1’
(p1’’’))
x1*(p (p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’’’) x1*(p1’)
x1*(p1’’)
p1
Ordinary
y
Own Price Changes
Own-Price demand curve
Fixed p2 and y. p1’’’ for commodity
y1
p1’’
p1’
(p1’’’))
x1*(p (p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’’’) x1*(p1’)
x1*(p1’’)
p1
Ordinary
y
Own Price Changes
y1
p1’’
p1’
(p1’’’))
x1*(p (p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’’’) x1*(p1’)
x1*(p1’’)
p1
Ordinary
y
Own Price Changes
y1
p1’’
p1 price
offer p1’
curve
(p1’’’))
x1*(p (p1’))
x1*(p x 1*
x1*(p1’’)
x1*(p1’’’) x1*(p1’)
x1*(p1’’)
Own Price Changes
Own-Price
 The curve containing all the utility-
maximizing bundles traced out as p1
changes, with p2 and y constant, is
the p1- price offer curve
curve.
 The plot of the x1-coordinate of the
p1- price offer curve against p1 is the
ordinary demand curve for
commodity 1.
Own Price Changes
Own-Price
 What does a p1 price-offer curve look
like for Cobb
Cobb-Douglas
Douglas preferences?
Own Price Changes
Own-Price
like for Cobb
Cobb-Douglas
Douglas preferences?
 Take
a b
U( x1 , x 2 )  x1 x 2 .
Then the ordinary demand functions
for commodities 1 and 2 are
Own Price Changes
Own-Price
* a y
x1 (p1 , p 2 , y)  
a  b p1
and
* b y
x 2 (p1 , p 2 , y)   .
a  b p2
Notice that x2* does not vary
y with p1 so the
p1 price offer curve is
Own Price Changes
Own-Price
* a y
x1 (p1 , p 2 , y)  
a  b p1
and
* b y
x 2 (p1 , p 2 , y)   .
a  b p2
Notice that x2* does not varyy with p1 so the
p1 price offer curve is flat
Own Price Changes
Own-Price
* a y
x1 (p1 , p 2 , y)  
a  b p1
and
* b y
x 2 (p1 , p 2 , y)   .
a  b p2
p1 price offer curve is flat and the ordinary
demand curve for commodity 1 is a
Own Price Changes
Own-Price
* a y
x1 (p1 , p 2 , y)  
a  b p1
and
* b y
x 2 (p1 , p 2 , y)   .
a  b p2
p1 price offer curve is flat and the ordinary
demand curve for commodity 1 is a
rectangular hyperbola.
Own Price Changes
Own-Price
Fixed p2 and y.
x2
x*2 
by
( a  b )p 2
x1*(p1’’’) x1
* ayy1’)
x1*(p
x1 
a  b )p1
x1*(p1(’’)
p1
Ordinary y
Own Price Changes
Fixed p2 and y. for commodity y1
x2
is
* ay
x1 
( a  b )p1
x*2 
by
( a  b )p 2 x 1*
x1*(p1’’’) y1’)
x1*(p
ay x1
*
x1 
a  b )p1
x1*(p1(’’)
Own Price Changes
Own-Price
like for a perfect-complements
perfect complements utility
function?
Own Price Changes
Own-Price
like for a perfect-complements
perfect complements utility
function?
i x1 , x 2.
U(( x1 , x 2 )  min
U
Own Price Changes
Own-Price
* * y
x1 (p1 , p 2 , y)  x 2 (p1 , p 2 , y)  .
p1  p 2
Own Price Changes
Own-Price
* * y
x1 (p1 , p 2 , y)  x 2 (p1 , p 2 , y)  .
p1  p 2
With p2 and y fixed, higher p1 causes
smaller x1* and x2*.
Own Price Changes
Own-Price
* * y
x1 (p1 , p 2 , y)  x 2 (p1 , p 2 , y)  .
p1  p 2
* * y
As p1  0, x1  x 2  .
p2
Own Price Changes
Own-Price
* * y
x1 (p1 , p 2 , y)  x 2 (p1 , p 2 , y)  .
p1  p 2
* * y
As p1  0, x1  x 2  .
p2
* *
As p1   , x1  x 2  0.
Own Price Changes
Own-Price
Fixed p2 and y.
x2
x1
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’
y/p
/ 2
x*2  p1’
y
p1’ p2 y x 1*
x*1 
p1’ p 2
y
x*1  x1
p1’ p 2
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’’
y/p
/ 2 p1’’
p1’
x*2 
y y x 1*
 p2
p1’’ x*1 
 p2
p1’’
y
x*1  x1
 p2
p1’’
p1
Own Price Changes
Own-Price
x2
p1 = p1’’’
y/p
/ 2 p1’’
p1’
x*2  y x 1*
y x*1 
 p2
p1’’’
 p2
p1’’’
y
x*1  x1
 p2
p1’’’
p1
Ordinary y
Own Price Changes
Fixed p2 and y. p1’’’ for commodity y1
x2 is
* y
p1’’ x1  .
y/p
/ 2 p1  p 2
x*2  p1’
y
p1  p2 y x 1*
p2
y
x*1  x1
p1  p 2
Own Price Changes
Own-Price
like for a perfect-substitutes
perfect substitutes utility
function?
U(( x1 , x 2 )  x1  x 2 .
U
Own Price Changes
Own-Price
* 0 , if p1  p 2
x1 ( p1 , p 2 , y)  
y / p1 , if p1  p 2
and
* 0 , if p1  p 2
x 2 (p1 , p 2 , y)  
y / p 2 , if p1  p 2 .
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’ < p2
x*2  0
* y
x1  x1
p1’
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’ < p2
p1’
* y x*
x1  1
p1’
x*2  0
* y
x1  x1
p1’
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’’ = p2
p1’
x 1*
x1
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’’ = p2
p1’
x 1*
x1
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’’ = p2
* y p1’
x2 
p2

 x 1*


* 
x 2  0  
* y x1
*
x1  0 x1 
p1’’
p1
Own Price Changes
Own-Price
Fixed p2 and y.
x2
p1 = p1’’ = p2
p2 = p1’’
* y p1’
x2 
p2
  
 x 1*
 *
0  x1 
y
 p2
* 
x 2  0  
* y x1
*
x1  0 x1 
p2
p1
Own Price Changes
Own-Price
x2
p2 = p1’’
* y p1’
x2 
p2
x*1  0 x 1*
x*1  0 x1
p1 Ordinary
Own Price Changes
Fixed p2 and y. p1’’’ for commodity 1
x2 * y
x1 
p1
p2 = p1’’
p1 price
y p1’
offer
ff
p2
curve   x 1*
* y
0  x1 
p2
x1
Own Price Changes
Own-Price
 Usually we ask “Given the price for

commodity 1 what is the quantity
demanded of commodity 1?”
 But
B we could ld also
l ask k the
h inverse
i
question “At what p
q price for
commodity 1 would a given quantity
of commodity 1 be demanded?
demanded?”
Own Price Changes
Own-Price
p1
Given p1’, what quantity is
demanded of commodity 1?
p 1’
x 1*
Own Price Changes
Own-Price
p1
A
Answer: x1’ units.
it
p 1’
x1’ x 1*
Own Price Changes
Own-Price
p1
A
it
The inverse q question is:
Given x1’ units are
demanded, what is the
price of
x * commodity 1?
x1’ 1
Own Price Changes
Own-Price
p1
A
it
The inverse q question is:
p 1’ Given x1’ units are
demanded, what is the
price of
x * commodity 1?
x1’ 1
Answer: p1’
Own Price Changes
Own-Price
 Taking quantity demanded as given
and then asking what must be price
describes the inverse demand
function of a commodity.
commodity
Own Price Changes
Own-Price
A Cobb-Douglas example:
* ay
x1 
( a  b )p1
is the ordinary demand function and
ay
p1 
*
( a  b ) x1
is the inverse demand function.
Own Price Changes
Own-Price
A perfect-complements example:
* y
x1 
p1  p 2
is the ordinary demand function and
y
p1   p2
*
x1
is the inverse demand function.
Income Changes
 How does the value of x1*(p1,p2,y)
change as y changes,
changes holding both
p1 and p2 constant?
Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’

Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’

Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’
x2’’’
x2’’
x2’
x1’ x1’’’
x1’’
Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’

Income
offer curve
x2’’’
x2’’
x2’
x1’ x1’’’
x1’’
Income Changes
 A plot of quantity demanded against
income is called an Engel curve
curve.
Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’

Income
offer curve
x2’’’
x2’’
x2’
x1’ x1’’’
x1’’
Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’

Income
offer curve y
x2’’’ y
y’’’
x2’’ y’’
x2’ y’
y
x1’ x1’’’ x1’ x1’’’ x1*
x1’’ x1’’
Income Changes
Fixed p1 and p2.
y’ < y’’ < y’’’

Income
offer curve y
x2’’’ y
y’’’
x2’’ Engel
y’’
x2’ y’
y
curve;
good 1
x1’ x1’’’ x1’ x1’’’ x1*
x1’’ x1’’
Income Changes y
Fixed p1 and p2. y
y’’’
y’’
y’ < y’’ < y’’’
y’
y
Income
offer curve x2’ x2’’’ x2*
x2’’
x2’’’
x2’’
x2’
x1’ x1’’’
x1’’
Income Changes y Engel
Fixed p1 and p2.
curve;
y
y’’’ good 2
y’’
y’ < y’’ < y’’’
y’
y
Income
offer curve x2’ x2’’’ x2*
x2’’
x2’’’
x2’’
x2’
x1’ x1’’’
x1’’
Fixed p1 and p2.
curve;
y
y’’’ good 2
y’’
y’ < y’’ < y’’’
y’
y
Income
offer curve y x2’ x2’’’ x2*
x2’’
x2’’’ y’’’
y
x2’’ Engel
y’’
x2’ y’
y
curve;
good 1
x1’ x1’’’ x1’ x1’’’ x1*
x1’’ x1’’
Income Changes and Cobb-
D
Douglas
l Preferences
P f
 An example of computing the
equations of Engel curves; the Cobb
Cobb-
Douglas case.
a b
U( x1 , x 2 )  x1 x 2 .
 The ordinary demand equations are
* ay * by
x1  ; x2  .
( a  b )p1 ( a  b )p 2
D
Douglas
l Preferences
P f
* ay * b
by
x1  ; x2  .
( a  b )p1 ( a  b )p 2
Rearranged to isolate y, these are:
( a  b)p1 *
y x1 Engel curve for good 1
a
( a  b)p 2 *
y x 2 Engel curve for good 2
b
D
Douglas
l Preferences
P f
y ( a  b)p1 *
y x1
a Engel curve
for good 1
x1*
y
( a  b)p2 *
y x2
b
Engel curve
for good 2
x2*
Income Changes and Perfectly-
C
Complementary
l Preferences
P f
 Another example of computing the
equations of Engel curves; the
perfectly-complementary case.
i x1 , x 2.
U( x1 , x 2 )  min
y
x*1  x*2  .
p1  p 2
C
Complementary
l Preferences
P f
* * y
x1  x 2  .
p1  p 2
Rearranged to isolate y, these are:
*
y  (p1  p 2 )x1 Engel curve for good 1
*
y  (p1  p 2 )x 2 Engel
g curve for good
g 2
Income Changes
Fixed p1 and p2.
x2
x1
Income Changes
Fixed p1 and p2.
x2
y’ < y’’ < y’’’
x1
Income Changes
Fixed p1 and p2.
x2
y’ < y’’ < y’’’
x1
Income Changes
Fixed p1 and p2.
x2
y’ < y’’ < y’’’
x2’’’
x2’’
x2’
x1’ x1’’’ x1
x1’’
Income Changes
Fixed p1 and p2.
x2
y’ < y’’ < y’’’
y
x2’’’ y
y’’’
x2’’ Engel
y’’
x2’ curve;
y’
y
good 1
x1’ x1’’’ x1 x1’ x1’’’ x1*
x1’’ x1’’
Fixed p1 and p2.
curve;
y
y’’’ good 2
x2 y’’
y’ < y’’ < y’’’
y’
y
x2’ x2’’’ x2*
x2’’
x2’’’
x2’’
x2’
x1’ x1’’’ x1
x1’’
Fixed p1 and p2.
curve;
y
y’’’ good 2
x2 y’’
y’ < y’’ < y’’’
y’
y
y x2’ x2’’’ x2*

x2’’
x2’’’ y
y’’’
x2’’ Engel
y’’
x2’ curve;
y’
y
good 1
x1’ x1’’’ x1 x1’ x1’’’ x1*
x1’’ x1’’
Fixed p1 and p2.
curve;
y
y’’’ good 2
*
y  ( p1  p 2 ) x 2 y’’
y’
y
y x2’ x2’’’ x2*

x2’’
y
y’’’
* Engel
y  ( p1  p 2 ) x1 y’’
curve;
y’
y
good 1
x1’ x1’’’ x1*
x1’’
S b i
Substitutable
bl Preferences
P f
 Another example of computing the
equations of Engel curves; the
perfectly-substitution case.
U(( x1 , x 2 )  x1  x 2 .
U
Substitutable Preferences
* 0 , if p1  p 2
x1 ( p1 , p 2 , y)  
y / p1 , if p1  p 2
* 0 , if p1  p 2
x 2 (p1 , p 2 , y)  
y / p 2 , if p1  p 2 .
* 0 , if p1  p 2
x1 ( p1 , p 2 , y)  
y / p1 , if p1  p 2
* 0 , if p1  p 2
x 2 (p1 , p 2 , y)  
y / p 2 , if p1  p 2 .
Suppose
pp p1 < p2. Then
* 0 , if p1  p 2
x1 ( p1 , p 2 , y)  
y / p1 , if p1  p 2
* 0 , if p1  p 2
x 2 (p1 , p 2 , y)  
y / p 2 , if p1  p 2 .
y *
and x 2  0
*
Suppose
pp p1 < p2. Then x1 
p1
* 0 , if p1  p 2
x1 ( p1 , p 2 , y)  
y / p1 , if p1  p 2
* 0 , if p1  p 2
x 2 (p1 , p 2 , y)  
y / p 2 , if p1  p 2 .
y *
and x 2  0
*
Suppose
pp p1 < p2. Then x1 
p1
*
y  p1x1 and x 2  0.
*
0
y y
*
* x 2  0.
y  p1x1
x1* 0 x2*
Engel curve Engel curve
for good 1 for good 2
Income Changes
 In every example so far the Engel
curves have all been straight lines?
Q: Is this true in general?
 A:
A No.
N Engel
E l curves are straight
i h
lines if the consumer’s preferences
p
are homothetic.
Homotheticity
 A consumer’s preferences are

homothetic if and only if
((x1,,x2)  (y1,y2)  (kx
( 1,,kx2)  ((ky
y1,,ky
y2)
for every k > 0.
 That is, the consumer’s MRS is the
same anywhere on a straight line
drawn from the origin.
Income Effects -- A
Nonhomothetic Example
 Quasilinear preferences are not
homothetic.
homothetic
U( x1 , x 2 )  f ( x1 )  x 2 .
 For example,
U( x1 , x 2 )  x1  x 2 .
Quasi linear Indifference Curves
Quasi-linear
x2 Each curve is a vertically
y shifted
copy of the others.
Each
E h curve intersects
i t t
both axes.
x1
Income Changes; Quasilinear
Utility
x2
x1
~
x1
Utility
x2
y Engel
curve
for
good 1
x1 ~ x1*
x1
~
x1
Utility y Engel
x2 curve
for
good 2
x2*
x1
~
x1
Utility y Engel
x2 curve
for
good 2
x2*
y Engel
curve
for
good 1
x1 ~ x1*
x1
~
x1
Income Effects
 A good for which quantity demanded
rises with income is called normal
normal.
 Therefore a normal good’s Engel
curve is
i positively
i i l sloped.
l d
Income Effects
 A good for which quantity demanded
falls as income increases is called
income inferior.
 Therefore
f an income inferior
f ’
good’s
g curve is negatively
Engel g y sloped.
Income Changes; Goods
y Engel
1 & 2 Normal
N l curve;
y
y’’’ good 2
y’’
y’
y
Income
offer curve y x2’ x2’’’ x2*
x2’’
x2’’’ y
y’’’
x2’’ Engel
y’’
x2’ y’
y
curve;
good 1
x1’ x1’’’ x1’ x1’’’ x1*
x1’’ x1’’
Income Changes; Good 2 Is Normal,
G d1B
Good Becomes IIncome IInferior
f i
x2
x1
G d1B
f i
x2
x1
G d1B
f i
x2
x1
G d1B
f i
x2
x1
G d1B
f i
x2
x1
G d1B
f i
x2
Income
offer curve
x1
G d1B
f i
x2
y
Engel curve
for good 1
x1 x1*
G d1B
f i
y
x2 Engel curve
for good 2
x2*
y
Engel curve
for good 1
x1 x1*
Ordinary Goods
 A good is called ordinary if the
quantity demanded of it always
increases as its own price decreases.
Ordinary Goods
Fixed p2 and y.
x2
x1
Ordinary Goods
Fixed p2 and y.
x2
p1 price
offer
curve
x1
Ordinary Goods
Fixed p2 and y. Downward-sloping
p g
x2 p1 demand curve

p1 price
offer Good 1 is
curve ordinary
di
x 1*
x1
Giffen Goods
 If, for some values of its own price,
the quantity demanded of a good
rises as its own-price increases then
the good is called Giffen
Giffen.
Ordinary Goods
Fixed p2 and y.
x2
x1
Ordinary Goods
Fixed p2 and y.
x2
p1 price offer
curve
x1
Ordinary Goods
Fixed p2 and y. Demand curve has
x2 p1 a positively
iti l
p1 price offer sloped part
curve

Good
G d 1 is
i
Giffen
x 1*
x1
Cross Price Effects
Cross-Price
 If an increase in p2
– increases demand for commodity 1
then commodity 1 is a gross
substitute
b i for
f commodity
di 2.
2
– reduces demand for commodity 1
then commodity 1 is a gross
complement for commodity 2 2.
Cross Price Effects
Cross-Price
A perfect-complements example:
* y
x1 
p1  p 2
so
 x1
*
y
  0.
 p2 p1  p2  2
Therefore commodity 2 is a gross

complement for commodity 1.
Cross Price Effects
Cross-Price
p1
Increase the price of
p1’’’ o p2’ to p2’’
good 2 from
and
p1’’
p1’
y x 1*
p 2’
Cross Price Effects
Cross-Price
p1
Increase the price of
p1’’’ o p2’ to p2’’
good 2 from
and the demand curve
for good 1 shifts inwards
p1’’
-- good 2 is a
p1’ complement
l t for
f good d 1.
1
y x 1*
p 2’’
Cross Price Effects
Cross-Price
A Cobb- Douglas example:
* by
x2 
( a  b )p 2
so
Cross Price Effects
Cross-Price
A Cobb- Douglas example:
* by
x2 
( a  b )p 2
so
 x2
*
 0.
 p1
Therefore commodity 1 is neither a gross
complement nor a gross substitute for
commodity
dit 2.
2

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Chapter 6

 Usually we ask “Given the price for

y’ < y’’ < y’’’

y’ < y’’ < y’’’

y’ < y’’ < y’’’

y’ < y’’ < y’’’

y’ < y’’ < y’’’

y’ < y’’ < y’’’

y’ < y’’ < y’’’

y x2’ x2’’’ x2*

y x2’ x2’’’ x2*

 A consumer’s preferences are

Therefore commodity 2 is a gross

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