Demand

1
 Comparative Statics
• Process of comparing two equilibria

• ‘Statics’ implies that we are not analyzing the

dynamics of how the consumer moves from
the first to second equilibrium.

• Changes in equilibrium due to:

– Own price changes.
– Cross price changes.
– Income changes.
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Own Price Changes

3
 Own Price Effects
• Impact of change in price of a good on
quantity demanded of that good.

• If the price of x decreases, how will this effect

the quantity demanded for x?

• What happens to BC when price changes?

– Rotates!

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 Decrease in price of x does not have to increase
consumption of x. (more next week)
•• xIncrease
does not
in change.
x and y
y y
I/Py1 I/Py1

y2 y2 U
y1 y1 2
U2 U1
U1 BC2
BC1 BC2 BC1
x1 x2 I/Px1 x x1 I/Px1 x

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 p1
Own-Price Changes
Fixed p2 and y.
x2
p1 = p1’

p1’

x1*(p1’) x1*

x1*(p1’) x1
 p1
Own-Price Changes
Fixed p2 and y.
x2

p1’’

p1’

x1*(p1’) x1*
x1*(p1’’)

x1*(p1’) x1
x1*(p1’’)
 p1
Ordinary
Own-Price Changes demand curve
Fixed p2 and y. p1’’’ for commodity 1
x2

p1’’
p1 price
offer p1’
curve
x1*(p1’’’) x1*(p1’) x1*
x1*(p1’’)

x1*(p1’’’) x1*(p1’) x1
x1*(p1’’)
 Own-Price Changes
• The curve containing all the utility-maximizing
bundles traced out as p1 changes, with p2 and
income constant, is the p1- price offer curve.
– Also called the price-consumption curve.

• The plot of the x1-coordinate of the p1- price

offer curve against p1 is the ordinary demand
curve for commodity 1.
Deriving Individual Demand Curve: Review

• Consider price decreases.

y
• Price-Consumption Curve
– Set of commodity bundles
x traced out as price changes, all
Px else equal.
PxA
PxB
PxC • Individual demand curve

xA xB xC x

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 Ordinary Goods
• A good is called ordinary if the quantity
demanded of it always increases as its own
price decreases.
• Most goods are ordinary goods (hence the
creative term, ‘ordinary’)

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 Ordinary Goods
Fixed p2 and y. Downward-sloping
x2 p1 demand curve
p1 price


offer Good 1 is
curve ordinary

x1*

x1
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 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.

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 Giffen Goods

Fixed p2 and y. Demand curve has

x2 p1 a positively
p1 price offer sloped part
curve


Good 1 is
Giffen

x1*

x1
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Income Changes

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 Income Changes
• How does the value of x*(p1,p2,I) change as I
changes, holding both px and py constant?

• Normal goods: x* increases as income

increases

• Inferior goods: x* decreases as income

increases
 Income Changes
• Normal Goods
– Increase in I implies an increase in consumption
y
I2/Py

I1/Py
y2
y1

BC1 BC2
x1 x2 I1/Px I2/Px x

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 Income Changes
• Inferior Goods
– Increase in I implies a decrease in consumption
(Amtrak)
y
I2/Py
Both goods cannot be
I1/Py inferior. We must spend all
of our money!
y2

y1

BC1 BC2
x2x1 I1/P I2/P x
x x

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Income Changes
If y is income now, and have fixed p1 and p2.
x2
y’ < y’’ < y’’’
Income
offer curve
x2’’’
x2’’
x2’
x1
x1’ x1’’’
x1’’
 Income Changes
• A plot of quantity demanded against income is
called an Engel curve.
Income Changes y Engel
Fixed p1 and p2.
curve;
x2 y’’’ good 2
y’’
y’ < y’’ < y’’’
y’
Income
offer curve y x2’ x2’’’ x2*
x2’’
x2’’’ y’’’
x2’’ Engel
y’’
x2’ curve;
y’
good 1
x1
x1’ x1’’’ x1’ x1’’’ x1*
x1’’ x1’’
 Income Effects
• A good for which quantity demanded rises with
income is called normal.
– In previous diagram, both goods were normal goods.
– Therefore a normal good’s Engel curve is positively
sloped.
• A good for which quantity demanded falls as
income increases is called income inferior.
– Therefore an income inferior good’s Engel curve is
negatively sloped.

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Income Changes; Good 2 Is Normal,
Good 1 Becomes Income Inferior
y
x2 Engel curve
for good 2

x2*
y
Engel curve
for good 1

x1 x1*

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Cross Price Effects

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 Cross Price Effects
• Impact of change in price of one good on quantity demanded of
another good.
• Gross Substitutes
– Increase in price of good 1  increase in quantity demanded of good 2.
– Heroin and methadone, coffee and tea, Toyotas and Hondas.

• Gross Complements
– Increase in price of good 1  decrease in quantity demanded of good
2.
– PB&J, cars and gasoline, coffee and cream

• If the 2 goods are unrelated, change in price of x has no impact

on consumption of y.

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 Cross Price Effects for Substitutes
• Increase in price of x, increase in y.
• Note that y in the next few graphs represents good y
y (as opposed to income).
I/
Py

y2
y1
U1
U2
BC2 BC1
x2 x1I/Px2 I/P 1 x
x

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 Cross Price Effects for Complements
• Increase in price of x, decrease in y.

y
I/
Py

y1
y2
U1
U2 BC1
BC2
x2 x1 x
I/Px2 I/Px1
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 Cross Price Effects for Unrelated Goods
• Increase in price of x has no effect
on y.

y
• Theory alone does not tell us how
I/ x and y are related.
Py
• Must look at data.
y2 = y1
• Could be different for different
U1
individuals or groups.
U2
BC2 BC1
x2 x1 I/P 2 I/Px1 x
x

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 Cross-Price Effects
A perfect-complements example:
* y
x1 
p1  p 2
so *
 x1 y
  0.
 p2 p  p 
1 2
2

Therefore commodity 2 is a gross

complement for commodity 1.
Can also just note that price of
commodity 2 is in the denominator.
 Cross-Price Effects
p1
Increase the price of
p1’’’ good 2 from p2’ to p2’’
and the demand curve
p1’’
for good 1 shifts inwards
-- good 2 is a
p1’ complement for good 1.

y x1*
p2’’
 Cross-Price Effects
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 2.