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ECON6021 Microeconomic Analysis

ECON6021 Microeconomic Analysis. Consumption Theory II. Topics covered. Price Change Price Elasticities Income Elasticities Market Demand. Price consumption curve (PCC) Or Price expansion path (PEP). B. A. x. Ordinary (Marshallian) Demand function. A. B. Price effect. y. P x. x.

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ECON6021 Microeconomic Analysis

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  1. ECON6021 Microeconomic Analysis Consumption Theory II

  2. Topics covered • Price Change • Price Elasticities • Income Elasticities • Market Demand

  3. Price consumption curve (PCC) Or Price expansion path (PEP) B A x Ordinary (Marshallian) Demand function A B Price effect y Px x

  4. Y J K M B A S Q X x0 xs x1 Price Effects • Initial consumption: A • Price decreases from Px to Px’ • Real income—Hick’s definition: an initial level of utility • x0 to xs (or A to S) is the sub. effect • xs to x1 (or S to B) is the income effect

  5. Price Effects • Price Effects= substitution effect + Income effect • Substitution Effect a.k.a (also known as) pure price effect: a change in relative price while keeping utility constant

  6. For income effects, S is the reference point. M: no income effect M-Q: X is normal J-M: X is inferior A is the reference point for the analysis of combined effect of income and substitution effect. K-Q: J-K: Giffen gd. Giffen gd  inferior gd.

  7. Price Elasticities

  8. Price and Expenditure Elasticities Own Price Elasticity Elastic demand Unitary demand Inelastic demand

  9. Price Elasticity of Expenditure

  10. An Example: Linear demand

  11. An Example: Linear Demand

  12. P Q TR Q Review: Linear Demand

  13. AOG AOG IEP (Income Expansion Path) IEP X X Income Change

  14. Px fixed variable Demand x variable x Engel Curve fixed I IEP

  15. Income Elasticities

  16. Income Elasticity

  17. if exI>1 if exI=1 If exI<1

  18. Engel Aggregation (Adding-up condition) Aggregate Income elasticity=1

  19. Y A B C D C’ I1 X Y E A-B B B-C C C-D D D-E Inferior superior No income eff superior Normal only superior Normal only normal only Superior normal only Superior no income effect Superior inferior I0 X Consider an income change…

  20. Cobb-Douglas Utility: U=xy

  21. Homogenous function • Homogenous function of degree k • If there exists a constant k so that for all m>0 and for all a, b Then, we say F(.) is homogenous of degree k.

  22. Euler Theorem • Euler Theorem • If F(a,b) is homogenous of degree k, then we have • Proof of Euler Theorem. • Differentiate equation (1) with respect to m & then set m=1

  23. Corollary of Euler Theorem

  24. Lump Sum Principle AOG A B S x

  25. Chosen dependent on IC Lump Sum Principle Note that the new consumption at (S) is in a higher IC. In order to get a fixed amount of taxation, lump-sum tax is less harmless to consumers/citizens.

  26. AOG X A 0 Lump Sum Principle The amount of A is a free gift from government. A sum of money equivalent to the value of gift is even better.

  27. Market Demand

  28. Individual demand Market Demand Assume 2 agents (1 and 2)

  29. 100 50 100 112.5 12.5 Market Demand

  30. The End

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