ESC Toulouse Microeconomics

1
ESC Toulouse Microeconomics

• Topic 3 Demand

2
Motivation Overview

• Focus switches from market to individual demand
• Greatest pleasure given limited income
• utility function / budget constraint
• What happens when prices or income changes?
• comparative statics

3
Preferences

• Represent preferences using utility function
• UU(x,y) x and y are two goods
• Indifference curves
• all points on a given indifference curve
  represent same utility

4
Quantity of good y per period
Qy1
1
2
Qy2
0
Qx1
Qx2
Quantity of good x per period
Fig 3.3 An indifference curve for the goods x and
y
5
Preferences II

• Properties of indifference curves
• slope downwards
• smooth
• continuous
• convex
• curves bowed towards origin

6
Budget constraint

• Can only afford to buy limited amounts of goods
• represent affordable combinations using budget
  constraint
• position depends upon ratio of good prices and
  income

7
Qy
M2
M3
M2
0
Qx
Fig 3.6 A set of budget constraints
8
Utility maximisation

• Maximise utility subject to budget constraint
• Most north easterly indifference curve possible
• Point of tangency between budget constraint and
  indifference curve

9
Qy
0
Qx
Fig 3.7 Utility maximization subject to a budget
constraint
10
Efficient Budget Allocation

• Marginal utility
• MUx
• increase in utility from one more unit good X
• Slope of indifference curve
• minus MUx / MUY

11
Qy
Qx
Fig 3.8a
12
Qy
slope
Qx
Fig 3.8b
13
Efficient Budget Allocation II

• Slope budget constraint
• minus Px / PY
• Efficient allocation
• MUx / PX MUY / PY
• Equalise marginal utility per Franc spent

14
Qy
slope
Qx
Fig 3.8c
15
Change in Price

• Fall in price
• Budget constraint swings outwards
• Relative prices change
• substitution effect
• Real income increases
• income effect

16
Qy
Y1
a
b
Y2
U2
U1
0
X1
X2
Qx
Figure 3.9 A fall in the price of good x
17
Qy
d
b
a
Y1
Y2
c
Y3
0
Qx
X2
X1
X3
SE
IE
Total effect
Fig 3.10 The substitution and income effects of a
fall in the price of good x
18
Change in Price II

• Normal good
• increase in income leads to higher consumption
• Inferior good
• increase in income leads to lower consumption
• income and substitution effects opposed
• Giffen good
• income effect outweighs substitution effect

19
Qy
Y2
Y1
U2
Y3
U1
0
Qx
X1
X2
X3
Fig 3.11 A fall in the price of good x, where
good x is an inferior good
20
Qy
Y2
Y1
U2
Y3
U1
0
Qx
X1
X2
X3
Fig 3.12 A fall in the price of good x, where
good x is an Giffen good
21
Team Tasks 3 - Demand

• What happens to demand for your organisations
  good when its price is increased?
• What happens to demand for your organisation's
  good when income increases?
• Under what circumstances will the demand for your
  organisations good fall when its price falls?
• Are there are any advantages in your organisation
  producing an inferior good?