Demand

Demand curve

From indifference curves to demand

Decomposition

change

of the reaction to a price

 Substitution
Direction
Relative

effect and income effect

of these

strengths of these

Algebraic representation

Algebraically,
x/p = substitution effect + income effect

Income effect: -x x/I

This is negative when the good is normal and
positive when the good is inferior.
The first , the substitution effect, is always
negative.
Slutskys equation.

Two implications of Slutskys eqn

1.

For normal goods, the second term

becomes negativeWhy?
The first term is always negative. Hence,
X / P is necessarily negative.
Therefore, normal goods necessarily obey
Law of Demand.
2. As -x becomes smaller income effect
becomes less and less significant. So can a
giffen good happen, even for inferior

 Results

in differently sloped PCC curves

Demand
And

derived from the PCC curves

hence reflects the behaviour of PCC

When PCC moves in the north easterly direction,

-What are the directions and relative strengths of the
two effects?
- what kind of a demand?

When PCC moves in the North westerly direction,

- directions and strengths of the two effects?
- what kind of demand?

 Giffen

goods
Stigler ,1966 noted that Anyone who
successfully isolated an exception to the Law of
Demand would be assured of
immortality( professionally speaking) and rapid
promotion. Since most economists would not dislike
either reward, we may assume that the total absence
of exceptions is not from lack of trying to find them.

APPLICATION of INDIFFERENCE Curves

The Backward bending Supply curve of labor.

Combination of leisure and consumption.
More consumption requires more income
So more work and so less leisure

Contd
Task:

to find Optimal combination of leisure and

consumption to maximize utility

 Budget

line: Combinations of leisure and

consumption available to the individual.
C = w(T n) so, c+ wn = wT
co
ns

Slope = w

Hours of leisure

Optimal choice

Hours of leisure

A:

works more when the wage falls

or works less when wage rises

B:

Works less when the wage falls

or works more when wage rises
What explains these different reactions?

Substitution and income effect

Substitution

effect: work more when wage

rises..why?

Income

..why?

effect: work less when wage rises.

Leisure
Leisure

is a normal good ( not inferior).

Hence when income rises, feel richer and so
have more of leisure; when income falls, feel
poorer and so have less of it.- income effect
When income rises, leisure becomes costlier,
and so have less of it. When income falls ,
leisure costs less, and so have more of it.Substitution effect

 The

sum of both captures the reaction to a

change in wages.
In A, income effect much stronger than
substitution effect resulting in?
In

B, substitution effect far stronger than the

income effect resulting in?

Backward bending SS curve of

labor

wages
Dominant income effect

Dominant subs effect

Q of labor

Another App: Overtime pay

Application of Indifference curves

Comparison

of cash and in-kind transfers

Read the uploaded reading.
food

housing

One more application

Buy

one get one free.

Other
goods
c
D

Pizza

Expression of preferences for

features in cars

Effect of income changes

Parallel

shift of budget line

Relative
Income

prices remain constant

consumption curve

ICC
For

inferior goods

For

normal ( superior) goods

Market Demand
Conceptually-

summation of individual

demands
How can this be operationalized??

Market Demand
Resort

to statistics, sample surveys.

 Question-

instances from markets where

Price decrease has increased sales
turnover?
Where price decrease has reduced
sales turnover?
Why? When P and Q are inversely related in
both cases?