Chapter 5 Properties of Demand.pdf

Chapter 5 Properties of Demand

Why? Theory – observable characteristics – testing – for future

Relative prices and real e

z Money is a veil. Economists often prefer to measure important economic
variables in real, rather than nominal terms.
p
z Relative prices i
p j
w
z Relative e
p j

z Homogeneity and budget balancedness
p p w
x(P,w) = x(tP,tw) ∀t > 0 ⇒ x(P,w) = x( 1 , 2 ,...,1, )
pn pn pn
Px(P,w) = w ∀(P,w)

The Slutsky equation

z What do we expect from the theory of consumer? --- The law of demand
Classical theory: the principle of diminishing marginal utility

z However, Giffen good! It is a product for which, among a poor population, a rise
in price will lead people to buy even more of the product.
Possible examples: the potato in the Irish famine of 1845-1849

[Figure ]

1
z Normal good and inferior good
∂x (P,w)
The “good” is the product for which demand increases in e. i > 0
∂w
∂x (P,w)
The “bad” is … i < 0
∂w

A Giffen good must be inferior, OR/AND an inferior good must be a Giffen
good ??

z e effect and substitution effect TE = SE + IE
Total effect: (price effect) measures the change of quantity demanded for a good
in response to a change in its price.
Substitution effect: measures the effect of relative price change, in which the
consumer s