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BackgroundBackground
to Demandto Demand
Background to Demand
Marginal Utility Theory
Total and marginal utility
meaning of total utility
marginal utility: ∆TU/∆Q
diminishing marginal utility
total and margin...
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Packets
of crisps
TU
in utils
0
1
2
3
4
5
6
0
7
11
13
14
14
13
Utility(utils)
Packe...
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Packets
of crisps
TU
in utils
0
1
2
3
4
5
6
0
7
11
13
14
14
13
Utility(utils)
Packe...
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Packets
of crisps
TU
in utils
0
1
2
3
4
5
6
0
7
11
13
14
14
13
MU
in utils
-
7
4
2
...
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Packets
of crisps
TU
in utils
0
1
2
3
4
5
6
0
7
11
13
14
14
13
MU
in utils
-
7
4
2
...
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
MU
∆TU = 2
∆Q = 1
MU = ∆TU / ∆Q
Utility(utils)
Packets of crisps consumed (per day)...
-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
MU
MU = ∆TU / ∆Q = 2/1 = 2
Utility(utils)
Packets of crisps consumed (per day)
TU
∆...
The optimum level of consumption: the
one-commodity version
consumer surplus (total and marginal)
marginal consumer surplu...
MU
P1
Q1O
MU, P
Q
Consumer surplus
Total
consumer
expenditure
MU
P1
Q1O
MU, P
Q
Consumer surplus
Total
consumer
expenditure
MU
Total
consumer
surplus
P1
Q1
MU, P
QO
Consumer surplus
The optimum level of consumption: the
one-commodity version
consumer surplus (total and marginal)
marginal consumer surplu...
MU = D
MU, P
QO Q1
P1
a
Consumption at Q1
where P1 = MU
Deriving an individual person’s demand curve
Q2O
P1
Q1
a
P2
b
Consumption at Q2
where P2 = MU
MU, P
Q
MU = D
Deriving an individual person’s demand curve
P2
Q2O
P1
Q3Q1
a
P3
c
Consumption at Q3
where P3 = MU
b
MU, P
Q
MU = D
Deriving an individual person’s demand curve
Limitations of the one-commodity
version
marginal utility affected by consumption of
other goods
marginal utility of money...
Background to Demand
Risk, Uncertainty and
Insurance
Demand under conditions of risk and
uncertainty
defining risk and uncertainty
types of odds
risk attitudes
Diminishing mar...
TU
5000 10 000 15 0000
Income (£)
Totalutility
U1
Total utility of income
a
TU
5000 10 000 15 0000
U2
U1
a
b
Income (£)
Totalutility Total utility of income
TU
5000 10 000 15 0000
U3
U2
U1
a
b
c
Income (£)
Totalutility Total utility of income
TU
5000 10 000 15 0000 8000
U3
U2
U1
U4
a
b
c
Income (£)
Totalutility
d
Total utility of income
Insurance: a way of removing risks
How insurers spread risks
the law of large numbers
importance of the independence of ri...
Background to Demand
Indifference Analysis
Indifference curves
constructing an indifference curve
INDIFFERENCE ANALYSIS
Pears
30
24
20
14
10
8
6
Oranges
6
7
8
10
13
15
20
Point
a
b
c
d
e
f
g
Combinations of pears and
oranges that Clive likes
...
0
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
0 2 4 6 8 10 12 14 16 18 20 22
Pears
Oranges
Pears
30
24
20
14
10
8
6
Oranges
6...
a
Pears
Oranges
Pears
30
24
20
14
10
8
6
Oranges
6
7
8
10
13
15
20
Point
a
b
c
d
e
f
g
Constructing an indifference curve
...
a
b
Pears
Oranges
Pears
30
24
20
14
10
8
6
Oranges
6
7
8
10
13
15
20
Point
a
b
c
d
e
f
g
Constructing an indifference curv...
a
b
c
d
e
f
g
Pears
Oranges
Pears
30
24
20
14
10
8
6
Oranges
6
7
8
10
13
15
20
Point
a
b
c
d
e
f
g
Constructing an indiffe...
Indifference curves
constructing an indifference curve
the shape of an indifference curve
diminishing marginal rate of sub...
0
10
20
30
0 10 206
26
7
UnitsofgoodY
Units of good X
a
b
∆Y = 4
∆X = 1
MRS = 4
MRS = ∆Y/∆X
Deriving the marginal rate of ...
0
10
20
30
0 10 20
a
b
UnitsofgoodY
Units of good X
26
6 7
d
∆Y = 4
∆X = 1
∆Y = 1
∆X = 1
MRS = 1
MRS = 4
13 14
9
c
MRS = ∆...
Indifference curves
constructing an indifference curve
the shape of an indifference curve
diminishing marginal rate of sub...
0
10
20
30
0 10 20
UnitsofgoodY
Units of good X
I1
I2
I3
I4
I5
An indifference map
Indifference curves
constructing an indifference curve
the shape of an indifference curve
diminishing marginal rate of sub...
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Assumptions
PX = £2
PY = £1
Budget = £30
A budget line
UnitsofgoodY
Units of good X
a
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Assumptions
PX = £2
PY = £1
Budget = £...
UnitsofgoodY
Units of good X
a
b
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Point on
budget line
a
b
Assumptions...
UnitsofgoodY
Units of good X
a
b
c
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Point on
budget line
a
b
c
Assumpt...
UnitsofgoodY
Units of good X
a
b
c
d
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Point on
budget line
a
b
c
d
Ass...
Indifference curves
constructing an indifference curve
the shape of an indifference curve
diminishing marginal rate of sub...
UnitsofgoodY
Units of good X
Assumptions
PX = £2
PY = £1
Budget = £30
Effect of an increase in income on the budget line
0...
UnitsofgoodY
Units of good X
Assumptions
PX = £2
PY = £1
Budget = £40
Budget
= £40
Budget
= £30
16
7
0
10
20
30
40
0 5 10 ...
Indifference curves
constructing an indifference curve
the shape of an indifference curve
diminishing marginal rate of sub...
0
10
20
30
0 5 10 15 20 25 30
Effect on the budget line of a fall in the price of good XUnitsofgoodY
Units of good X
Assum...
0
10
20
30
0 5 10 15 20 25 30
Effect on the budget line of a fall in the price of good XUnitsofgoodY
Units of good X
Assum...
0
10
20
30
0 5 10 15 20 25 30
Effect on the budget line of a fall in the price of good XUnitsofgoodY
Units of good X
Assum...
Effect on the budget line of a fall in the price of good XUnitsofgoodY
Units of good X
Assumptions
PX = £1
PY = £1
Budget ...
The optimum consumption point
INDIFFERENCE ANALYSIS
Finding the optimum consumption
UnitsofgoodY
Units of good X
O
I1
I2
I3
I4
I5
UnitsofgoodY
Units of good X
O
Finding the optimum consumption
I1
I2
I3
I4
I5
UnitsofgoodY
O
Units of good X
Budget line
Finding the optimum consumption
I1
I2
I3
I4
I5
UnitsofgoodY
O
Units of good X
r
v
s
u
Y1
X1
t
Finding the optimum consumption
The optimum consumption point
equating the marginal rate of substitution
with the price ratio
MRS = MUA/MUB = PA/PB
INDIFF...
I1
I2
I3
I4
I5
UnitsofgoodY
O
Units of good X
r
v
s
u
Y1
X1
t
Finding the optimum consumption
The optimum consumption point
equating the marginal rate of substitution
with the price ratio
MRS = MUA/MUB = PA/PB
The ef...
The optimum consumption point
equating the marginal rate of substitution
with the price ratio
MRS = MUA/MUB = PA/PB
The ef...
UnitsofgoodY
O
Units of good X
B1
Effect on consumption of a change in income
I1
a
I2
UnitsofgoodY
O
Units of good X
B1
B2 I1
Effect on consumption of a change in income
I2
UnitsofgoodY
O
Units of good X
B1
B2 B3 B4 I1
I3
I4
Effect on consumption of a change in income
I2
UnitsofgoodY
O
Units of good X
B1
B2 B3 B4 I1
I3
I4
Income-consumption curve
Effect on consumption of a change in income
The optimum consumption point
equating the marginal rate of substitution
with the price ratio
MRS = MUA/MUB = PA/PB
The ef...
Bread
B1
B2 B3
I3
I2
I1
CDs
Deriving an Engel curve from an income-consumption curve
B1
B2 B3
I3
I2
I1
Income-consumption
curve
CDs
Bread
Deriving an Engel curve from an income-consumption curve
B1
B2 B3
I3
I2
I1
Income-consumption
curve
CDs
BreadIncome(£)
Deriving an Engel curve from an income-consumption curve
B1
B2 B3
I3
I2
I1
Income-consumption
curve
BreadIncome(£)
CDs
Qb1
Qcd1
a
Deriving an Engel curve from an income-consumptio...
B1
B2 B3
I3
I2
I1
Income-consumption
curve
BreadIncome(£)
CDs
Qb1
Y1
Qcd1
Qcd1
a
a
Deriving an Engel curve from an income-...
B1
B2 B3
I3
I2
I1
Income-consumption
curve
BreadIncome(£)
CDs
Qb2
Qb1
Y2
Y1
Qcd2
Qcd1
Qcd2
Qcd1
a
b
a
b
Deriving an Engel ...
B1
B2 B3
I3
I2
I1
Income-consumption
curve
BreadIncome(£)
CDs
Qb3
Qb2
Qb1
Y3
Y2
Y1
Qcd3
Qcd2
Qcd1
Qcd3
Qcd2
Qcd1
a
b
c
a
b...
B1
B2 B3
I3
I2
I1
Income-consumption
curve
BreadIncome(£)
CDs
Qb3
Qb2
Qb1
Y3
Y2
Y1
Qcd3
Qcd2
Qcd1
Qcd3
Qcd2
Qcd1
Engel cur...
The optimum consumption point
equating the marginal rate of substitution
with the price ratio
MRS = MUA/MUB = PA/PB
The ef...
B1
B2 B3
I3
I2
I1
Income-consumption
curve
BreadIncome(£)
CDs
Qb3
Qb2
Qb1
Y3
Y2
Y1
Qcd3
Qcd2
Qcd1
Qcd3
Qcd2
Qcd1
Engel cur...
The optimum consumption point
equating the marginal rate of substitution
with the price ratio
MRS = MUA/MUB = PA/PB
The ef...
Effect of a rise in income on the demand for an inferior goodUnitsofgoodY
(normalgood)
Units of good X
(inferior good)
O
I...
UnitsofgoodY
(normalgood)
O
I2
I1B1 B2
a
b
Units of good X
(inferior good)
Effect of a rise in income on the demand for an...
UnitsofgoodY
(normalgood)
O
Income-consumption curve
I2
I1B1 B2
a
b
Units of good X
(inferior good)
Effect of a rise in in...
The effect of changes in price
the price–consumption curve
INDIFFERENCE ANALYSIS
0
10
20
30
0 5 10 15 20 25 30
Assumptions
PX = £2
PY = £1
Budget = £30
Effect of a fall in the price of good XUnitsofgoodY...
UnitsofgoodY
Units of good X
Assumptions
PX = £2
PY = £1
Budget = £30
B1 I1
0
10
20
30
0 5 10 15 20 25 30
j
Effect of a fa...
UnitsofgoodY
Units of good X
B1 I1
j
Assumptions
PX = £1
PY = £1
Budget = £30
0
10
20
30
0 5 10 15 20 25 30
Effect of a fa...
UnitsofgoodY
Units of good X
Assumptions
PX = £1
PY = £1
Budget = £30
B1 I1 B2
a
j
0
10
20
30
0 5 10 15 20 25 30
I2
k
Effe...
0
10
20
30
0 5 10 15 20 25 30
UnitsofgoodY
Units of good X
B1 I1 B2
a
j
I2
Price-consumption curve
k
Effect of a fall in t...
The effect of changes in price
the price–consumption curve
deriving the individual's demand curve
INDIFFERENCE ANALYSIS
Deriving a demand curve from a price-consumption curve
B1
I1
Expenditureon
allothergoods
Units of good X
a
I2
Deriving a demand curve from a price-consumption curve
B1 B2
I1
Expenditureon
allothergoods
Units of good X
a b
Fall in...
I2
Deriving a demand curve from a price-consumption curve
B1 B2
I1
Expenditureon
allothergoods
Units of good X
a b
Further...
Deriving a demand curve from a price-consumption curve
B1 B2 B3
I3
I2
I1
I4
B4
Expenditureon
allothergoods
Units of good X...
Deriving a demand curve from a price-consumption curve
B1 B2 B3
I3
I2
I1
I4
B4
Expenditureon
allothergoods
Units of good X...
Deriving a demand curve from a price-consumption curve
B1 B2 B3
I3
I2
I1
I4
B4
Expenditureon
allothergoods
Units of good X...
Deriving a demand curve from a price-consumption curve
B1 B2 B3
I3
I2
I1
I4
B4
Expenditureon
allothergoods
Units of good X...
The effect of changes in price
the price–consumption curve
deriving the individual's demand curve
Income and substitution ...
The effect of changes in price
the price–consumption curve
deriving the individual's demand curve
Income and substitution ...
UnitsofgoodY
I1
I2
I3
I4
I5
I6
B1
f
QX1
Income and substitution effects: normal good
Units of Good X
UnitsofgoodY
I1
I2
I3
I4
I5
I6
B2
h
B1
QX1
f
Rise in the price
of good X
Income and substitution effects: normal good
Unit...
UnitsofgoodY
B2
Substitution
effect
B1
QX1
h
f
I1
I2
I3
I4
I5
I6
QX2
B1a
Substitution effect
of the price rise
g
Income an...
Units of Good X
UnitsofgoodY
I1
I2
I3
I4
I5
I6
Substitution
effect
Incom
e
QX1
h
f
g
B2 B1
QX2
QX3
B1a
Income effect of
th...
The effect of changes in price
the price–consumption curve
deriving the individual's demand curve
Income and substitution ...
Units of Good X
UnitsofgoodY
B1
Income and substitution effects: Inferior (non-Giffen) good
f
QX1
I1
I2
Units of Good X
UnitsofgoodY
f
QX1
B2
QX3
I1
I2
Rise in the price
of good X
h
B1
Income and substitution effects: Inferior...
Units of Good X
UnitsofgoodY
f
QX1
B2
h
QX2
I1
I2
Substitution effect
B1a
Substitution effect
of the price rise
B1
Income ...
Units of Good X
UnitsofgoodY
f
QX1
B2
g
QX2
QX3
I1
I2
Substitution effect
h
Income effect
B1a
Income effect of
the price r...
The effect of changes in price
the price–consumption curve
deriving the individual's demand curve
Income and substitution ...
Units of Good X
UnitsofgoodY
B1
Income and substitution effects: Giffen good
f
QX1
I1
I2
Units of Good X
UnitsofgoodY
f
QX1
B2
QX3
I1
I2
Rise in the price
of good X
h
B1
Income and substitution effects: Giffen g...
Units of Good X
UnitsofgoodY
f
QX1
B2
h
QX3
I1
I2
QX2
B1a
g
Substitution effect
Substitution effect
of the price rise
B1
I...
Units of Good X
UnitsofgoodY
f
QX1
B2
h
QX3
I1
I2
g
QX2
Substitution effect
Income effect
Income effect of
the price rise
...
The effect of a change in price on the
demand for other goods
The usefulness of indifference analysis
superiority of using...
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  1. 1. BackgroundBackground to Demandto Demand
  2. 2. Background to Demand Marginal Utility Theory
  3. 3. Total and marginal utility meaning of total utility marginal utility: ∆TU/∆Q diminishing marginal utility total and marginal utility curves MARGINAL UTILITY THEORY
  4. 4. -2 0 2 4 6 8 10 12 14 16 0 1 2 3 4 5 6 Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 Utility(utils) Packets of crisps consumed (per day) Darren’s utility from consuming crisps (daily)
  5. 5. -2 0 2 4 6 8 10 12 14 16 0 1 2 3 4 5 6 Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 Utility(utils) Packets of crisps consumed (per day) TU Darren’s utility from consuming crisps (daily)
  6. 6. -2 0 2 4 6 8 10 12 14 16 0 1 2 3 4 5 6 Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 MU in utils - 7 4 2 1 0 -1 Utility(utils) Packets of crisps consumed (per day) TU Darren’s utility from consuming crisps (daily)
  7. 7. -2 0 2 4 6 8 10 12 14 16 0 1 2 3 4 5 6 Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 MU in utils - 7 4 2 1 0 -1 Utility(utils) Packets of crisps consumed (per day) TU MU Darren’s utility from consuming crisps (daily)
  8. 8. -2 0 2 4 6 8 10 12 14 16 0 1 2 3 4 5 6 MU ∆TU = 2 ∆Q = 1 MU = ∆TU / ∆Q Utility(utils) Packets of crisps consumed (per day) TU Darren’s utility from consuming crisps (daily)
  9. 9. -2 0 2 4 6 8 10 12 14 16 0 1 2 3 4 5 6 MU MU = ∆TU / ∆Q = 2/1 = 2 Utility(utils) Packets of crisps consumed (per day) TU ∆TU = 2 ∆Q = 1 Darren’s utility from consuming crisps (daily)
  10. 10. The optimum level of consumption: the one-commodity version consumer surplus (total and marginal) marginal consumer surplus: MU – P total consumer surplus: TU – TE MARGINAL UTILITY THEORY
  11. 11. MU P1 Q1O MU, P Q Consumer surplus
  12. 12. Total consumer expenditure MU P1 Q1O MU, P Q Consumer surplus
  13. 13. Total consumer expenditure MU Total consumer surplus P1 Q1 MU, P QO Consumer surplus
  14. 14. The optimum level of consumption: the one-commodity version consumer surplus (total and marginal) marginal consumer surplus: MU – P total consumer surplus: TU – TE maximising consumer surplus: P = MU Marginal utility and the demand curve MARGINAL UTILITY THEORY
  15. 15. MU = D MU, P QO Q1 P1 a Consumption at Q1 where P1 = MU Deriving an individual person’s demand curve
  16. 16. Q2O P1 Q1 a P2 b Consumption at Q2 where P2 = MU MU, P Q MU = D Deriving an individual person’s demand curve
  17. 17. P2 Q2O P1 Q3Q1 a P3 c Consumption at Q3 where P3 = MU b MU, P Q MU = D Deriving an individual person’s demand curve
  18. 18. Limitations of the one-commodity version marginal utility affected by consumption of other goods marginal utility of money not constant Optimum combination of goods the equi-marginal principle MUA/MUB = PA/PB deriving a demand curve MARGINAL UTILITY THEORY
  19. 19. Background to Demand Risk, Uncertainty and Insurance
  20. 20. Demand under conditions of risk and uncertainty defining risk and uncertainty types of odds risk attitudes Diminishing marginal utility of income and attitudes towards risk taking RISK, UNCERTAINTY AND INSURANCE
  21. 21. TU 5000 10 000 15 0000 Income (£) Totalutility U1 Total utility of income a
  22. 22. TU 5000 10 000 15 0000 U2 U1 a b Income (£) Totalutility Total utility of income
  23. 23. TU 5000 10 000 15 0000 U3 U2 U1 a b c Income (£) Totalutility Total utility of income
  24. 24. TU 5000 10 000 15 0000 8000 U3 U2 U1 U4 a b c Income (£) Totalutility d Total utility of income
  25. 25. Insurance: a way of removing risks How insurers spread risks the law of large numbers importance of the independence of risks Problems for insurers adverse selection moral hazard RISK, UNCERTAINTY AND INSURANCE
  26. 26. Background to Demand Indifference Analysis
  27. 27. Indifference curves constructing an indifference curve INDIFFERENCE ANALYSIS
  28. 28. Pears 30 24 20 14 10 8 6 Oranges 6 7 8 10 13 15 20 Point a b c d e f g Combinations of pears and oranges that Clive likes the same amount as 10 pears and 13 oranges Constructing an indifference curve
  29. 29. 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 0 2 4 6 8 10 12 14 16 18 20 22 Pears Oranges Pears 30 24 20 14 10 8 6 Oranges 6 7 8 10 13 15 20 Point a b c d e f g Constructing an indifference curve
  30. 30. a Pears Oranges Pears 30 24 20 14 10 8 6 Oranges 6 7 8 10 13 15 20 Point a b c d e f g Constructing an indifference curve 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 0 2 4 6 8 10 12 14 16 18 20 22
  31. 31. a b Pears Oranges Pears 30 24 20 14 10 8 6 Oranges 6 7 8 10 13 15 20 Point a b c d e f g Constructing an indifference curve 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 0 2 4 6 8 10 12 14 16 18 20 22
  32. 32. a b c d e f g Pears Oranges Pears 30 24 20 14 10 8 6 Oranges 6 7 8 10 13 15 20 Point a b c d e f g Constructing an indifference curve 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 0 2 4 6 8 10 12 14 16 18 20 22
  33. 33. Indifference curves constructing an indifference curve the shape of an indifference curve diminishing marginal rate of substitution INDIFFERENCE ANALYSIS
  34. 34. 0 10 20 30 0 10 206 26 7 UnitsofgoodY Units of good X a b ∆Y = 4 ∆X = 1 MRS = 4 MRS = ∆Y/∆X Deriving the marginal rate of substitution (MRS)
  35. 35. 0 10 20 30 0 10 20 a b UnitsofgoodY Units of good X 26 6 7 d ∆Y = 4 ∆X = 1 ∆Y = 1 ∆X = 1 MRS = 1 MRS = 4 13 14 9 c MRS = ∆Y/∆X Deriving the marginal rate of substitution (MRS)
  36. 36. Indifference curves constructing an indifference curve the shape of an indifference curve diminishing marginal rate of substitution an indifference map INDIFFERENCE ANALYSIS
  37. 37. 0 10 20 30 0 10 20 UnitsofgoodY Units of good X I1 I2 I3 I4 I5 An indifference map
  38. 38. Indifference curves constructing an indifference curve the shape of an indifference curve diminishing marginal rate of substitution an indifference map The budget line constructing a budget line INDIFFERENCE ANALYSIS
  39. 39. Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Assumptions PX = £2 PY = £1 Budget = £30 A budget line
  40. 40. UnitsofgoodY Units of good X a Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Assumptions PX = £2 PY = £1 Budget = £30 Point on budget line a A budget line 0 10 20 30 0 5 10 15 20
  41. 41. UnitsofgoodY Units of good X a b Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Point on budget line a b Assumptions PX = £2 PY = £1 Budget = £30 A budget line 0 10 20 30 0 5 10 15 20
  42. 42. UnitsofgoodY Units of good X a b c Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Point on budget line a b c Assumptions PX = £2 PY = £1 Budget = £30 A budget line 0 10 20 30 0 5 10 15 20
  43. 43. UnitsofgoodY Units of good X a b c d Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Point on budget line a b c d Assumptions PX = £2 PY = £1 Budget = £30 A budget line 0 10 20 30 0 5 10 15 20
  44. 44. Indifference curves constructing an indifference curve the shape of an indifference curve diminishing marginal rate of substitution an indifference map The budget line constructing a budget line effect of a change in income INDIFFERENCE ANALYSIS
  45. 45. UnitsofgoodY Units of good X Assumptions PX = £2 PY = £1 Budget = £30 Effect of an increase in income on the budget line 0 10 20 30 40 0 5 10 15 20
  46. 46. UnitsofgoodY Units of good X Assumptions PX = £2 PY = £1 Budget = £40 Budget = £40 Budget = £30 16 7 0 10 20 30 40 0 5 10 15 20 m n Effect of an increase in income on the budget line
  47. 47. Indifference curves constructing an indifference curve the shape of an indifference curve diminishing marginal rate of substitution an indifference map The budget line constructing a budget line effect of a change in income effect of a change in price INDIFFERENCE ANALYSIS
  48. 48. 0 10 20 30 0 5 10 15 20 25 30 Effect on the budget line of a fall in the price of good XUnitsofgoodY Units of good X Assumptions PX = £2 PY = £1 Budget = £30
  49. 49. 0 10 20 30 0 5 10 15 20 25 30 Effect on the budget line of a fall in the price of good XUnitsofgoodY Units of good X Assumptions PX = £2 PY = £1 Budget = £30
  50. 50. 0 10 20 30 0 5 10 15 20 25 30 Effect on the budget line of a fall in the price of good XUnitsofgoodY Units of good X Assumptions PX = £1 PY = £1 Budget = £30
  51. 51. Effect on the budget line of a fall in the price of good XUnitsofgoodY Units of good X Assumptions PX = £1 PY = £1 Budget = £30 B1 B2 a b0 10 20 30 0 5 10 15 20 25 30 c
  52. 52. The optimum consumption point INDIFFERENCE ANALYSIS
  53. 53. Finding the optimum consumption UnitsofgoodY Units of good X O
  54. 54. I1 I2 I3 I4 I5 UnitsofgoodY Units of good X O Finding the optimum consumption
  55. 55. I1 I2 I3 I4 I5 UnitsofgoodY O Units of good X Budget line Finding the optimum consumption
  56. 56. I1 I2 I3 I4 I5 UnitsofgoodY O Units of good X r v s u Y1 X1 t Finding the optimum consumption
  57. 57. The optimum consumption point equating the marginal rate of substitution with the price ratio MRS = MUA/MUB = PA/PB INDIFFERENCE ANALYSIS
  58. 58. I1 I2 I3 I4 I5 UnitsofgoodY O Units of good X r v s u Y1 X1 t Finding the optimum consumption
  59. 59. The optimum consumption point equating the marginal rate of substitution with the price ratio MRS = MUA/MUB = PA/PB The effect of a change in income INDIFFERENCE ANALYSIS
  60. 60. The optimum consumption point equating the marginal rate of substitution with the price ratio MRS = MUA/MUB = PA/PB The effect of a change in income the income–consumption curve INDIFFERENCE ANALYSIS
  61. 61. UnitsofgoodY O Units of good X B1 Effect on consumption of a change in income I1 a
  62. 62. I2 UnitsofgoodY O Units of good X B1 B2 I1 Effect on consumption of a change in income
  63. 63. I2 UnitsofgoodY O Units of good X B1 B2 B3 B4 I1 I3 I4 Effect on consumption of a change in income
  64. 64. I2 UnitsofgoodY O Units of good X B1 B2 B3 B4 I1 I3 I4 Income-consumption curve Effect on consumption of a change in income
  65. 65. The optimum consumption point equating the marginal rate of substitution with the price ratio MRS = MUA/MUB = PA/PB The effect of a change in income the income–consumption curve the Engel curve INDIFFERENCE ANALYSIS
  66. 66. Bread B1 B2 B3 I3 I2 I1 CDs Deriving an Engel curve from an income-consumption curve
  67. 67. B1 B2 B3 I3 I2 I1 Income-consumption curve CDs Bread Deriving an Engel curve from an income-consumption curve
  68. 68. B1 B2 B3 I3 I2 I1 Income-consumption curve CDs BreadIncome(£) Deriving an Engel curve from an income-consumption curve
  69. 69. B1 B2 B3 I3 I2 I1 Income-consumption curve BreadIncome(£) CDs Qb1 Qcd1 a Deriving an Engel curve from an income-consumption curve
  70. 70. B1 B2 B3 I3 I2 I1 Income-consumption curve BreadIncome(£) CDs Qb1 Y1 Qcd1 Qcd1 a a Deriving an Engel curve from an income-consumption curve
  71. 71. B1 B2 B3 I3 I2 I1 Income-consumption curve BreadIncome(£) CDs Qb2 Qb1 Y2 Y1 Qcd2 Qcd1 Qcd2 Qcd1 a b a b Deriving an Engel curve from an income-consumption curve
  72. 72. B1 B2 B3 I3 I2 I1 Income-consumption curve BreadIncome(£) CDs Qb3 Qb2 Qb1 Y3 Y2 Y1 Qcd3 Qcd2 Qcd1 Qcd3 Qcd2 Qcd1 a b c a b c Deriving an Engel curve from an income-consumption curve
  73. 73. B1 B2 B3 I3 I2 I1 Income-consumption curve BreadIncome(£) CDs Qb3 Qb2 Qb1 Y3 Y2 Y1 Qcd3 Qcd2 Qcd1 Qcd3 Qcd2 Qcd1 Engel curve a b c a b c Deriving an Engel curve from an income-consumption curve
  74. 74. The optimum consumption point equating the marginal rate of substitution with the price ratio MRS = MUA/MUB = PA/PB The effect of a change in income the income–consumption curve the Engel curve income elasticity of demand and the income–consumption curve INDIFFERENCE ANALYSIS
  75. 75. B1 B2 B3 I3 I2 I1 Income-consumption curve BreadIncome(£) CDs Qb3 Qb2 Qb1 Y3 Y2 Y1 Qcd3 Qcd2 Qcd1 Qcd3 Qcd2 Qcd1 Engel curve a b c a b c Deriving an Engel curve from an income-consumption curve
  76. 76. The optimum consumption point equating the marginal rate of substitution with the price ratio MRS = MUA/MUB = PA/PB The effect of a change in income the income–consumption curve the Engel curve income elasticity of demand and the income–consumption curve the effect of a rise in income on the demand for an inferior good INDIFFERENCE ANALYSIS
  77. 77. Effect of a rise in income on the demand for an inferior goodUnitsofgoodY (normalgood) Units of good X (inferior good) O I1B1 a
  78. 78. UnitsofgoodY (normalgood) O I2 I1B1 B2 a b Units of good X (inferior good) Effect of a rise in income on the demand for an inferior good
  79. 79. UnitsofgoodY (normalgood) O Income-consumption curve I2 I1B1 B2 a b Units of good X (inferior good) Effect of a rise in income on the demand for an inferior good
  80. 80. The effect of changes in price the price–consumption curve INDIFFERENCE ANALYSIS
  81. 81. 0 10 20 30 0 5 10 15 20 25 30 Assumptions PX = £2 PY = £1 Budget = £30 Effect of a fall in the price of good XUnitsofgoodY Units of good X
  82. 82. UnitsofgoodY Units of good X Assumptions PX = £2 PY = £1 Budget = £30 B1 I1 0 10 20 30 0 5 10 15 20 25 30 j Effect of a fall in the price of good X
  83. 83. UnitsofgoodY Units of good X B1 I1 j Assumptions PX = £1 PY = £1 Budget = £30 0 10 20 30 0 5 10 15 20 25 30 Effect of a fall in the price of good X
  84. 84. UnitsofgoodY Units of good X Assumptions PX = £1 PY = £1 Budget = £30 B1 I1 B2 a j 0 10 20 30 0 5 10 15 20 25 30 I2 k Effect of a fall in the price of good X
  85. 85. 0 10 20 30 0 5 10 15 20 25 30 UnitsofgoodY Units of good X B1 I1 B2 a j I2 Price-consumption curve k Effect of a fall in the price of good X
  86. 86. The effect of changes in price the price–consumption curve deriving the individual's demand curve INDIFFERENCE ANALYSIS
  87. 87. Deriving a demand curve from a price-consumption curve B1 I1 Expenditureon allothergoods Units of good X a
  88. 88. I2 Deriving a demand curve from a price-consumption curve B1 B2 I1 Expenditureon allothergoods Units of good X a b Fall in the price of X
  89. 89. I2 Deriving a demand curve from a price-consumption curve B1 B2 I1 Expenditureon allothergoods Units of good X a b Further falls in the price of X
  90. 90. Deriving a demand curve from a price-consumption curve B1 B2 B3 I3 I2 I1 I4 B4 Expenditureon allothergoods Units of good X a b c d Further falls in the price of X
  91. 91. Deriving a demand curve from a price-consumption curve B1 B2 B3 I3 I2 I1 I4 B4 Expenditureon allothergoods Units of good X Price-consumption curve a b c d
  92. 92. Deriving a demand curve from a price-consumption curve B1 B2 B3 I3 I2 I1 I4 B4 Expenditureon allothergoods Units of good X a Price-consumption curve b c d PriceofgoodX Units of good X P1 Q1 a
  93. 93. Deriving a demand curve from a price-consumption curve B1 B2 B3 I3 I2 I1 I4 B4 Expenditureon allothergoods Units of good X a Price-consumption curve b c d PriceofgoodX Units of good X a Demand P1 P2 P3 P4 Q1 Q2 Q3 Q4 b c d
  94. 94. The effect of changes in price the price–consumption curve deriving the individual's demand curve Income and substitution effects of a price change INDIFFERENCE ANALYSIS
  95. 95. The effect of changes in price the price–consumption curve deriving the individual's demand curve Income and substitution effects of a price change a normal good INDIFFERENCE ANALYSIS
  96. 96. UnitsofgoodY I1 I2 I3 I4 I5 I6 B1 f QX1 Income and substitution effects: normal good Units of Good X
  97. 97. UnitsofgoodY I1 I2 I3 I4 I5 I6 B2 h B1 QX1 f Rise in the price of good X Income and substitution effects: normal good Units of Good X QX3
  98. 98. UnitsofgoodY B2 Substitution effect B1 QX1 h f I1 I2 I3 I4 I5 I6 QX2 B1a Substitution effect of the price rise g Income and substitution effects: normal good Units of Good X QX3
  99. 99. Units of Good X UnitsofgoodY I1 I2 I3 I4 I5 I6 Substitution effect Incom e QX1 h f g B2 B1 QX2 QX3 B1a Income effect of the price rise Income and substitution effects: normal good
  100. 100. The effect of changes in price the price–consumption curve deriving the individual's demand curve Income and substitution effects of a price change a normal good an inferior good INDIFFERENCE ANALYSIS
  101. 101. Units of Good X UnitsofgoodY B1 Income and substitution effects: Inferior (non-Giffen) good f QX1 I1 I2
  102. 102. Units of Good X UnitsofgoodY f QX1 B2 QX3 I1 I2 Rise in the price of good X h B1 Income and substitution effects: Inferior (non-Giffen) good
  103. 103. Units of Good X UnitsofgoodY f QX1 B2 h QX2 I1 I2 Substitution effect B1a Substitution effect of the price rise B1 Income and substitution effects: Inferior (non-Giffen) good g
  104. 104. Units of Good X UnitsofgoodY f QX1 B2 g QX2 QX3 I1 I2 Substitution effect h Income effect B1a Income effect of the price rise B1 Income and substitution effects: Inferior (non-Giffen) good
  105. 105. The effect of changes in price the price–consumption curve deriving the individual's demand curve Income and substitution effects of a price change a normal good an inferior good a Giffen good (a special type of inferior good) INDIFFERENCE ANALYSIS
  106. 106. Units of Good X UnitsofgoodY B1 Income and substitution effects: Giffen good f QX1 I1 I2
  107. 107. Units of Good X UnitsofgoodY f QX1 B2 QX3 I1 I2 Rise in the price of good X h B1 Income and substitution effects: Giffen good
  108. 108. Units of Good X UnitsofgoodY f QX1 B2 h QX3 I1 I2 QX2 B1a g Substitution effect Substitution effect of the price rise B1 Income and substitution effects: Giffen good
  109. 109. Units of Good X UnitsofgoodY f QX1 B2 h QX3 I1 I2 g QX2 Substitution effect Income effect Income effect of the price rise B1 Income and substitution effects: Giffen good B1a
  110. 110. The effect of a change in price on the demand for other goods The usefulness of indifference analysis superiority of using ordinal measures limitations of indifference analysis INDIFFERENCE ANALYSIS

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