Describing Consumer Describing Consumer Preferences Using Preferences Using Indifference Curves Indifference Curves
Chapter 8 Appendix Chapter 8 Appendix
© 2003 McGrawHill Ryerson Limited
8A 2
Income expansion path Income expansion path
inferior
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u Income expansion path -IEP- traces all the best (utility-maximizing) choices a consumer makes as income changes. l The IEP slopes up if a good is a normal good l The IEP is downward sloping if a good is
8A 3
Fig. A81 a and
Income expansion path, Fig. A81 a and Income expansion path,
b, p 195 b, p 195
Good Y
Good Y
IEP
U3
U2
U3
U2
U1
U1
Good X
Good X
IEP
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a) Normal good a) Inferior good
8A 4
Engel Curves Engel Curves
u An Engel curve plots all the best
choices a consumer makes against INCOME. l It is an incomequantity relationship
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u If an Engel curve is upward sloping, a good is normal; downward sloping indicates an inferior good.
8A 5
Fig. A82, p 195
Engel Curves, Fig. A82, p 195 Engel Curves,
Income elastic normal good (luxury) X1
Income inelastic normal good (necessity)
Quantity demanded
Inferior good
X2
X3
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Income
8A 6
Price Expansion Path Price Expansion Path
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u Price expansion path – PEP – traces all the best choices of a consumer as the relative price changes.
8A 7
Fig. A83, p 195
Price Expansion Path, Fig. A83, p 195 Price Expansion Path,
Good Y B/Py
PEP
U2
B/(Px)2
B/(Px)1
U1
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Good X
8A 8
Income and substitution effects Income and substitution effects
© 2003 McGrawHill Ryerson Limited.
u The law of demand states that there is an inverse relationship between price and quantity demanded. Two effects occur: l Income effect l Substitution effect
8A 9
Income and substitution effects Income and substitution effects
u Income effect reflects the purchasing
power change as a result of the change in price. l With a price decrease we can afford to buy
more – a purchasing power increase
l With a price increase we can afford to buy less
– a purchasing power decrease.
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8A 10
Income and substitution effects Income and substitution effects
u Substitution effect reflects our
willingness to switch consumption away from goods that become relatively more expensive. l If relative price of a good falls, we buy more of
it;
l At the same time, we buy less of the relatively
more expensive product.
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8A 11
Income and substitution effects Income and substitution effects
u For normal goods, income and
substitution effects work in the same direction
u For inferior goods, income and
substitution effects work in the opposite direction.
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8A 12
Income and substitution effects, Income and substitution effects,
Fig. 84a, p 196 Fig. 84a, p 196
B/Py
Good Y
a)Normal good X
E G
F U2
B/(Px ) 2
B/(Px)1
U1
Substitution effect
Income effect
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Good X
8A 13
Income and substitution effects, Income and substitution effects,
Fig. 84b, p 196 Fig. 84b, p 196
B/Py
Good Y
b)Inferior good X
E G
U2
F
B/(Px)2
B/(Px)1
U1
Substitution effect
Income effect
© 2003 McGrawHill Ryerson Limited.
Good X
8A 14
Figure A85a, p 197
Deriving the Demand Curve Deriving the Demand Curve for Good X, Figure A85a, p 197 for Good X, Good Y
B/P1
B/P2
B/P3
a)Priceexpansion path PEP C B A
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X1 X2 X3 Good X
8A 15
Figure A85b, p 197
Deriving the Demand Curve Deriving the Demand Curve for Good X, Figure A85b, p 197 for Good X, Price of Good X
b)Demand curve A P1
B
P2
C
P3
Demand
X1 X2 X3
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Quantity of Good X
Describing Consumer Describing Consumer Preferences Using Preferences Using Indifference Curves Indifference Curves
End of Chapter 8 Appendix End of Chapter 8 Appendix
© 2003 McGrawHill Ryerson Limited
