Consumer’s Problem

The consumer maximizes Utility from consuming two goods X & Y subject to budget constraint (BC).

At equilibrium:

MUX/ PX = MUY/PY (*)

Or: - MUX/ MUY = MRS = - PX/PY

(Slope of IC = Slope of BC)

[ LN. C3, p. 21 & p.32 for more detail on (*)]

Price of X decreases, ceteris paribus Quantity of good X demanded increases Own-price Elasticity

(by (*): MUX decreases  Qx increases) E = {dQx/Qx}/{dPx/Px}

(by law of diminishing returns) - Always negative (downward sloping

PX
QY demand)
Greater than 1 in absolute value  elastic
P1 Smaller than 1 in absolute value  inelastic

P2
DX

QX
Q1 Q2
QX
Q1 Q2
(Changing own price  moving along one
demand curve)
Price of Y decreases, ceteris paribus (At any price), demand for good X change: Cross-price Elasticity

- May increase or decrease depending on the E = {dQx/Qx}/{dPy/Py}

relationship between two goods:
Shift to the right if X & Y are complements; Can be:
Shift to the left if X & Y are substitutes. Positive
QY
PX Negative

DX’
DX

Q1 Q2 QX QX

Income increases, ceteris paribus (At any price), demand for good X change: Income Elasticity
QY Shift to the right if X is normal good;
Shift to the left if X is inferior good. E = {dQx/Qx}/{dBUD/BUD}

PX Can be:
Positive
Negative

QX DX DX’
QX
(this is how you derive the Engel curve)