Derivation of ordinary demand function, Microeconomics

Assignment Help:

Derivation Of Ordinary Demand Function:

Suppose, 1675_Derivation Of Ordinary Demand Function.png and q1 = (Q11, Q21,..., Qn1)T. Let M0 be the money income and p0q0 = M0 and p0q0≥ p0q1, where p0q1 is the total expenditure of buying q1 at p0 set of prices. q0 is revealed preferred to q1. Let the set of prices when she buys q1 be p1 = (p11, p12,..., p1n), then q0 is not an available alternative at p1 price. p1q11q0 and M11q0


For simplicity lets consider a two-goods world and at initial prices and money income, budget line is AB, which is shown in the following figure.  According to the axiom, budget line is downward sloping and linear. Suppose the consumer chooses the bundle (x10, x20). Moreover suppose that for given money income M and price of the good two (viz. p2) (i.e., given the intercept of the budget line) p1 decreases. Then 448_Derivation Of Ordinary Demand Function2.png would fall. Now initial budget line is AB becomes flatter with same intercept. None of the commodity bundles on the new budget line are previously available. Therefore, according to weak axiom of revealed preference, consumer can choose any commodity bundle from the new budget line AC. Suppose it is at point V. That means ordinary demand curve can take any algebrical slope. In this case, x1 increases due to fall in p1 for given p2 and M. Ordinary demand curve is downward sloping or, own price effect is negative. Let us show that this own price effect consists of own substitution effect and income effect for a price change by using Slutsky's method, where real income is measured in terms of purchasing power. Given the money income, as p1 decreases, real income increases by which demand for x1 changes. To ignore this, money income reduces proportionately so that real income in terms of purchasing power is constant i.e., after adjustment of money income, the budget line AC shifts parallely downward such that it passes through the original commodity bundle i.e., point z to maintain same purchasing power.   


443_Derivation Of Ordinary Demand Function3.png

 Such a budget line is known as compensated budget line along which real income (in terms of purchasing power) is constant. This is denoted by line A'C' in the diagram. Note that the consumer always chooses a commodity bundle only from the compensated budget line A'C'. But according to weak axiom of revealed preference, consumer can't choose any bundle between A'z since all these bundle are previously available at the budget line AB. But consumer doesn't prefer these as she preferred the bundle z. Therefore, consumer can choose any bundle in between z and C' under constant real income. If the consumer chooses the bundle z, then we have a single quantity of good 1 with two different prices which is not possible in view of the fact that the demand function is single valued. Hence, under the constant real income consumer actually chooses any bundle on the line A'C' right to the point z, say at point T.   

Related Discussions:- Derivation of ordinary demand function

Gdp, Suppose that investment spending increases by $10 million, shifting up...

Suppose that investment spending increases by $10 million, shifting up the aggregate expenditure line and increasing GDP from GDP1 to GDP2. If the MPC is 0.9, then what is the chan

Calculate profit maximizing output level , Qustions: You are the sales ...

Qustions: You are the sales manager at SoftSystem, a dominant firm that produces operating system. The new operating system, Doors XR, has been newly developed. Its demand is e

Need anser, Consider what would happen if a taxes of 10000$ was imposed on ...

Consider what would happen if a taxes of 10000$ was imposed on imported automobiles on dealers.Using a demand and supply diagram, show its impact of price and quantity. Suppose the

Benefits of education, Benefits of Education The returns a person/soci...

Benefits of Education The returns a person/society (state/government) gets from acquiring education is referred to as benefits from education. If such returns are paid/receive

Rationale for government intervention, Rationale for government interventio...

Rationale for government intervention There are six major functions the government can perform in an economy. 1. The government provides a legal and social framework within which

Why the productivity growth slowdown of america in 1973, The Productivity G...

The Productivity Growth Slowdown However in 1973 steady trend of climbing rates of productivity growth stopped cold. Between 1973 and 1995 measured growth in output per worker

Monopolistic competition and oligopoly, Monopolistic Competition and Oligop...

Monopolistic Competition and Oligopoly: It was recognized that most industries exhibit the features of monopolistic competition in real-life. However, it must be pointed out t

Find out the budget constraint, 1. Suppose that there is a credit market im...

1. Suppose that there is a credit market imperfection because of asymmetric information. In the economy, there are N consumers. A fraction b of consumers consists of lenders, who e

Write Your Message!

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd