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6 derivation of demand.doc

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ECON 1100

Preference Theory and Derivation of DemandCONSUMER CHOICE THEORY DEMANDBUDGET CONTRAINTSSuppose that the consumer household consumes only two goods X and YGiven the Prices of the two goods P P and the consumers income m the possible XYquantities purchasable by the consumer X Y are constrained byooPXPYmXoYoeg Suppose that a student has a budget for coffee and milk of 100monthIf the price of Coffee X say is 1cup and the price of Milk Y is 2litre the budget constraint is1Q2Q100CMNote We can define one of the goods Y say as a composite commodity representing all goods other than XBudget LineDefinition The maximum combination of two commodities purchasable by a consumer given the prices of the two commodities and the consumers money incomeRearranging the budget equation for the assumption that all income is spent gives the Budget lineYomPPP XYXY0egThe budget line for Coffee and Milk with Milk as the Y commodity is Q100212Q5005QMCCSince the Opportunity Cost of XdYdXRecall Opportunity Costthe best foregone option Opportunity Cost of XdYdXPP slope of the budget line XYdYPP dXXY 1
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