ECON 401 Lecture Notes - Lecture 6: Inferior Good, Giffen Good, Convex Preferences

• School: U of M
• Department: Economics
• Course: ECON 401
• Professor: Rudi Bachmann

Document Summary

The price elasticity of demand: (dd1/dp1)(p1/d1) = epsilon. Percentage change in d1 if price p1 increases by 1%. The income elasticity of demand: (dd1/dy)(y/d1) = xi. Percentage change in d1 if income y increases by 1%. Expenditure minimization e* solves an expenditure minimization problem: Given prices p1; p2; target utility level u. The goal is to find the consumption bundle (q1, q2) which achieves u with the smallest expenditure. With monotone and convex preferences, when the quantities of both goods are strictly positive: Mrs = price ratio (du/dq1)/(du/dq2) = p1/p2. Price elasticity of demand = price elasticity of compensated demand expenditure share in income. Theta is the share of income spent on good i. The first half is the substitution effect and the second half is the income effect. For normal goods (xi > 0) the price elasticity of demand is negative (epsilon.