Demand Functions

In this lecture you will learn how to,

 Derive demand functions using diagrams.

 Derive Engel curves using diagrams.

 Derive demand functions and Engel curves

mathematically.
Where are we?
 In the last few lectures we have seen how to
solve for the consumer’s optimal bundle
given prices and income.
 If either prices or income were to change,
then so would the optimal bundle.
 In this lecture we shall derive demand
functions and Engel curves by, ceteris
paribus, changing price and income,
respectively.
What is a Demand function?
 If we hold Py and m constant and plot the
optimal demand x* as a function of Px we obtain
the Marshallian or Ordinary/Normal demand
curve of the consumer.
 Note that if Py or m changes then we obtain a
new demand curve.
 Deriving a demand curve
We are given a set of preferences, m
y
and py and want to derive demand for X.
B.C.(p’’’)
Let px = p’ and find x*. This
B.C.(p’)
gives a point on the
B.C.(p’’)
demand function,
U=k
Decrease the price, px = p’’
x
pX and find the new x*. This
gives the next point on the
p’ Demand function demand function.
p’’ And so on, plotting the
p’’’
points along the demand
function.
x* x* x* x
Types of demand function
 The demand function for most goods is
downward sloping (i.e. demand falls when price
increases).
 The demand function can theoretically slope
upwards because:
 The good is a Giffen good (decrease in prices
decreases demand).
 Veblen effects – people want to signal they are rich
and can afford expensive goods.
 Imperfect information – the more expensive a good
the better it must be?
 Later, we shall look in more detail at different
types of demand function.
What is an Engel curve?
 If we fix Py and Px and plot the optimal
demand x* as a function of m we obtain the
Engel curve or Income Offer Curve of the
consumer.
 NB: as ‘own price’ changes the optimal choice
moves along the offer curve as against the
income offer curve, which is derived from
changes in income, ceteris paribus.
 Note that if Py or Px change then we obtain a
new Engel curve.
 Deriving an Engel curve
We are given a set of preferences,
y
pX and py and want to derive the
B.C.(m’’’) Engel curve for good X.
B.C.(m’) Fix income, m = m’ and find
x*. This gives a point on the
B.C.(m’’) U=k Engel curve,

x Increase income to m = m’’

m
and find the new x*. This
m’’’
gives the next point on the
Engel curve.
m’’
Engle Curve
m’
And so on, plotting the
points along the Engel
x* x* x* x
curve.
 Types of Engel Curve (part 1)
For a normal good
m
the Engel curve is For an inferior good
m
upward sloping. the Engel curve is
downward sloping.
Engel Curve

Engel Curve
x
x

m
For a luxury good a d%
Engel Curve
change in m causes a
more than d% change in x.

x
 Types of Engel Curve (part 2)

An inferior good for high levels of

income

m
A normal good for intermediate
levels of income.

Engle Curve
A good could be a luxury
good for low levels of
income.

x
 Homothetic preferences
If the demand for a good goes up by the same proportion
as income then we say the consumer has homothetic
preferences.

In this case the Engel Curve must be linear. For

m example, a doubling of m will double x.

This angle measures the proportion

of income spent on Good X.
Engle Curve
Cobb Douglas preferences are
homothetic because pXx = pYy.
Other examples are perfect
complements and substitutes.
x
 Quasi-linear preferences
If the utility function has the form U(x, y) = f(x) + y then
we say the consumer has quasi linear preferences.

In this case the consumer has a ‘desired level’ of

x. Beyond this an increase in income does not
m change x. So, the Engel Curve is vertical.

The desired amount of good X.

Engle Curve
There are many goods that we only
want a fixed amount of, for
example, toothpaste.

x
The consumer must buy
something!
 The Engel curves of goods X and Y (and Z…)
must be interrelated.
 For example, it cannot be that all goods are
inferior.
 It also could not be that all goods are luxury
goods.
 Can good X and good Y both be normal?
The algebra of demand
functions and Engel curves
 The good news is that we already know how
to derive an expression for the demand
function and Engel curve.
 We just need to use the same techniques as
we went through on Monday last.
Another Example
The consumer wishes to

0.5 0.5
Max U ( x, y )  2 x y
subject to p x x  p y y  m; x  0; y  0
 Draw the solution
The budget constraint is linear with equation y  m  p x x.
py

Preferences are convex. An indifference

y curve has equation y  (U  2 x 0.5 ) 2

The optimal bundle (x*, y*) may be

y* an interior, tangency solution.

But, it could also be

B.C. B.C.
U=k
a boundary solution!

x* x
Look for a tangency solution
 Let’s try the tangency condition
PX MU X

PY MU Y
 In this example

MU X  x 0.5 and MU Y  0.5 y 0.5 .

 So, we get
0.5 0.5
px x 2y
  0.5
 0.5 .
p y 0.5 y x
The tangency solution
2
 Rearranging we get x  p x 
y .
4  p y 
 Using the budget constraint gives
2
p y x  px   p 
m  px x     p x x 1  x .
4  p y  
 4 py 

 So,
4mp y mp x
x and y  .
p x 4 p y  p x  p y 4 p y  p x 
The solution
 Note that boundary solutions can be ruled out
– the solution must be interior. (How and
why?)
 We can see these preferences are
homothetic because the Engel curve is linear
4 py
x  m .
p x 4 p y  p x 

 Demand for both goods is normal.

Market vs individual
 We have been talking about deriving an
individual consumer’s demand curve.
 To derive a market demand curve we need to
sum all of the individual consumers
demands.
 So, if x1* is the demand of consumer 1 and
x2* the demand of consumer 2 and so on the
market demand is given by x1* + x2* + ….
Elasticity of demand
 Elasticity of demand is a measure of the
curvature of the demand function or Engel
curve. Usually it is calculated for a market
demand curve.
p x dx
 Price elasticity of demand =  p  .
x dp x
m dx
 Income elasticity of demand = m  .
x dm
Where to next
 Demand functions and Engel curves are some of
the most important things in microeconomics so
make sure you know what they are and how to
derive them.
 Next, we shall look in more detail at demand
changes.
 Further reading is …