6.

1 Normal and Inferior Goods

If good 1 is a normal good, then the demand for it increases when income increases,
and decreases when income decreases
For a normal good the quantity demanded always changes in the same way as
income changes: x1/ m > 0.
an increase of income results in a reduction in the consumption of one of the goods.
Such a good is called an inferior good.

6.2 Income Offer Curves and Engel Curves

income offer curve. This curve illustrates the bundles of goods that are demanded
at the different levels of income, as depicted in Figure 6.3A.

The Engel curve is a graph of the demand for one of the goods as a function of
income, with all prices being held constant. For an example of an Engel curve, see
Figure 6.3B.

6.3 Some Examples

Perfect complement

Cobb_Douglas Preferences

Homothetic Preferences
If the demand for a good goes up by a greater proportion than income, we say that
it is a luxury good, and if it goes up by a lesser proportion than income we say that
it is a necessary good.
The dividing line is the case where the demand for a good goes up by the same
proportion as income. This is what happened in the three cases we examined
above.
Suppose that the consumers preferences only depend on the ratio of good 1 to
good 2. This means that if the consumer prefers (x1, x2) to (y1, y2), then she
automatically prefers (2x1, 2x2) to (2y1, 2y2), (3x1, 3x2) to (3y1, 3y2), and so on,
since the ratio of good 1 to good 2 is the same for all of these bundles. In fact, the
consumer prefers (tx1, tx2) to (ty1, ty2) for any positive value of t. Preferences that
have this property are known as homothetic preferences

Quasilinear Preferences

If preferences are quasilinear, we sometimes say that there is a zero income

effect for good 1. Thus the Engel curve for good 1 is a vertical lineas you change
income, the demand for good 1 remains constant

6.4 Ordinary Goods and Giffen Goods

It is logically possible to find wellbehaved preferences for which a decrease in the

price of good 1 leads to a reduction in the demand for good 1. Such a good is called
a Giffen good,

6.5 The Price Offer Curve and the Demand Curve

Ordinarily, when the price of a good increases, the demand for that good will
decrease. Thus the price and quantity of a good will move in opposite directions,
which means that the demand curve will typically have a negative slope. In terms of
rates of change, we would normally have x1 /p1 < 0
6.6 Some Examples
Perfect substitute
As we saw in Chapter 5, the demand for good 1 is zero when p1 >p 2, any amount
on the budget line when p1 = p2, andm/p1 when p1 <p 2. The offer curve traces
out these possibilities.
In order to find the demand curve, we fix the price of good 2 at some price p 2 and
graph the demand for good 1 versus the price of good 1 to get the shape depicted
in Figure 6.12B.

Perfect complements

A discrete good
The price at which the consumer is just indifferent to consuming or not consuming
the good is called the reservation price
(pg 111)

6.7 Substitutes and Complements

(pg111)

Chap 7: Revealed preference

7.1 The idea of revealed preference

. If preferences are not strictly convex, so that indifference curves have at spots, it
may be that some bundles that are on the budget line might be just as good as the
demanded bundle

When we say that X is revealed preferred to Y , all we are claiming is that X is

chosen when Y could have been chosen
7.2 From Revealed Preference to Preference

Revealed preferred just means that X was chosen when Y was affordable;
preference means that the consumer ranks X ahead of Y . If the consumer
chooses the best bundles she can afford, then revealed preference implies
preference, but that is a consequence of the model of behavior, not the definitions
of the terms

Another way to say this is to note that the true indifference curve through (x1,x2),
whatever it is, must lie above the shaded region.
7.3 Recovering preferences

7.4 The Weak Axiom of Revealed Preference

Weak Axiom of Revealed Preference (WARP). If (x1,x2) is directly revealed preferred
to (y1,y2), and the two bundles are not the same, then it cannot happen that
(y1,y2) is directly revealed preferred to (x1,x2).

In English: if the y-bundle is affordable when the x-bundle is purchased, then when
the y-bundle is purchased, the x-bundle must not be affordable.

7.6 The Strong Axiom of Revealed Preference

Strong Axiom of Revealed Preference (SARP). If (x1,x2) is revealed preferred to

(y1,y2) (either directly or indirectly) and (y1,y2) is different from (x1,x2), then
(y1,y2) cannot be directly or indirectly revealed preferred to (x1,x2).
The Weak Axiom of Revealed Preference requires that if X is directly revealed
preferred to Y, then we should never observe Y being directly revealed preferred to
X. TheStrong Axiom of Revealed Preference (SARP) requires that the same sort of
condition hold for indirect revealed preference.
Thus SARP is a necessary implication of optimizing behavior: if a consumer is always
choosing the best things that he can afford, then his observed behavior must satisfy
SARP