Last week you learned about indifference curves and budget constraints, and how we could use these concepts to understand individual choice. In the end we were able to build a demand curve that related the quantity demanded by an individual to the price of the product.
This week you will go through more details about the demand curve, and then go into other examples where the budget constraint is not “monetary income at a point in time” but instead related to intertemporal consumption and the work-leisure choice with your scarce time.
These examples are a bit more complex, so if you don’t understand them at first that is normal – just keep going through them to see if you can.
With respect to demand curves a key idea is to ask what this “price-quantity” space refers to, namely what is endogenous in this graph, and what elements of our choice model are not included (and are then termed exogenous).
So when looking at a particular good (eg apples) the demand curve tells us the relationship between the price of apples and the quantity of apples demanded – holding everything else constant (ceteris paribus).
What is everything else whose changes are not included in our demand curve model? Changes in the monetary income level, the price of other goods, and consumer preferences – all the other elements that were used to build our indifference curve and budget constraint model!
If these elements did change it would shift the curve – what we call a change in demand (as compared to a change in quantity demanded from the change in the price of the good).
So we build this model of a demand curve from some underlying construct of indifference curves and budget constraints, and then by allowing the price of the good to vary we can look at how the quantity demanded of this good changes – holding everything else fixed. In the end, the demand curve is a graphical representation of this other process.
Now lets take this to the very different work-leisure choice model – which ended with a specific type of choice we were trying to understand:
- What is the quantity we are trying to describe with this model?
- Is this quantity we are describing the allocation of something that produces utility directly – if not how do we understand it?
- What is the price that determines this quantity choice?
- Did this describe a demand curve? If not, what is the demand for this quantity – and whose choice would we need to model for that?