DERIVING THE DEMAND CURVE
We have just seen how changes in the price of a good alter the consumer’s budget constraint and, there fore, the quantities of the two goods that he chooses to buy. The demand curve for any good reflects these consumption decisions. Recall that a demand curve shows the quantity demanded of a good for any given price. We can view a consumer’s demand curve as a summary of the optimal decisions that arise from his
budget constraint and indifference curves For example, Figure 11 considers the demand for Pepsi. Panel (a) shows that when the price of a pint falls from $2 to $1, the consumer’s budget constraint shifts outward. Because of both income and substitution effects, the consumer increases his purchases of Pepsi from 250 to 750 pints. Panel (b) shows the demand curve that results from this consumer’s decisions. In this way, the theory of consumer choice provides the theoretical foundation for the consumer’s demand curve.
Although it is comforting to know that the demand curve arises naturally from the theory of consumer choice, this exercise by itself does not justify developing the theory. There is no need for a rigorous, analytic framework just to establish that people respond to changes in prices. The theory of consumer choice is, however, very useful. In the next action, we use the theory to delve more deeply into the determinants of household behavior.
Figure 11 Deriving the Demand Curve
Panel (a) shows that when the price of Pepsi falls from $2 to $1. the consumer’s optimum moves from point A to point B. and the quantity of Pepsi consumed rises from 250 to 750 pints. The demand curve in panel (b) reflects this relationship between the price and the quantity demanded.
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