Page 144 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-7: Recent Developments in Demand Theory

(3) To estimate the demand curve, multiple regression concept is ‘Best Fit’ for the numerical numbers. Notes
But ‘Best Fit’ can be poor and can describe a very small ratio of change in demand curve.
(4) The personal calculation in demand curve is just a good assumption, if the restricted assumptions
of errors are valid. If it is not then this might do correction which is not necessarily good.
(5) The integration is a big score while assuming the demands curve. The demand curve is best fit if it
is drawn by the price of a product and a set of its demand. But if the supply curve shifts, then the
traced points of supply curve can integrate the demand curve too. To solve the integrated portion
of demand curve, there are so many equations needed which is a big and complex process.

To estimate the demand curve, multiple regression concept is ‘Best Fit’ for the
numerical numbers.

7.2 The Linear Expenditure System

Prof. R. Stone has proposed the model of linear expenditure system based on the utility function in
which by maximizing utility function subject to a budget restriction demand function can be derived
in a general way. In this aspect, the concept of LES is similar to the concept of an indifference curve.
But there are two differences between them – (1) Indifference curve is related to individual commodity
whereas LES is related to group of commodities (2) In the indifference curve system, substitution in a
single of goods can be done whereas LES substitution between the groups cannot be done.

Its Assumptions
A model of Linear Expenditure System is based on following assumptions:
1. Consumer goods have five groups A, B, C, D and E.
2. Each group of goods includes all substitutes and complements.
3. There is no substitution of goods between groups but there can be substitution in a single group.
4. Income of the consumer is given and fixed.
5. The consumer without considering the price of the commodities, purchases minimum quantity of goods
from each group. These are called subsistence quantities which the consumer spends on maintaining
his life and the money spent on these are known as subsistence income. The remaining income which is
called additional income is allocated among the various groups of commodities on the basis of its price.
6. The consumer works rationally.
7. Utilities are additional.

Model of LES
On these given assumptions, Prof. Stone has proposed a useful utility solution of groups of products
in logarithms.
n
U ∑ a log(Q – C )
i–l i i i
That is U = U + U + U + U + U E
D
C
B
A
or U = (Q – C ) 1 . (Q – C ) 2 … (Q – C ) n
a
a
a
1
2
2
1
n
n
or U = a log (Q – C ) = a log (Q – C ) + a .… log (Q – C )
1 1 1 2 2 2 n n n
[O < a < 1; > C; > 0; (Q – C ) > 0]
i 1 1
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