A Reconsideration of the Theory of Value. Part II. A Mathematical Theory of Individual Demand Functions Author(s): J. R. Hicks and R. G. D.

Allen Source: Economica, New Series, Vol. 1, No. 2, (May, 1934), pp. 196-219 Published by: Blackwell Publishing on behalf of The London School of Economics and Political Science and The Suntory and Toyota International Centres for Economics and Related Disciplines Stable URL: http://www.jstor.org/stable/2548749 Accessed: 30/07/2008 12:47
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[MAY

A Reconsideration of the Theory of Value

By J. R. HICKS and R. G. D.
ALLEN

Part II.-A

Mathematical Theory of Individual Demand Functions

By R. G. D.
ALLEN

THEestablisheddefinitionof the way in which a pair of goods can be relatedin an individual'sscale of preferencesis due, in its precise form, to Edgeworth and Pareto. The definition assumesthe existence of a utility function giving the utility to the individual of any combination of the set of consumers' goods, X,Y,Z........ which enter into the individual'sbudget. Denoting the function by u=b(x,y,z. ...... ), the EdgeworthPareto definition of the relation between any pair of goods,
axay 32U or complementary competitive according as

X and Y, depends on the sign of

aa

The goods are

is positive or

negative. If the individual possesses an increasedamount of one good, the marginal utility of the other good increases in the complementary case and decreasesin the competitivecase. This definition ignores one fundamentalfact. Even if the utility function exists at all, it is by no means unique and it of can serve only as an index,and not as a measure, individual utility. Pareto himself established this fact, but failed to deduce the logical corollary that the derivative a is also indeterminateboth in sign and in magnitude. To prove this corollarywe proceed as follows. The utility function index is the integral of the " indifference" differe :Jtialequation: ....... o, 0,,ndx+O,dy+O,dz+
where O., +) Oz) .... are the marginal utility functions,
I96

determinateonly as to their ratios. If u=O(x,y,z ....... ) is one

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form of the integral, and if 0b, 0, . ...... are arrangedto be the partialderivativesof this function, then the general utility function index is:
u F {b(x,y,z ......

where F is an arbitraryfunction with a positive derivative.' The partial derivativesof the function index are @@ aau uF(o).O.<; aau=F(o).ov; a8 F'(0)...... The signs of these derivativesare the signs of f0,r,, ~,.. 0, respectivelyand their ratiosare determinate(as required). On the other hand, the sign of the second-orderderivative
axFf (0).*x + VF"f(0). ox . ov

cannot be taken as determinateand it depends entirely on the function.2 The above definition form adoptedfor the arbitrary of complementaryand competitive goods is thus indefinite; for a given combination(x,y,z....... ), the same pair of goods can be sometimes complementaryand sometimes competitive accordingto the form taken for the utility function index. The definitionis not adequatefor the distinction Edgeworth-Pareto of relationsbetween a pair of goods and it must be rejectedin any precise theory of individual choice. The development which follows will decide, amongst other things, what can be put in its place.
I. INDIVIDUAL DEMAND IN THE CASE OF TWO GOODS

I. In the presentsectionwe shall considerthe casewhereonly two goods, Xand Y, enterinto the budget of a given individual. The case can be interpretedin two ways. Eitherall goods other than the pair XY are possessed by the individual in known amounts, and he considershis expenditureon X and Y independently,or the pair XY representtwo broadclassesof goods (e.g. food and other items) which together make up the individual's complete budget. In either case, it is seen that the theory of demandfor two goods is subjectto severe limitations in possible applications.

1 The positivederivativeis only necessaryto ensure that u is a genuine index of or together. utility in the sensethat all its formsincrease decrease a a is definitein sign is when either z or Xv is zero, 2 The only case in which i.e. when the marginalutility ratio j: q, is zero or infinite and the individualis " " saturated with one of the goods. This possibilitydoes not concern us in our
consideration of the individual under market conditions.

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2. The individual's scale of preferences.-The individual possesses the combination (x,y) of amounts of the two goods X and Y.1 The fundamental postulate of the theory is that there exists a unique " indifference direction " for variations from the combination (x,y) defined by a differential equation: (. dx+Rydyz o .............................. The equation expresses a relation between increments dx and dy (one positive and one negative) which just compensate each other as far as the individual is concerned. The expression Ry -dx/dy is the (limiting) ratio of compensating increments in x and y,2 i.e. Ry is the marginal rate of substitution Xfor Y. As of the combination (x,y)varies, so does the individual's indifference direction and the value of Ry. In fact, Ry is a function of x and y, and its values for various combinations (x,y) describes the scale of preferencesof the individual. Only the function Ry is needed, since the marginal rate of substitution of Y for X is

RY

I/RY.

Three assumptions are made about the scale of preferences: Ry is a continuous function of x and y. (i) (2) Ry is positive at all points (x,y). (3) For the variation of the indifference direction from any point, the expression dx+ Rydy always decreases: subject to dx+Rydyz o, d(dx+Rydy)<o i.e. I Ry a a

-RyRy

Ry<o

......

(2).

The differential equation (i) is always integrable, and from it is obtained a system of indifferencecurves in the OXY plane. The tangent to the indifference curve at any point has gradient (-Ry) referred to OY, or gradient (-Ry) referred to OX. The first two assumptions imply that each indifference curve has a continuously variable tangent which is always downward sloping. The third assumption implies that the indifference curves are everywhere convex to 0. The numerical value of the tangent gradient referred to OY (or to OX) increases as
I The problem is a completelystatic one and the time element is abstractedby of thatcomeinto thepossession theindividual(to be disposed takingx andy as amounts of by him) per unit of time. 2 The " preference directionof direction" of the individual(i.e. his most preferred direction." Hence, acquisitionof the goods) is at right angles to the " indifference of direction. There is thus a secondinterpretation R', R"=dy/dx along the preference the marginalrate of increaseof y with respectto x for a change in the preference direction.

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we move along an indifferencecurve away from OY (or away from OX). The marginal rate of substitution of X for Y increases as we continue to substitute X for Y. This is the principleof increasing marginalrate of substitution.' or There are three characteristics indicesof the individual's which are sufficientto describethe complete scaleofpreferences form of the scale or of the indifferencecurve system. All the indices are expressed in terms of first-ordervariationsof Ry; they refer only to the scale of preferencesitself and not to market conditions. It will be found, further, that the indices are sufficientfor the descriptionof the individual'sreactionto market conditions. The first index refers to a single indifferencecurve only. between X and Y is defined as The elasticity substitution of d(
Y

)
Y
Ry Xy

dRY
X RY ' "'Ry

d(Y) dRY x
x dRx

taken along the indifferencedirectionat (x,y). Hence:

X + RYyx

a RY-RYy

ay

ax

Ry

from the condition (2). The elasticityof substitutionis independent of units and is symmetrical with respectto x andy. It is a measureof the curvatureof the indifferencecurve at (x,y), varying in value from zero when the curve is in the form of a right angle at (x,y) to very large values when the curve is flat. The other two indicesreferto the relationof one indifference curve to anotherand adjacentcurve,and they can be calledthe
coefficients income-variation: of
P$ -

Y x aaRy

and p, ==xy ~~~~xPy.

Both coefficientsare expressed in " elasticity" form and are

1 Of the threeassumptions madehere,the firstis introduced simplyfor mathematical convenience, but, apartfrom this, thereis no reasonto assumeaway discontinuities in the indifference curvesystem. The other two assumptions on a differentfooting, are but they are not necessarily satisfied. They must certainly be relaxed when the individualpossesses much of one (or more)of the goods that he would pay to get so rid of it. Further,it is not contendedthat they apply to a positionon the preference scale where the individual finds himself below the " subsistence level." It is maintained, however, that the assumptions serve to describe all positions in which the individual is likely to find himself under market conditions.

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of independent units. It followsfrom(2) thatp$ andpz,cannot

both be negative; they are both positive in the "normal " case and one is positiveand the other negativein the" exceptional" case. demandfunctions.-Ifthe individualspends 3. Theindividual a given money incomepuon the two goods X and Y at given uniformmarketpricesp,,andp,, then his equilibriumpurchases are given by the following conditionsfor equilibrium: to In diagrammatic terms,the equationscorrespond the fact that the purchasesof the individualin equilibriumare represented by the co-ordinatesof the point in XY space where the given price line (i.e. xp$+yp,=-tk) touches an indifferencecurve. The solution of the equations(3) gives x andy as functionsof,u, p0, functions. By the assumption and p5,-the individual demand of increasingmarginalrate of substitution(indifferencecurve system convex to the origin), a single equilibrium position exists for each set of,a, P. andp, and the demandfunctionsare
single-valued., denoted by Kc,
=p i xp5,+ ypy = p and I _ Pr Pr

. ..

........ W.

Let the proportionsof total income spent on X and on Y be

xp andK,
=

IV

(where K$+

IK,=

I).

From the

equations (3) the values of the three indices of the scale of preferencesin the equilibriumposition are:
p
a3= _

Pv
Poo

Xy

YA.

yR Pa
Pvp-

pa8Y
P/ ax

PV ay Ry.

-a

The problem is to trace the variation of the equilibrium position and of the demandfunctionsas income or pricesvary. of (a) Income-elasticitiesdemand.-Let k varywhilep,, andpv of are kept fixed,and denote the income-elasticities the demand functions by
E,,(x) ?) ax and E,z(y) a,Y
I The relaxing of the third assumption made above leads to multiple positions of equilibrium and to multi-valued demand functions. The introduction of this complica-

tion is not necessary unless,and until,thesimplertheory,basedon the thirdassumption, of fails to describethe phenomena the market.

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Differentiate(3) partiallywith respect to ,u:

xpZ,, E,(x)
Xa

. ...... a RyE,(y Ry Es,X x-R~EX(xt() + yY_R Ez(y)=o --

yp,

Eju(y)

-L1

(4)-

The solution of the equations (4), making use of the equilibriumvaluesof a, px andp11, appearsquite easilyin the form: a . and El., . p,, ... ............... p,, (y)-cr ES, (5). (X) From the first equation of (4), it follows at once that
KocE,.,(X) +

Ez() Kv
a

and hence that KxP$

KVpM--

It is not possible for both and E}J(y) be negative: in to Eoi,(x) the " normal" case both are positive and the demands for X and Y increasewith increasingincome. In the " exceptional" case, on the other hand, one income-elasticityis negative and the demand for this good decreases with increasing income. of If the income-elasticity demand for a good is negative, this to good is said to be inferior the other good. Notice that E,(x) is a positive multiple (a) of the second index of the individual'spreferencescale and that E,, (y) is the same multiple of the third index. The income-elasticitiesof demand can thus be used instead of these two indices. (b) Price-elasticities demand.-Let p< vary while p and p, of are kept fixed, and denote the p.l-elasticitiesof demand by
E., (x) P.,,a t P x aXand EP,X(y)

ap,

__a

y_

y apr

Differentiate(3) partiallywith respect to p$: + yp, Evx,(y) = XP1 xp,,E, (x) a Ry pv . ...... (6). x a_ y R -RYE, (x) +y Y- E y)
-

So

xE2,,(x)

yEvx(y)

R Ry Pv a
_p a

xp4 Ry- pv

Ryp R -p a Ky
=

Hence Ep (x)and E,,,(y)

=-

P+
(PV

Ki0E,(x)+
-Ka

(I

K.)

PV

PV)

(y) KxEp

using the results(5) and the equilibriumvalues of a, pxand p,,.

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Similarresults hold for the pu-elasticities demand. Hence: of (x) E2,,. -KXEj,(X) + (I-KI) a or E2,,(y) _ Kc,E,(y) - IC.( * e a = 7)j (X) E?,(X)
E,y(y)

KI,El,

KvE,,(y) + (I -Kg,) a

Two relations exist between the four price-elasticitiesof demand given by (7). From the first equationof (6)
K.E2,,(X) + K,,E,(y)
KX. KV.

Similarly

KoE.V(X)+ KVEV,(y)

The conclusionsthat can be derivedfrom the equations(7) are set out fully by Dr. Hicks.' There is, however, one point that cannot be over-emphasised. The substitution term in Ep,(x) and in E,.(y) is always negative, and a fall in the price of one good causes a substitution of this good for the other. Hence, two goods must always be regardedas substitutes, or as " competitive," when they stand by themselves; complementarity is a characteristicwhich does not appear until at least three goods are considered.2 Further, if the elasticity of substitutionis a more important(i.e. numericallylarger)quantity than the income-elasticities,then both the " cross " priceare elasticitiesE.,,(y) andEj,,,(x) negative,i.e. both ay and ax of are positive. This is the traditionalcharacteristic substitute " competitive" goods in a generalsense. But, if the incomeor elasticities are at least as important in magnitude as the

ay and ax .. elasticity of substitution, then the derivatives Y apv can be of either sign, and their signs need not agree.
II. INDIVIDUAL--DEMAND IN THE CASE OF THREE OR MORE GOODS

i. We turn now to the general case where any number of inter-related goods enterinto the individual'sbudget. In order to simplify the mathematicalanalysis, only the case of three goods is consideredin detail. It is a difficultstep from the case of two goods to that of three goods, but no additionaldifficul1 Hicks, ECONOMICA, February I934, pp. 65 et seq. This is the first part of the present joint article. 2 The coefficient of (y) or E_,,(x) is what correK. or K,, in the second term of Ev11 sponds to the " elasticity of complementarity " in the general case considered in the following section. Here the coefficient is equal in magnitude but opposite in sign to the elasticity of substitution.

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ties or complicationsare encounteredin the generalisationof the latter to the case of n goods. of complex preferences.-The fundamental 2. Theindividual's postulate is that, for variationsfrom any combination(x,y,z) of amounts of three goods, X, Y and Z, possessed by the directions" individual,thereexist certaindefinite" indifference defined by the differentialequation: dx + Rydy + Rxdz=o ............................ (8), where the incrementsdx, dy and dz can take any values that compensatefor each other as far as the individualis concerned. rate of The expressionRy = -dx/dy(z constant)is the marginal substitution X for Y, and Rx= -dx/dz (y constant) is the of of marginalrate of substitution X for Z. Both Ry and Rx are functions of x, y and z, and together their values make up the Othermarginalratesof subofpreferences.1 individual'scomplex stitutionexist but can be obtainedfrom the two writtenabove: Rx; IRX;Ry Rx. Ry = Ry.Rx _ /Ry' R=I/RY; Rx are Three assumptions2 madeaboutthe individual'scomplex of preferences: (i) Ry and Rz are continuous functions of x, y and z. (2) Ry and Rz are positive at all points (x,y,z). (3) For a variation in any indifferencedirection from any point, the expression dx + Rydy Rzdz decreases: + d(dx+Rydy+Rzdz)< o subject to dx+Rydy+Rzdz=o,
I i.e.

IaRxY

Ry aaRx

and similar determinantsare

negative
Rz
is positive ............ (9).

ax I
and

y~~~ Ry

ax aX

az ay as x -a x a Rx z aR z
ay az

1 The term "complex " of preferences a better descriptionof this idea in the is which sufficesin the simplertwo generalcase than the term " scale" of preferences goods case. In the generalcase (withoutthe integrabilitycondition)it is not possible of to " integrate" the preferences an individualinto anything like a completeand ordered scale. The " preferencedirection" (the most preferreddirection) of the directions. individualis still unique,and it is at right anglesto each of the indifference It is given by dz dx dy
I

Ry

RZ

direction. dz/dx for a changein the preference dy/dx and Rx== Hence, Ry==
2 As before, the assumptions are not necessarily satisfied but serve to describe all situations in which the individual is likely to find himself under market conditions.

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If the differential equation (8) is integrable (which is not always, or even usually, the case), then a complete indifference surface system exists in XYZ space. The first two assumptions imply that each indifference surface has a continuously variable tangent plane which is always downward sloping both in the OX direction and in the OY direction. The third assumption implies that the indifference surfaces are everywhere convex to 0. In particular, the second-order determinants with negative values in (9) give the principle of increasing marginal rate of substitution-the marginal rate of substitution of one good for another increases as we continue to substitute these goods, the third good remaining fixed in amount. The following notations are required:
_Ry Rz RxR

xyz

ax

x? X + Ryvy Rxz + yRx Ry Rx a RI a Ry _ Ry

ay

az

ax

a Rz a R, a RX x

eY_ az

The coefficient a is positive from the condition (g); it is independent of units and symmetrical with respect to x, y and z. Further, it denotes the mutual substitutability of the three goods and, if the indifference surface system exists, it measures the curvature of the surface passing through any point. Consider now one good, say X, apart from the other two. The elasticity of substitution between Y and Z is

d( 2:)
y z

divided by

dRy

where the differential can be taken along any one of the three perpendicular indifference directions at the point (x,y,z). There are thus three elasticities of substitution between Y and Z which we can denote by 11;u,, $, u^ and $ z accordingas it is taken along the YZ indifference direction (X constant), along the XZ indifference direction (Y constant), or along the XY indifference direction (Z constant). Evaluating:

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=
-

__

yz

.y

Y
~j

Ryz
Rz
yy

which is positive,

and~~~cr.~~==

i,awR

z
Rz a R

s
Rz>Rz

All these elasticities are independent of units. The first ,avz is symmetrical with respect to y and z and measures the ordinary elasticity of substitution between Y and Z (X being now fixed in amount). The other two elasticities are new and can be positive or negative; $zaz measures the elasticity of substitution between Y and Z when the relation between these goods varies on account of a substitution of X for Z, Y remaining fixed in amount, and similarly for ,,a,%. There are three similar elasticities when Y is considered apart from XZ and three more when Z is considered apart from XY. 3. The form of the individual's complex of preferences is described by twelve indices, all of which are expressed in terms of first-order variations of Ry and Rz. The indices refer only to the complex of preferences and not to market conditions. The twelve indices of the complex of preferences can be divided into three sets: The elasticity of substitutionbetween X and the pair YZ (i)
lz vZ

and two similar elasticities

'zrxz

and
xV

All three elasticia is the mutual elasticity

ties are positive. In general terms,

vzafuz

of the triad X, Y and Z reduced by the elasticity of substitution of Y and Z between themselves. The elasticity can be large, therefore, if the triad is a highly substitutable one (a large) or if Y and Z themselves are hardly substitutable at all (v,=Uv, small). The elasticity of complementarity Y with X against Z (2) of
a

sczOlyz

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of and the elasticityof complementarity Z with X against Y

U
cx1 aJ

In these elasticities a is again reduced by one of the elasticities of substitution between Y and Z-the new ones in this case. The signs of the elasticities of complementarity can be positive or negative, and these will be interpreted later in terms of the competitive and complementary nature of the relations between X, Y and Z. There are four other and similar elasticities of complementarity:

;
XIZ $ ax Z

;
laVZ $Va

; ~and-CZ

of (3) The coefficients income-variation: R Rz )Z

Ry ay nxXZ aRYZaRV a

ay
and

_ az Ax

RR

a
ax

a
az

Ry

Y Ry

Ry

a Rza Rz
These coefficients are the co-factors (adjusted to be independent of units) of the first row of the positive third-order determinant given in (9). It follows that they cannot be all negative; they are all positive in the " normal " case, and either one or two of them are negative in the " exceptional cases. The three indices of (i) and the six indices of (2) refer only to the indifference directions at the point (x,y,z), i.e. to a single indifference surface (if the system exists). The three indices of (3) refer to variations from one set of indifference directions to another and adjacent set, or from one indifference surface to another and adjacent surface. 4. The individual demandfunctions.-If the individual spends a given money income Z on the three goods X, Y and Z at given uniform market prices px, py and pz, then his purchases in equilibrium are given by the conditions: ni zpzrn su xpx+ypv
XP$+7p

+Zz-Kand and--

exists,

_ Rx Rx

(IO (io).

If the indifference surface system exists, these equations

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conditionthat the individual's correspondto the diagrammatic equilibrium purchases are the co-ordinates of the point in XYZ space where the given price plane (xp$ + yp, + zpz = touches an indifferencesurface. The equations(io) suffice to determine x, y and z as functions of ,u, p$,, p, and pz-the These functions are single-valued individualdemandfunctions. since the assumption (g) implies that a unique equilibrium positionexistsfor any set of ,u, p$, p, andpz.
Let
K$=

X -,Kg

Yv

and Kz-Z

denote the proportions

+KV+Kz

oftotal income spent on X, Yand Z respectively(K$

I).

For convenience, denote

D-

P$

ax

Ry a Ry a Ry

PV

PZ

a a Rx" Rz a Rx
The values, in the equilibrium position, of the various elasticities and coefficients defined above are:
(-K.) pZ

ay

az

a =

Z Xy p 2 D

I-b

P-Pz

I '

va v =

a RZ a RZ
ILKx
__
_

Y Py PV PZ

etc.

(j-Kx

PZ
_

Pz

xz

vavz=

1
Pz
XZ D.*
-

_(II)

p YpP

etc.

Rz aRa,) ~Y ay PZ PXP
=

Rz a R y
PVP p.
-

yzp,2 D

1D

where D1, Dv and Dz are the co-factors of the first row of D. The problem of the variation of the demand functions, as income or as prices vary, is treated by the method adopted in the two-goods case. (a) Income-elasticities of demand.-Denoting the three income-elasticities of demand by

ax E,.(y)A E,.(x)= P

ay E..tz)-i

ao8
differentiate (io)

ECONOMICA

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partially with respect to ,u:

xpU, E,(X)

+ ypv Erj(y)

+ zpz E,L(z)

aaa (x)+ axRYEE,

X8RzE,Z(X) +

Ry

EZA(z) =o 0

E+E(y)+z iRY za Rx s() aRx EPi( +

(I 2)

Solving the equations

xE_,(x)

in determinant form,
zE,L(z)

yE,p(y)

D Dz Substituting the values of the various expressions given by (i i), ( 3). . P a ............... p#,; E, (x) a. p$; _u(y)- * a E,(z)u From the first equation of (i 2) we have a relation between the income-elasticities and hence between p,, pu and pz:
Do,

Dv

KOEI,(X)+ Ky E,(y) KxP$ +

KVPV

+ KzE(z)

I (4)1

Kzpz =

It follows that all three income-elasticities cannot be negative. In the " normal " case they are all positive and each demand increases with increasing income. In the " exceptional " cases one (or two) of the income-elasticities is negative and the demand for one (or two) of the goods decreases with increasing income. A good is said to be inferior if its demand decreases with increasing income, and it is possible, therefore, for one or two of a set of three goods to be inferior in this sense. Since the income-elasticities of demand are positive multiples of the third set of indices, they can be used instead of the latter to characterise the individual's complex of preferences. (b) Price-elasticitiesof demand. Denoting the pm-elasticitiesof demand by E., (x) =
p EDZ(y)= _ y~ a*Ez apj differentiate (iO) partially with respect to pa,: + zp, E,,(z) = XpX xp, E...(x) + ypv E (y)
x

ap;

ap,

ap;)

R EP(x)

+-

RXEPZ(Y) + z-

RyxE7(Z) = P

Xa Rt E,, (x) + yaa RX Efi.(y) + z

Rz E(z)

Px

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Solving the equations (i 5) in determinantform: z EX (z) y E.(y) x Elil(x) p xpp, x PZ XP$ p1 PZ Ppo P

Py a y a Ry
RZ

D'

ax paz Ry Ry
P$y

ay ax y I Pv
RX

p, ay
iy

t aaRx

az

vx
Pl2
a

RZPZa RxR

P$az

ax

ay

p$

[xpaDZ+
+a{

{P a RX- PaRX
p4zRy p4RV}] y
a,

K$)

D-X

Pz f
(I I)

using the expressions Hence, from (I I) and

and making the transformation

RZ= Ry.RY together with the equilibrium equations (I O).

(I

3),
liz el/l

By an exactly similarprocedure,w7pe obtain

+ Ew$z(y) = KXE,L(y) K$ $zyz
-

? andElil(Z) KSEH(z)K$

y $V

Similarsets of resultscan be obtainedfor the pt-elasticitiesand for the pR-elasticitiesof demand. Hence:
Eli (X) KzE - E(X) K$

( II +

-K )
a

-a

VZavz

Ell (y)

EA(y)?Kl K$
K$

Z a

.(E6

El/li(Z)=-K$E,y(Z) +

ay liyz

and two similar sets of three equations

first term being a multiple of the third set of indices of the complex of preferences (the coefficients of incomze-variation) and the second term being a multiple of the first and second set of indices (the elasticities of substitution and complementarity). One relation can be found between each of the three sets of

Each price-elasticity demandthus consists of two terms, the of

2IO

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price-elasticitiesof demand. From the first equation of (i5),

KXE22 (X) + Ky1EV, (y) + KZE,X (Z) =Kw

and two similarrelations

Hence,
(IK)
vz avz xz avz
__+ K__

+Kz
xvvz I

=(7). and two similarrelations The three relations of the type (I 7) between the indices of the first and second sets imply, amongst other things, that the elasticities of substitution can be obtained in terms of the

elasticities of complementarity. both

f
$Z (7wVZ

Further, since

ff
21Z02/Z

>

o,

and
$2

f
l

cannot be positive.
X

There are, there-

fore, only two possibilities. Either both elasticities of complementarity of Y and Z with X are negative or one elasticity is negative and the other positive. 5. A number of important conclusions can be derived from the results (i 6).1 The increases and decreases in the various demands that follow a change in any one price are made up of two separate changes, the first due to the change in real income and the second to the substitutions made possible by the change in the relative prices. The effect of a change in the price of a good on the demand for the same good is clear. The change is measured by an elasticity of the form E,fx(x) and this is positive in almost all cases. The demand for a good is thus increased by a fall in its price. It is possible, however, that this result is reversed in very exceptional cases. A price-elasticity of the form Evx(x) can be negative and the demand for a good can increase with a rise in its price, provided that the income-elasticity of demand for the good is negative and large relative to the substitution effect. Hence, the demand curve for a good X can be rising, in the Giffen-Marshall sense, provided that X is an inferior good and that a large proportion of total income is spent on X for which no ready substitutes are available. The effect of a change in the price of a good on the demands for other goods is more involved, and it is here that we must look for observable evidence of the " competitive " or " complementary " nature of the relations between the three goods.
1 For a complete account of these conclusions, see the first part of this article by Dr. Hicks, ECONOMICA, February I934, p. 67 and pp. 69 et seq.

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Consider the three-way substitution made possible by the relativeprice changesapartfrom the effect of the change in the level of real income. The second terms of the results (i6) indicate this substitution effect. The effect of substitution following a fall in the price of X is to increaseor decreasethe demand for Y accordingas the elasticity of complementarity of Y with X against Z is positive or negative. A4negative with that Y competes X against implies of elasticity complementarity X Z and a positiveelasticity Y complements againstZ. The that signs of the elasticities of complementaritydetermine the natureof the relationsbetween competitiveand complementary the three goods and their magnitudes indicate the extent of of the relations.' Since both elasticitiesof complementarity Y and Z with X cannot be positive, it is impossiblethat both Y and Z complementX. There must be anelementof competition between one good and the other pair. In conclusion, it is importantto notice that these competitiveand complementary relationsdependonly on the indicesof the individual'scomplex of preferences,and not on market prices or conditions.
III. THE INTEGRABILITY CASE

i. The development of the previous section was perfectly general and, in particular,it was independentof the existence differential equation(8). The of an integralof the fundamental results to be set out in the present section, on the other hand, hold only in cases where the equation (8) is integrable. The mathematical condition for integrability imposes a restriction on the form of RI and Rx.2 Assuming that the condition is satisfied,there exists a func.tionindex of utility

u- F{(x,y,z)}
where O(x,y,z) is any one integral of (8) and F denotes the arbitraryfunction involved in the general integral. Writing the partialderivativesof O(x,y,z)by 0r,,0, and 0b, we have Ry= v and Rz=

1 In the complementary case the demands for both X and Y increase at the expense of the demand for Z (apart from the effect of the change in real income). This is why only competitive goods are possible in the two-goods case; there is no third good to absorb the loss that must occur in substitution. 2Tecondition caa is-R azX

a -+ Rz,

Ry

X ax

a RzZ X

a y ax R

0.

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The analysis can now be expressed in terms of the function b(x,y,z) and its partialderivativesof the firstand secondorders, rememberingthat only the ratiosof /$, + and 0b are definite. All the results given below, however, can be shown to involve only these ratios or the derivativesof the ratios, and not the functions themselves. and 2. Simpikficationthe competitive complementary of relations.
-In the integrability case the values of the six elasticities of complementarity are
a _ s+ X Ay+ + zoz (15y a

_za_+z

XYX+
-x

k
zoz

auo_z z a ce zuxi

azI

yoy
Y+Z

ccii%z U a

bZ

X00

yo xzo

0 xz

determinant where- 0 standsfor the negativeand symmetrical

OXIY Og IYl
xzZ OIZ

kcx1

k1I1 fruz oxy

IZ
oZZ oZ

+Xy

0 sb1 Sz and OX.)O, and IPx,are the co-factorsof fxv, fvz and xz1in the determinant. Symmetryis, therefore,introducedinto the relationsbetween the three goods when the integrability condition is satisfied. For the relation between any pair of goods X and Y (with respect to the third good Z), the elasticityof complementarity of Y with X against Z is equal to the elasticityof complementarityof X with Y against Z. It is now possible to speak of the elasticity of complementarityof the pair XY (against Z): ox~
a
xv = $2 or.
V. orw

and there are only three of these elasticities, ao,,, au,, and a,Z, instead of the full set of six.' The signs of or,, auz and a,,,, determinethe competitiveand complementary relationsof the whole set of three goods. If a, is negative X and Y are competitive, if positive X and Y are complementary (with respect to Z in each case). Similar criteria apply to the relation between the other pairs.
I The integrability condition is clearly sufficientfor this symmetry; to be a necessary condition. it also appears

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The equations
(I -

(I

7) now take the form:

+ Kg U0 + KzcT =:- 0.
vz

K0 ) --

avz

and two similar relations Hence, at least two of uTX,) and Yz are nega-tive, and it is not auz, possible for more than one pair of the three goods to be complementary. Further, the equations can be solved either to give the elasticities of substitution of the goods in pairs (,zcr,z) $zUoz and xrx,) in terms of the elasticities of complementarity of the
and orz), or conversely. goods in pairs (cr0x, oru,z The latter is the
I
xzz z

mTore interesting solution. We obtain:

Iz 2 a _( $V MyoV Kx

KZ) Kly

I-Koc

I -K
Kx

zKy lyz Ory

and two similar expressions Hence, the goods X and Y can only be markedly comple-

mentary if the term I

Uy

XK

f+

z
KV

is large comparedwith the

other two terms of the expression (i 8), i.e. if the elasticity of substitution of the pair XY is small compared with the two similar elasticities, or if Kz iS large compared with Kx and Kv,, or both. The results stated by Dr. Hicks on this point follow at
once.'

Consider, finally, the two actual variations in demand:

ax
_

Xy

ap1,

{E4(x) + oz} and aY = _

II,p,1-

{E,,(y)

+ or,,}.

Both ax and ak are independent of units and can be comap11 ap1, pared directly. The two variations are equal only if E,l(,) E,,(y), i.e. if an increase in income has the same proportional effect on the demands for the two goods. This may approximate to the actual state of affairs in many cases, but it is certainly not exactly true in general. Further, the two variations are in the same direction (without necessarily being of equal magnitude) either if both income-elasticities are small or if they are large but differ by a small amount.2 It is, howFebruary 1934, p. 73. 1Hicks, ECONOMICA, It is worth while distinguishing the two alternatives. It is only in the first alternative, where E (x) and E (y) are small, that we can say that the common sign of ax
2

and 22' is determined by the sign of uX,. In this case the two variations are positive if

apG

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ax ever, quite possible that ap1,and -ay are different,not only in

ap,

magnitude,but also in sign. The symmetryof the system does not necessarilyextend to these two changes in demand. goods.-The three goods form an 3. The caseof independent independentsystem if the marginalrate of substitutionof one good for another depends only on the amounts possessed by the individualof these two goods, i.e. if Ry is a function of x and y, R' a function of y and z and Rx a function of x and z. It follows at once that each marginalrateof substitutioncan be expressedas a productof two functionsof a single variable,and that we can write:
I

ox(x)

~~Ry 0y(Y)

Rx
oz(

The differentialequation (8) is + +r +X(x)dx Ov(y)dy 0 (z)dz -=o and this is always integrable. The function index of utility is u= F{Ox(x)+ Ov + ?>(z)}, (y) the general integral of the equation, where = ?Z(x)= f ox,(x)dx; (y) = f (y)dy;Oz5(z) f z (z)dz. OY The utility index is, in all its forms, a function of the sum of three functionsof a single variable,and the goods X, Y and Z make independentcontributionsto the utility index. The case significant. of independentgoods is thus at least mathematically It is only in the independentgoods case that we can derive anything correspondingto the marginalutility functions and analysis. The marginalrateof substitucurvesof the traditional tion of Y for X is Ry= O (x): 0, (y), and this is a constanttimes +$(x) when only x varies. The same is true of the marginalrate of substitution of Z for X. There is, therefore, a singlevariablefunction Ox(x)which representsthe marginal rate of substitutionof any good for X for variousamountsof X. It is only necessaryto multiplythe functionby a constantdepending on which good is substitutedfor X and on the (fixed) amount of this good possessed by the individual. Let EQ(0,)= ,x d representthe elasticityof the function
X and Y are competitive and negative if X and Y are complementary. In the second alternative, though the variations are in the same direction, the direction does not necessarily correspond to the competitive or complementary relation between the pair

of goods XY.

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+$r(x), i.e.

the elasticity of the marginalrate of substitutionof any good for X taken for variationsin the amountpossessedof X. In the same way we can obtain two other elasticities, and E,Q(k). Each of these three elasticitiesis perfectly E,(%b) definite, being independent of units, of which good is substituted for the one namedand of the amountof the substituted good that happensto be possessed. The elasticitiescorrespond to the elasticitiesof the marginalutility functions or curves of Pareto's theory of value. If the signs of all E$($), E,(f,) and E,,(,) are negative we have the case of " decreasing marginal utility " in Pareto's sense. It is, however, not necessarythat this case should obtain for all sets of independent goods. In the case of independent goods the following equilibrium values of the fundamentalcoefficientsare obtained:
a =
I

EOEVEE

K
z

I ;

_I

I I
EK

v z K Ez etc.;
px

etc.;

$z

v=z

E EvEz etc.,

where K
so on.

E +
$
v

?_ +
Ez

and E, stands for E,(O.),and

The equilibriumvalues of the twelve indices of the individual's complex of preferencesare: (i) the elasticities of substitution are
Ur

and .,r~,
vzavyz
(2)

{
Q

I-K,j IKx

Ex

i_{) Ex

1<K

and two similarexpressions,all being positive

the elasticities of complementarity are
I
aM,
-

E$,EV K and two similar expressions (3) the coefficients of income-variation are PMo E.,,; p, - E. Ez andp., E. E, =E, and so (y) E,,(x) = aE,,E, ; E,z, = aE.E,, and E,,(z) = aE,,E. The indices are all determined by the three elasticities E,,, E. and Ez. There must, therefore, be a number of relations between them. As in the general integrability case the elasticities of substitution can be expressed in terms of the

_=

aE~.

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elasticities of complementarity,or conversely, by means of equations(i 8). In the independentgoods case, however,there is a further set of relations between the indices. The coand efficientsof income-variation, hence the income-elasticities of demand, can be expressed in terms of the elasticities of complementarityalso. We have:
_ .r E,~(y)= ,,X -Ovoxz I ; E E
$gZn

and E,L(z)=-

or

oa

...IJZ

As in the integrabilitycase at least two of oxy)a,lz and aZz aocz aE1, , and oEz, oz = (v being positive), at least two of E$, E, and E,nmust also be negative. There are thus only two possibilities; eitherall Ex, Ey and Ez are negative, or one of them is positiveand the other twro negative. (i) V/hen E,,, E?,and Ez are all negative we have the case

mnust negative. Sincea, be

of" decreasing marginal utility." From the expressions above

elasticitiesof substitutionare positive, all the elasticities of complementarityare negative, and all the coefficientsof are income-variation positive. It follows that all the incomeof demand are positive. Further, from the results elasticities (i6), E_,,,(x), (y) and E,,,(z), i.e. the demandelasticitieswith E. respectto the price of the good concerned,are also all positive. The three goods compete with each other in pairs and there is no possibility of " exceptional" behaviourof any kind. (2) When E$ is positive and Ey and E,z are negative we have the case where one good has " increasing marginal utility." Since a must be positive there is one restrictionin this case:
lJL lthe
K/c
KgC Kz

+ E E,, >-E, The elasticity of complementarityof the pair YZ is now positive, and the other two elasticities are negative. Of the income-elasticitiesof demand only E,,(x) is positive and the other two are negative. In this case both Y and Z are inferior to X, and they complement each other while competing separately with X. The p,,-elasticities of demand are all definite in sign from (i 6), E1,,,(x) being positive and the other two negative. A fall in the price of the superior good X increasesthe demandfor the good at the expense of a decrease in the demandfor each of the inferiorgoods. The other priceelasticities can be of either sign and, in particular, rising demand curvesfor Y and Z are possible.

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2I7

The independent goods case includes a case of perfectly " normal" relationship between X, Y and Z. But it also includesa case where a pairof goods is inferiorto, and complement each other against, the third good. It is, therefore,not sufficientto take the goods as an independentset if it is desired to give a simple analyticaltreatment(as a first approximation) of the case of three goods " normally" related. One additional conditionis necessaryfor this, the conditionthat the elasticities of the marginalrates of substitutionare all negative.' To returnto the case of two goods for a moment, the only definitionof two independent goods that can be given is that the marginalrate of substitutiondivides into two functionsof a
= singlevariable:RY-

(y)

Thereareagaintwo possibilities.

are and El,(%b) both negative, in which case the EitherE,(Ok,) income-elasticitiesof demand are both positive. Or E,(q,) and E,f%) are of opposite signs, in which case the incomeelasticitiesof demandare also of opposite signs. But these two possibilities cover all the cases that can arise when there are only two goods. The case of two independent goods is thus no more restricted(in general terms) than the complete case, and any relationshipbetween two goods can be represented, for at least approximately small variations,by the independent relationship. The two-goods case can be treatedperfectlywell by assuming independencefrom the beainning.2 This is not
1 Only one condition is required here since two of the three elasticities are negative in any case. 2 See HicKs, ECONOMICA, February I934, pp. 75-6. In the case of two independent and E,(qI,). The former is goods X and Y, the two fundamental elasticities are E$(OX) the elasticity (X variable) of the marginal rate of substitution of Y for X, or (broadly) the elasticity of the marginal utility of X. The other elasticity is similarly interpreted. All demand elasticities are expressed in terms of E, and E11; in particular E$, -a E15(x) -a E,, and E1jy) =y

? _r Ky , the elasticity of substitution between X and Y. + Ex Ely These remarks throw some light upon the meaning of Professor Frisch's " money Professor Frisch, in flexibility" (New Methods of Measuring Marginal Utility, I932). effect, takes X as one particular commodity (say sugar) and Y as the group of all other commodities. Then El, is the elasticity of the marginal rate of substitution of sugar for all other commodities when the expenditure on the latter varies. This is the elasticity of the marginal utility of all other commodities, i.e. of money income. Hence, Professor Frisch's money flexibility is E, It follows, for example, that income-elasticity of demand for sugar is the product of the elasticity of substitution between sugar and all other commodities and the numerical value of money flexibility. The question arises is whether the value of EW, independent of the choice of X. If this is the case, as Professor
where a = -

E ,E

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true in the case of more than two goods, and here the case of independenceis definitelymore restrictedthan the generalcase (even if integrabilityis assumed),and must be treatedas such. 4. Notes on the " degreesoffreedom" of the system.-Three cases of the relationshipbetween three or more goods have been considered: (a) The general case. (b) The case where the integrabilitycondition is satisfied and a utility function index exists. (c) The case of independentgoods. It is proposedto add a number of concluding remarkson the way in which the number of " degrees of freedom" of the system is decreasedas we proceedfrom the generalto the more particularcases. The meaning of the term " degrees of freedom " will be apparentfrom the nature of these remarks. (a) In the general case it is found that three relations(I 7) exist between the elasticities of substitution and of complementarity and one relation (I4) between the coefficients of income-variation. The restrictions (g) are only inequalities and do not affect the independenceof the indices. There are indices of the individual's complexof thus eigh7t independent and these can be taken as the six elasticities of preferences complementarity and two of the coefficients of incomevariation.

The variationof individualdemand for changes in income or in the marketpricesis describedby twelve incomeand priceelasticities of demand. By the relations (I 4) and (I 7) one income-elasticity and three price-elasticities depend on the others. There arethus eight independentelasticitiesof demand and the eight independent indices account for these. The general case, therefore,has eight degrees of freedom. (b) The integrability case introduces symmetry into the are system. The six elasticitiesof complementarity reduced to indicesof the three, and there are now only five independent individual'scomplexof preferences.These can be taken, for and two example, as the three elasticitiesof complementarity coefficientsof income-variation. There is a reductionof three in the number of degrees of freedom in the system. On the demandside this must be paralleledby three relationsbetween the eight independentelasticitiesof demand. These relations
Frisch claims, the income-elasticity of demand for any commodity is a constant multiple of the elasticity of substitution between this and all other commodities.

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are providedby the symmetryof the system and are, from the equations(i 6),

I E.(y)

E,(x)-

E,(y)

Es,(x)

and two similarrelations. As we found, these relationsprovide a means of comparingE,(y) and E,,(x), and so on. The fact that there are five degrees of freedomin the system is also shown by the number of second-orderderivativesof /(x,y,z). There are six of these derivatives and one is not independentsince the integrabilityconditionmust be satisfied. The remaining five are independentand describe the system. (c) The furtherparticularcase of a set of three independent goods introducestwo furtherrestrictions. From the equations of (i 9), it follows that the two independentcoefficients incomevariationare expressiblein terms a.,, a,, and u,Z, and are no longer independent. There are now only three independent of indicesof the individual'scomplex preferences.These can be taken as ax.),Uz and aZI Alternatively,since all indices can be expressed in terms of the definite elasticities E4(Ox),E/b11) and Ez(cz), these can be taken to represent the three independent indices. There are thus three degrees of freedom in the system. On the demand side, in addition to the relations of the integrability case, there are two relations connecting and the income-elasticities the price-elasticities. Hence, of the elasticities of demand, only three are independent (e.g. the and these are accounted for by the three pM-elasticities), independentindices. This is checked by the fact that there are only three non-zero second-orderderivatives of the function
O(X,Y,Z)=

Finally, the independent goods case with one additional conditioncan be used to describea case of three goods related in a perfectly " normal" way. Since the additionalcondition takes the form of an inequalitythere is no furtherreductionin the number of degrees of freedom. The case of independent goods " normally" related is still described by three independent indices and still displays three degrees of freedom.

(X) + IP,(y) + PZ (Z).