Transcript Introduction to Production and Resource Use

Consumer
Equilibrium
and Market
Demand
Chapter 4
Discussion Topics
Conditions for consumer equilibrium
Changes in equilibrium
The law of demand
Tastes and preferences
Consumer surplus
2
Measurement and
Interpretation of
Consumer Equilibrium
3
Consumer Equilibrium
Remember that utility represents the level
of satisfaction with alternative bundles or
collection of goods
Assume the consumer wants to maximize
utility given his/her limited budget
Utility only impacted by the level of
consumption of market goods
How can we represent this problem
graphically and mathematically?
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Consumer Equilibrium
Point A is consumer equilibrium
Good 2
U4
U2
G2
*
A
→ Slope of Indifference Curve
= Slope of Budget Line
→MRS12= – P1/P2
→ At A, MU1/MU2 = P1/P2
→ At A, on the boundary of the budget
set and on highest indifference curve
Budget Constraint ($C*)
U3
U1 < U2 < U3 < U4
U1
G1*
Good 1
Previously: Slope of Indifference Curve =MRS
Slope of budget line = price ratio
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Consumer Equilibrium
 Point A can be interpreted as
Good 2
the combination of goods that
generates
 The maximum utility (U3)
 While being limited by a
fixed budget ($C*)
U4
U2
G2
*
A
U3
U1
G1*
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Good 1
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Consumer Equilibrium
 Point A can also be interpreted
Good 2
C3*
C1*< C2*< C3* as the combination of goods
C2*
C1 *
G2
*
A
that generates
 The minimum cost ($C*)
 While generating a desired
level of utility (U3)
U3
G1
*
Good 1
Why are these parallel shifts
of the budget constraint?
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Consumer Equilibrium
We can rearrange the above equilibrium
conditions:
MU1
P1
MU1 P1
MU1 MU 2
 




MU 2
P2
MU 2 P2
P1
P2
 → the marginal utility derived from last
dollar spent on each good, MUi/Pi, is identical
 This can be expanded to include all goods and
services purchased by the consumer
Lets extend this to the textbook example of
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tacos vs. hamburger consumption
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 Utility is maximized by
Consumer Equilibrium
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buying
 5 tacos @ $0.50
 2 hamburgers @
$1.25
 Total expenditures
equals the weekly
budget of $5.00
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Consumer Equilibrium
 Points B and D exceed
the $5 budget
 How can you tell?
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Consumer Equilibrium
Point C does not
maximize utility
How can you
tell?
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Consumer Equilibrium
 What happens to the above consumer
equilibrium when the price of one of
the products changes?
 Will the consumption of both
commodities change even though only
1 price impacted?
 Lets assume the price of Hamburgers
(PH) changes
 $5.00
 $1.25 (Current Price)
 $1.00
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Effect of Price Changes
Budget Line ED:
 Price of Hamburgers (PH) = $1.25
 Price of Tacos (PT) = $0.50
 Income = $5.00
 Equilibrium:
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Taco Consumption per Week
10 E
9
8
7
6
 5 Tacos
 2 Hamburgers
A
5
4
3
2
1
D
1
13
2
3
4
5
6
Hamburger Consumption per Week
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Effect of Price Changes
Budget Line EF:
 Price of Hamburgers (PH) = $1.00
 Price of Tacos (PT) = $0.50
 Income = $5.00 10
 Equilibrium:
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Taco Consumption per Week
10
E
9
8
 4 Tacos
 3 Hamburgers
7
6
A
5
B
4
3
2
1
F
D
1
14
2
3
4
5
Hamburger Consumption per Week
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Effect of Price Changes
Budget Line EG:
 Price of Hamburgers (PH) = $5.00
 Price of Tacos (PT) = $0.50
 Income = $5.00
 Equilibrium:
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Taco Consumption per Week
10
E
9
 5 Tacos
 0.5 Hamburger
8
7
6
5
A
C
B
4
3
2
1
D
1
15
2
3
4
F
6
Hamburger Consumption per Week
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Effect of Price Changes
Line CAB represents a consumer
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Taco Consumption per Week
10
E
demand schedule for hamburgers
Shows how the consumer responds to
changes in a good’s price
↑ in price, ↓ in quantity demanded
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8
7
6
C
A
5
4
B
3
2
1
D
1
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2
3
4
F
6
Hamburger Consumption per Week
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Effect of Price Changes
 Lets collect the equilibrium points for the three
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hamburger price scenarios
Equilibrium
PH
QH
Point
($/lb) (No.)
C
$5.00
0.5
A
$1.25
2.0
B
$1.00
3.0
 We can then graph the quantity purchased at each
price level
 Vertical axis is price
 Horizontal axis is quantity
 Referred to as the demand curve for
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hamburgers
Consumer Equilibrium
This graph shows the demand curve
for hamburgers
PH($/Burger)
$5.00 ̶
C
What is the relationship between
price and quantity demanded?
A
$1.25 ̶
$1.00 ̶
B
̶
̶
̶
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0.5
2.0
3.0
QH(Burgers)
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Effect of an Income Change
Budget Line KJ:
 Price of Hamburgers (PH) = $1.25
 Price of Tacos (PT) = $0.50
 Income = $5.00
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Taco Consumption per Week
10 K
9
8
Original Equilibrium
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6
A
5
4
3
2
1
J
1
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2
3
4
5
6
Hamburger Consumption per Week
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Effect of an Income Change
Taco Consumption per Week
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12
11
G
10
K
Budget Line KJ: Income = $5.00
BudgetLline GF: Income = $6.00
Both hamburgers and tacos
New
Equilibrium
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8
7
6
are normal goods as budget
increased from $5 to $6/week
Normal goods are goods
whose demand increases
with higher budget (income)
and decreases with lower
budget (income)
B
5
A
4
3
2
Original
Equilibrium
1
F
J
1
20
2
3
4
5
6
Hamburger Consumption per Week
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Effect of an Income Change
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Budget Line KJ: Income = $5.00
Budget Line GF: Income = $6.00
Budget Line ED: Income = $8.00
E
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14
Taco Consumption per Week
13
12
11
G
10
K
Tacos become an inferior good
when budget (income) increased
to $8/week
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 Inferior goods are goods whose
demand ↓ with ↑ in the budget and ↑
with ↓ in the budget
8
7
6
B
A
5
C
4
3
2
1
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1
2
3
4
D
F
J
5
6
Effect of an Income Change
 We can plot demand
Taco Consumption per Week
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12
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G
10
K
levels under alternative
budgets (income)
 Referred to as an Engel
Curve
9
8
7
6
B
A
5
C
4
3
2
1
22
1
2
3
4
D
F
J
5
6
Equilibrium Impacts of Income Changes
Hamburger Engel Curve
Typical shape of a normal
good’s Engel curve over all
income levels
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Tacos Engel Curve
Example of an Engel curve for
a good that is an inferior good
at higher income (budget) levels Page 58
Measurement and
Interpretation of
Market Demand
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Concept of Market Demand
The above model of consumer
behavior has focused on a single
individual
We can extend the above model to one
where we refer to overall or total
market demand for a city, county,
state, country, etc. as a whole
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Concept of Market Demand
Notice the
kink
 The market demand curve for a good is the horizontal summation of
demand schedules for all the consumers in the particular market
 In the above example with PH = $1.50
 Paula purchases 2 hamburgers/week while
 Beth purchases 1 hamburger
 → market demand = 3 hamburgers @ a price $1.50/hamburger
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Demand Curve Description
When discussing events in the market place
economists use specific terms to distinguish
between movement along a demand curve vs.
a shift in a demand curve
Movement along a demand curve referred to
as a change in quantity demanded
Only 1 demand curve, just a different point on it
Alternatively a shift in the demand curve
referred to as a change in demand
Need not be a parralel shift in the demand curve
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Movement from point
A to C is referred to as
a change in demand
Movement from
point A to B is
called a change in
quantity demanded
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Demand Curve Description
 Reasons for a change in a demand curve
 Change in household income
 Change in population characteristics
 Number of children
 Change in marital status
 Household composition
 Price of substitutes
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Concept of Consumer Surplus
A characteristic of market demand
curve
 Concept of consumer surplus (CS) or
economic well-being
 CS is derived from consumption and the
fact we have a negatively slope demand
curve
A demand curve reveals the willingness
of consumers to pay a certain price for
a particular quantity of a good
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Page 63-64
Concept of Consumer Surplus
As we showed earlier, consumers are
willing to pay a higher price for a lesser
$
quantity
P2
P2 > P1
Q2 < Q1
B
A
P1
Q2
Q1
Q
 Actually do not have to pay the higher price
given the level of supply coming into the
market
 → Consumers realize a savings
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Page 63-64
Quantifying Consumer Surplus
$
Area ABC is the consumer surplus
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when price is $6.
B
10
 Demand curve implies consumers are
willing to pay $10 for the 1st unit, $9 for
the 2nd unit, etc.
 Only had to pay $6 each for all 5 units
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8
7
6
A
5
C
D
4
 Area DACE is the gain
E
in consumer surplus if
the price falls to $5
3
2
1
0
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Q
1
2
3
4
5
6
7 8
9 10 11
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Quantifying Consumer Surplus
$
The level of consumer
surplus is [(H × L)/2], or
(($11-$6)×5)/2=$12.50
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B
10
9
8
7
6
A
5
C
D
4
E
3
2
1
0
33
1 2
Q
3
4
5
6
7
8
9 10 11
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In Summary
Consumer equilibrium for an
individual for a given price and budget
Individual consumer’s demand
schedule
Market demand curve
Engel curves
Change in demand vs. change in
quantity demanded
Consumer surplus
Chapter 5 examines the
concept of an elasticity, one of
the most important concepts in
all of economics….