Transcript From Individual Demand to Consumer Surplus

From Individual Demand to
Consumer Surplus
Today: Deriving market demand from
individual demand; using reservation
prices to derive consumer surplus
Previously…
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7 core principles
Thinking like economists
Introduction to supply and demand
Equilibrium
A route choice experiment and its
equilibrium
Deriving individual demand
Today
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Using individual demands to derive
market demand
Reservation price
Consumer surplus
Recall individual demand
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Last time, we went through the
assumptions that gave us a downwardsloping individual demand curve
We will use “horizontal addition” to
derive market demand from all
individual demands
Example: Individual demand
to market demand
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Suppose Pat and
Shannon have the
following demand
schedules for
apples
Price
Shannon’s
quantity
demanded
Pat’s
quantity
demanded
$6
0
0
$5
2
0
$4
4
0
$3
6
0
$2
8
3
$1
10
6
$0
12
9
Example: Individual demand
to market demand
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How do we
get the
market
demand from
individual
demands?
We add them
up
Price Shannon’s
Pat’s
Total
quantity
quantity demand
demanded demanded
$6
0
0
0
$5
2
0
2
$4
4
0
4
$3
6
0
6
$2
8
3
11
$1
10
6
16
$0
12
9
21
Some graphing reminders
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Some reminders of
graphs
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Label axes
Label dollar
amounts,
quantities, etc.
To save space, all
quantity numbers
here are apples
Graphing demands:
Shannon (left) & Pat (right)
Total demand
How can we graph demand
with only the graphs?
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Another method of graphing total
demand from individual demand is a
method called horizontal addition
We horizontally add quantities
demanded from each person AT A
GIVEN PRICE
Price greater than $3
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When price is
greater than $3,
Shannon is the only
person demanding a
positive quantity
Thus, the top half of
Shannon’s demand
curve is the same as
the market’s
At $3, 6 + 0 units are
demanded
At $0, 12 + 9 units are
demanded
Bottom half of the demand
curve
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At $3, 6 units are
demanded
At $0, 21 units are
demanded
Bottom half of
demand curve
connects (6, $3) and
(21, $0)
Reservation price and
consumer surplus
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How “well off” are we when we buy
something?
Calculate consumer surplus by using
demand curve and reservation price
Reservation price
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Reservation price is the highest price a
person is willing to pay for a good or
service
Note that reservation price for the nth
unit corresponds to a particular point of
a demand curve
Let’s return to part of
Shannon’s demand
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Shannon’s
reservation price for
6th apple is $3
Price
Shannon’s quantity
demanded
$6
0
$5
2
$4
4
$3
6
Core principle: Efficiency
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Today, we calculate consumer surplus to
help on our quest to efficiency
Calculating consumer surplus
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Consumer surplus (CS) for the nth unit
is the vertical difference between the
demand curve and the price paid
We will calculate CS two ways
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Discretely
Approximate using area under demand
curve
Back to Shannon
Price
Shannon’s
quantity
demanded
Quantity
Reservation
price
1st unit
$5.50
$6
0
2nd unit
$5
$5
2
3rd unit
$4.50
4th unit
$4
5th unit
$3.50
6th unit
$3
$4
$3
4
6
If P = $3…
Quantity Reservation
price
1st unit
2nd
$5.50
CS
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$2.50
unit
$5.00
$2.00
3rd unit
$4.50
$1.50
4th unit
$4.00
$1.00
5th unit
$3.50
$0.50
6th unit
$3.00
$0.00
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At P = $3, Shannon
demands 6 apples
To calculate total
consumer surplus
for Shannon, we
simply add CS for
each unit purchased
CS for 6 units purchased
Quantity Reservation
price
CS
1st unit
$5.50
$2.50
2nd unit
$5.00
$2.00
3rd unit
$4.50
$1.50
4th unit
$4.00
$1.00
5th unit
$3.50
$0.50
6th unit
$3.00
$0.00
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CS is the sum of the
six dollar amounts in
the right column, or
$7.50
CS from demand curves
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CS can be
approximated by
calculating the area
under the demand
curve and above the
price
The area of this
triangle is a good
approximation of
CS
CS from demand curves
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Height of triangle is
($6 – $3), or $3.
Length of triangle is
(6 – 0), or 6
Area of triangle is
one-half times
length times height
CS = $9
The area of this
triangle is a good
approximation of
CS
This concludes demand
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What have we learned?
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How individual demand is derived
Utility
The rational spending rule
Deriving market demand from individual
demand
Consumer surplus