Transcript INDIVIDUAL AND MARKET DEMAND

3
Consumer Choice:
Individual and Market
Demand
Outline
● Scarcity and Demand
● Utility: A Tool to Analyze Purchase Decisions
● Consumer Choice as a Trade-off: Opportunity
Cost
● From Individual Demand Curves to Market
Demand Curves
● Exceptions to the Law of Demand
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Scarcity and Demand
● Income is limited → consumers face constraints
on their choices
● Wealthy and poor individuals have limited
incomes relative to their desires.
● Every decision has an opportunity cost.
♦ ↑purchases of clothing → ↓purchases of restaurant
meals
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Utility: A Tool to Analyze
Purchase Decisions
● How do consumers make choices?
♦ Theory of consumer choice = each consumer spends
his or her income in a way that yields the greatest
satisfaction or utility.
♦ Cannot measure utility (or satisfaction) directly.
How should we measure your utility of a movie theater
ticket?
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Total vs. marginal utility
● Total utility = largest sum of money that a consumer will
voluntarily give up for a good
♦ E.g., I will buy 7 pints of Chunky Monkey only if it costs
$21.50 or less. So the TU (or benefit) that I receive from 7
pints is $21.50.
● Marginal utility = addition to TU that an individual
receives by consuming 1 more unit of the good
♦ E.g., if I consumed 6 pints of Chunky Monkey, MU measures
how much add. satisfaction I get by consuming 7 pints instead.
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TABLE 1. Leah’s Total and Marginal
Utility from Chunky Monkey
Quantity
(per month)
Total Utility
(dollars)
Marginal Utility
(dollars)
Label for
graph
0
0.00
------
------
1
6.00
6.00
A
2
11.00
5.00
B
3
15.00
4.00
C
4
18.00
3.00
D
5
20.00
2.00
E
6
21.00
1.00
F
7
21.50
0.50
G
8
21.50
0.00
H
Total vs. marginal utility
● TU: 1 pint is worth no more than $6.00 to me and 2 pints
are worth no more than $11.00 to me, etc.
● MU: 1st pint is worth $6 to me and 2nd pint is worth
$5.00 to me, while the 3rd is worth $4.00, etc.
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1. Leah’s Marginal Utility
Curve for Chunky Monkey
Marginal Utility (Price) per pint
FIGURE
$7
6
5
4
$3
2
1
0
A
B
C
D
Price
E
F
G
H
1 2 3 4 5 6 7 8
Number of pints per Month
“Law” of Diminishing MU
● Law of diminishing MU = the more of a good a
consumer has, the less MU an additional unit contributes
to overall satisfaction.
● Additional units of a good are worth less and less to a
consumer in money terms.
♦ E.g., each add. pint is worth less to me. 1st pint eat by myself;
2nd share with my husband; 3rd share with my friend; 4th share
with my dog, Dante; 5th share with my mother-in-law. Thus,
each successive pint has a lower priority.
Can you think of any exceptions to the law of diminishing
marginal utility?
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Total vs. marginal utility
● Graph of MU has (-) slope → ↓MU as ↑Qd.
● ↑TU as long as MU is (+).
♦ E.g., when a commodity is very scarce (diamonds),
economists expect it to have high MU even though it
provides very little TU.
Can you think of a good that has a very low MU but
a very high TU?
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Using MU: The Optimal
Purchase Rule
How many pints of Chunky Monkey should I purchase?
● Goal: max. total benefit from pints while min. their cost.
As long as MU is (+), ↑TU by consuming more pints.
But each add. pint costs money.
● Net TU = TU – total expenditure; where TE = P*Qd.
● Max. net TU by watching net MU; net MU = MU – P.
♦ E.g., If P = $3.00/pint and I buy 3 pints, then net MU = $1.00;
so I can ↑net TU by purchasing more.
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
Using MU: The Optimal
Purchase Rule
● Two rules govern the optimal purchase rule:
1. if net MU is (+) (or MU > P) → consumer buys too
little of the good to max. net TU
2. if net MU is (-) (or MU < P) → consumer buys too
much of the good to max. net TU
● Combining these 2 rules → net TU is maximized when
net MU = 0 (or MU = P).
MU = P is the optimal purchase rule
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From MU to Demand Curves
● Demand curve = MU curve
♦ Law of diminishing MU  (-) slope of D curves
♦ P  Qd  MU
■ E.g., P = $3 → Qd = 4 pints. But if the ↑P to $5 → Qd = 2
pints. If ↓P to $2 → Qd = 5 pints. As ↑P, use the good for
higher valued uses –to share with my friend or husband. As
↓P, use the good for lower valued uses –to share with my
dog or mother-in-law.
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
Consumer Choice as a TradeOff: Opportunity Cost
● Recall the importance of opportunity cost
● Decision to purchase something  decision to forgo
something else
♦ Real cost of 4 pints purchased for $3.00 each is not the $12
given up. It is the 4 movie rentals that are given up. I have
given up $12 worth of other goods to buy 4 pints of Chunky
Monkey.
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
Consumer Surplus
● CS = net TU = TU - TE
● Economists assume that firms max profit and
consumers max CS.
● Consumer must experience some gain from a
voluntary transaction; otherwise the consumer
would refuse to purchase the good.
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TABLE
2. Calculating CS
Quantity
(pints per mo.)
Marginal Utility
Price
Net MU
(per unit surplus)
1
$ 6.00
$ 3.00
$ 3.00
2
5.00
3.00
2.00
3
4.00
3.00
1.00
4
3.00
3.00
0.00
5
2.00
3.00
-1.00
Two ways of calculating CS:
(1) CS = TU – TE or (2) CS = ∑(MU – P)
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Marginal Utility and Price per pint
FIGURE
2. Graph of CS
MU
7
6
$6
A
$5
5
MU (or D) curve
CS per unit
B
$3
$4
$2
4
C
$1
$3
3
D
P
$2
$0
2
E
0
F
$.50
$1
1
1
2
3
4
5
6
G
$0
7
H
8
Number of pints purchased
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Graph of Consumer Surplus
● CS = area under D curve and above P.
♦ Leah was willing to pay $18 for the 4 pints (i.e., the
TU of 4 pints), but only paid $12 (i.e., $3*4) so her
total CS = $6.
● TU = area under entire D curve
● TE = rectangular area that reflects P*Qd
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From Individual to Market D
Curves
● Market D curve = horizontal sum of individual
D curves
● Steps to move from individual D to market D:
1. Pick any relevant P.
2. Find Qd at that P for each person.
3. Add the Qd at that P to get Qd in the market.
Repeat these steps for all possible prices.
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3. Total Market D vs.
Individual Consumer D
FIGURE
$7
$3
Joe’s
demand
L
L
M
Market demand
Price
Z
Price
Price
D
Leah’s
demand
J
J
K
M
M
4
D
0
4
Quantity Demanded
(a)
3
Z
0 1
3
Quantity Demanded
(b)
M
0 1
7
Quantity Demanded
(c)
From Individual to Market D
Curves
● The “Law” of Demand
♦ (-) slope for market D curves
■ Individual D curves have (-) slopes because of the law of
diminishing MU
■ Lower P draws new customers into the market
● E.g., Fig. 3, only Joe will buy Chunky Monkey at P =
$7. Yet, at P < $7, Leah will also purchase ice cream.
As ↓P, Joe will buy more and Leah will enter the
market, insuring that ↑Qd as ↓P.
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From Individual to Market D
Curves
● Exceptions to the “Law” of Demand
♦ Goods whose quality is judged by price –if a ↓P
signals poor quality → ↓Qd
■ E.g., Bayer aspirin vs. generic brand aspirin
♦ Goods with snob appeal –some people buy expensive
goods to advertise their wealth
■ E.g., Rolls Royce
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