Embed Size (px)
Citation preview
Demand Analysis
Some Questions
• What is behind a consumer’s demand curve?
• How do consumers choose from among various consumer “goods”?
• What determines the value of a consumer good?
What is Consumer Theory?
• Study of how people use their limited means to make purposeful choices.
• Assumes that consumers understand their choices (possibilities) and the prices (opportunity costs) associated with each choice.
• Assumes that consumers consider the alternatives and choose the one they like best.
Consumer Theory - Why?
• Two important reasons:– to understand the foundations of market
demand (bake the demand curve from scratch)
– to address several interesting consumer theory issues that are best understood using this model rather than the aggregate demand model
Two Components of Consumer Demand
• Opportunities:– What can the consumer afford?– What are the consumption possibilities?– Summarized by the budget constraint
• Preferences:– What does the consumer like?– How much does a consumer like a good?– Summarized by the utility function
Utility • The value a consumer places on a unit of a good or
service depends on the pleasure or satisfaction he or she expects to derive form having or consuming it at the point of making a consumption (consumer) choice.
• In economics the satisfaction or pleasure consumers derive from the consumption of consumer goods is called “utility”.
• Consumers, however, cannot have every thing they wish to have. Consumers’ choices are constrained by their incomes.
• Within the limits of their incomes, consumers make their consumption choices by evaluating and comparing consumer goods with regard to their “utilities.”
Our basic assumptions about a “rational” consumer:
• Consumers are utility maximizers• Consumers prefer more of a good (thing) to less of it. • Facing choices X and Y, a consumer would either prefer
X to Y or Y to X, or would be indifferent between them. • Transitivity: If a consumer prefers X to Y and Y to Z, we
conclude he/she prefers X to Z• Diminishing marginal utility: As more and more of good
is consumed by a consumer, ceteris paribus, beyond a certain point the utility of each additional unit starts to fall.
How to Measure Utility
Measuring utility in “utils” (Cardinal): • Jack derives 10 utils from having one slice of pizza but only 5 utils from
having a burger.
• In many introductory microeconomics textbooks this approach to measuring utility is still considered effective for teaching purposes.
Measuring utility by comparison (Ordinal): • Jill prefers a burger to a slice of pizza and a slice of pizza to a hotdog. Often consumers are able to be more precise in expressing their preferences.For example, we could say: • Jill is willing to trade a burger for four hotdogs but she will give up only
two hotdogs for a slice of pizza. • We can infer that to Jill, a burger has twice as much utility as a slice of
pizza, and a slice of pizza has twice as much utility as a hotdog.
Utility and Money • Because we use money (rather than hotdogs!) in just about
all of our trade transactions, we might as well use it as our comparative measure of utility.
(Note: This way of measuring utility is not much different
from measuring utility in utils) • Jill could say: I am willing to pay $4 for a burger, $2 for a
slice of pizza and $1 for a hotdog.
Note: Even though Jill obviously values a burger more (four
times as much) than a hot dog, she may still choose to buy a
hotdog, even if she has enough money to buy a burger, or a
slice of pizza, for that matter. (We will see why and how shortly.)
Total Utility versus Marginal Utility • Marginal utility is the utility a consumer
derives from the last unit of a consumer good she or he consumes (during a given consumption period), ceteris paribus.
• Total utility is the total utility a consumer derives from the consumption of all of the units of a good or a combination of goods over a given consumption period, ceteris paribus.
Total utility = Sum of marginal utilities
The Law of Diminishing Marginal Utility
• Over a given consumption period, the more of a good a consumer has, or has consumed, the less marginal utility an additional unit contributes to his or her overall satisfaction (total utility).
• Alternatively, we could say: over a given consumption period, as more and more of a good is consumed by a consumer, beyond a certain point, the marginal utility of additional units begins to fall.
Total and Marginal Utility for Ice Cream
Q ($) TU ($) MU0 01 40 402 85 453 120 354 140 205 150 106 157 77 160 38 160 09 155 -510 145 -10
145
Total Utility
0
50
100
150
200
1 2 3 4 5 6 7 8 9 10 11
($) MU
-20
-10
0
10
20
30
40
50
1 2 3 4 5 6 7 8 9 1 11
Q ($) TU ($) MU0 01 40 402 85 453 120 354 140 205 150 106 157 77 160 38 160 09 155 -510 145 -10
145
How much ice cream does Jill buy in a month?
Some facts of life: • Limited income• Opportunity cost of making a choice:
Buying ice cream leaves Jill less money to buy other things: each dollar spent on ice
cream could be spent on hamburger. • In fact, consumers compare the (expected)
utility derived from one additional dollar spent on one good to the utility derived from one additional dollar spent on another good.
What is a Budget Constraint?
• A budget constraint shows the consumer’s purchase opportunities as every combination of two goods that can be bought at given prices using a given amount of income.
• The budget constraint measures the combinations of purchases that a person can afford to make with a given amount of monetary income.
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
(Attainable)Q
ua
nti
ty o
f A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
(Unattainable)
THE BUDGET LINE:What is Attainable
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
(Attainable)Q
ua
nti
ty o
f A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
(Unattainable)An Increase in income
makes the purchase of
more of either or both
items possible
THE BUDGET LINE:What is Attainable
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12
(Attainable)Q
ua
nti
ty o
f A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
(Unattainable)
Price changes causea change in the quantitydemanded of the items
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2
j
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4
j
k
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6
j
k
l
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
j
k
lm
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
j
k
lm
I
INDIFFERENCE CURVESWhat is Preferred
I2
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
j
k
lm
The sloperepresents
the marginalrate of substi-tution, (MRS)
I1
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
I1
If the consumer
had greater income,
more of either or
both products could
be purchased
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
I1
A higher
combination
of choices will
be preferred
I2
I3
I4
INDIFFERENCE CURVESWhat is Preferred
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
I1
I2
I3
I4
A family of all
such expressions of
indifference can be
developed for every
level of income
AnIndifference
Map
INDIFFERENCE CURVESWhat is Preferred
EQUILIBRIUM AT TANGENCY
I1
I2
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
I3
I4
(Attainable)
(Unattainable)
Units ofA Price$1.50
Units ofB Price$1.00
TotalExpenditures
8 0 $126 3 124 6 122 9 120 12 12An Indifference
ScheduleCombi-nation
Unitsof A
Unitsof B
j 12 2k 6 4l 4 6m 3 8
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
(Attainable)
(Unattainable)
Equilibriumoccurs whenthe consumer
selects thecombination
which reachesthe highestattainable
indifferencecurve. I1
I2
I3
I4
EQUILIBRIUM AT TANGENCY
What happens if the price of Bincreases to $1.50?
PriceB QuantityB
$1.00 6
I3
The budget linerotates reflectingthe reduction inthe quantity of B
units which isattainable.
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
EQUILIBRIUM AT TANGENCY
What happens if the price of Bincreases to $1.50?
PriceB QuantityB
$1.00 1.50
63
By recording thevarious quantitiesdemanded at thevarious prices yieldsthe Demand schedule
I2
I3
The budget linerotates reflectingthe reduction inthe quantity of B
units which isattainable.
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
EQUILIBRIUM AT TANGENCY
What happens if the price of Bincreases to $1.50?
PriceB QuantityB
$1.00 1.50
63
By recording thevarious quantitiesdemanded at thevarious prices yieldsthe Demand schedule
I2
I3
The budget linerotates reflectingthe reduction inthe quantity of B
units which isattainable.
Qu
an
tity
of
A
Quantity of B
12
10
8
6
4
2
02 4 6 8 10 12
EQUILIBRIUM AT TANGENCY
What happens if the price of Bincreases to $1.50?
PriceB QuantityB
$1.00 1.50
63
By recording thevarious quantitiesdemanded at thevarious prices yieldsthe demand schedule.
DERIVING THE DEMAND CURVE
Price of B
Quantity of B
$1.50
1.00
0
2 4 6 8 10 12
DB
Plotting the Points yields the Demand Curve for Product B
