demand curve in economics

8/10/2019 demand curve in economics

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Preview of 4 Coming Attractions

Today: Derivation of the Demand Curve

Consumers (Buyers)

Next: Derivation of the Supply Curve

Firms (Sellers)

Later: Double Auction Market

Buyersand and sellerscome together

Still later: Competitive Equilibrium Model


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05_01PRICE

QUANTITY DEMANDED

Demand curve


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Why study the derivation of the

demand curve? Helps explain why a competitive market

works well.

Helps determine the position of the demand

curve and the sensitivity of quantity

demanded to price.


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A brief digression on elasticity

Elasticity is a measure of how sensitive one

variable (e.g. quantity demanded) is to

another variable (e.g. price).

Definition: the price elasticity of demandis

the percentage change in quantity demanded

divided by the percentage change in price

e= (%Q)/(%P)


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Where we are going

Start with anindividualconsumer

maybe you, maybe me, but could be anyone

Derive demand curve for that individual

focus on marginal utility or marginal benefit

Add up demand curves for manysuch

individuals to get marketdemand curve


7/19

Assumption about consumer

behavior General economic

principle

People make purposeful

choices

with limited resources

When applied to the

behavior of consumers

People maximize utility

subject to a budget

constraint


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Utility: a numerical indicator of

preferences Marginal Utility

Diminishing Marginal Utility

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05_03T Quantity Utility

Pounds Pounds From of of Grapes and From From Grapes Bananas Bananas Grapes Bananas

1 1 16 6 102 1 20 10 10

3 1 23 13 104 1 25 15 105 1 26 16 10

1 2 24 6 182 2 28 10 183 2 31 13 184 2 33 15 185 2 34 16 18

1 3 28 6 222 3 32 10 223 3 35 13 224 3 37 15 225 3 38 16 22

1 4 30 6 24

2 4 34 10 243 4 37 13 244 4 39 15 245 4 40 16 24

1 5 31 6 252 5 35 10 253 5 38 13 254 5 40 15 25

5 5 41 16 25

The consumer prefersthis combination

to this combinationbecause the utility ishigher for the former.

The consumer isindifferent betweenthese combinations

because utility isequal.

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Note:The red numbers are outside the budget constraint (the sum is greater than $8). The black numbers arewithin the budget constraint (the sum is less than or equal to $8).

Expenditures:Price of

Grapes = $1Price of

Bananas = $1

1 1 2 32 1 3 53 1 4 74 1 55 1 6

1 2 3 42 2 4 63 2 5 84 2 6

5 2 7

1 3 4 52 3 5 73 3 64 3 75 3 8

1 4 5 62 4 6 8

3 4 74 4 85 4

1 5 6 72 5 73 5 84 55 5

911

10

12

91113

1012

9 14

911

9 1310 15

Poundsof

Bananas


Grapes = $2Price of

Bananas = $1

Poundsof

Grapes

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05_05T

1 1 16 2 3

2 1 20 3 53 1 23 4 7

4 1 25 5 9

5 1 26 6 11

1 2 24 3 4

2 2 28 4 6

3 2 31 5 8

4 2 33 6 10

5 2 34 7 121 3 28 4 5

2 3 32 5 7

3 3 35 6 9

4 3 37 7 11

5 3 38 8 13

1 4 30 5 6

2 4 34 6 8

3 4 37 7 104 4 39 8 12

5 4 40 9 14

1 5 31 6 7

2 5 35 7 9

3 5 38 8 11

4 5 40 9 13

5 5 41 10 15


Grapes = $1Price of

Bananas = $1

Poundsof

Bananas


Grapes = $2Price of

Bananas = $1

Poundsof

Grapes

Utilityfrom

Grapesand

Bananas

A maximum utilityof 39 can beobtained with an$8 budget atthese prices.

A maximum utilityof 34 can beobtained with an

$8 budget atthese prices.


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Marginal conditions for utility

maximization Ratio of marginal utilities equals ratio of

prices for any two goods

(MUG/MUB) = (PG/PB)

Explanation of Diamond Water Paradox

First pointed out by Adam Smith


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The willingness to pay

approachAmountof X

Willingnessto pay

MarginalBeneift

0 $0 ---1 $4 $4

2 $7 $3

3 $9 $2

4 $10 $1

05 05


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05_05

1 2 3 4 5

1

2

3

4

5

0

QUANTITY DEMANDED (POUNDS)

DOLLARS


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An Important Conclusion:

MB = P The consumer chooses an amount such that

the marginal benef i t (MB) equals pr ice (P)

When I see a demand curve, I think of themarginal benefit to consumers

WGAD: Why do economists put the

quantity on the horizontal axis?


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Consumer Surplus

Willingness to pay is usually greater than

the price

for example my willingness to pay for a pair ofeyeglasses is much more than the price

Consumer surplus is the area under the

demand curve and above the price


18/19

Market Demand Curve

Consider all consumers in the market

Add up quantity demanded by all

individuals at each price to get marketdemand

Add horizontally


19/19

demand curve in economics

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