demand curve in economics
TRANSCRIPT
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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
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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
05 03T
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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
Expenditures:Price of
Grapes = $2Price of
Bananas = $1
Poundsof
Grapes
05 05T
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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
Expenditures:Price of
Grapes = $1Price of
Bananas = $1
Poundsof
Bananas
Expenditures:Price of
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
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Market Demand Curve
Consider all consumers in the market
Add up quantity demanded by all
individuals at each price to get marketdemand
Add horizontally
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