Consumer Equilibrium and Market Demand Chapter 4

Discussion Topics Conditions for consumer equilibrium Changes in equilibrium The law of demand Tastes and preferences Consumer surplus

Measurement and Interpretation of Consumer Equilibrium

Consumer Equilibrium Must find the point where where utility is maximized subject to the budget constraint. This occurs where: MU HAMBURGERS MU TACOS P HAMBURGERS P TACOS = Page 68

Consumer Equilibrium Must find the point where where utility is maximized subject to the budget constraint. This occurs where: MU HAMBURGERS MU TACOS P HAMBURGERS P TACOS = In other words, the marginal utility derived from the last dollar spent on each good is identical. This can be expanded to include all goods and services purchased by the consumer. Page 68

Page 67 Utility is maximized by buying 5 $0.50 and 2 $1.25 given a budget constraint of $5.00 per week…. Utility is maximized by buying 5 $0.50 and 2 $1.25 given a budget constraint of $5.00 per week…. Consumer Equilibrium

Page 67 Points B and D exceed the budget Points B and D exceed the budget Consumer Equilibrium

Page 67 Point C does not maximize utility… Point C does not maximize utility… Consumer Equilibrium

Page 68 Effects of Changes in Price of the Product Let’s look at the impact of three separate price levels ($5.00, $1.25 and $1.00) on this consumer’s weekly purchases of hamburgers Let’s look at the impact of three separate price levels ($5.00, $1.25 and $1.00) on this consumer’s weekly purchases of hamburgers

Page 68 Effects of Changes in Price of the Product A price decrease of hamburger prices to $1.00 would cause Carl to increase his weekly purchases Of hamburgers from 2 to 3. A price decrease of hamburger prices to $1.00 would cause Carl to increase his weekly purchases Of hamburgers from 2 to 3.

Page 68 Effects of Changes in Price of the Product If the price instead increases to $5.00, Carl would only want one-half a hamburger per week (would you believe 1 hamburger every other week?) If the price instead increases to $5.00, Carl would only want one-half a hamburger per week (would you believe 1 hamburger every other week?)

Page 68 Effects of Changes in Price of the Product Line CAB forms a consumer demand schedule, showing how the consumer would respond to changes in the price of hamburgers. Line CAB forms a consumer demand schedule, showing how the consumer would respond to changes in the price of hamburgers.

Original equilibrium Original equilibrium Page 71 Effects of Changes in Available Income

Original equilibrium Original equilibrium Both hamburgers and tacos are “normal” goods as income increased from $5 to $6 per week. Both hamburgers and tacos are “normal” goods as income increased from $5 to $6 per week. Page 71 Effects of Changes in Available Income

Original equilibrium Original equilibrium Page 71 Effects of Changes in Available Income But tacos became an “inferior” good however when income increased to $8 per week. As income increased, taco consumption fell …. But tacos became an “inferior” good however when income increased to $8 per week. As income increased, taco consumption fell ….

Engel curve for hamburgers Engel curve for tacos Normal good as the budget increases from $5 to $8 Normal good as the budget increases from $5 to $8 Inferior good as the budget increases from $6 to $8 Inferior good as the budget increases from $6 to $8 Page 72

Measurement and Interpretation of Market Demand

The market demand curve for a particular product can be seen as a horizontal summation of the demand schedules for all the consumers in the market. At a price of $1.50, Paula would buy 2 hamburgers per week while Beth would buy one. Therefore, the market demand is equal to 3 hamburgers! The market demand curve for a particular product can be seen as a horizontal summation of the demand schedules for all the consumers in the market. At a price of $1.50, Paula would buy 2 hamburgers per week while Beth would buy one. Therefore, the market demand is equal to 3 hamburgers! Page 73 + =

Some Important Jargon When discussing events in the market place, economists use specific terms to distinguish between movement along a demand curve and a shift in a demand curve.

Some Important Jargon When discussing events in the market place, economists use specific terms to distinguish between movement along a demand curve and a shift in a demand curve. A movement along a demand curve is referred to as a change in the quantity demanded.

Some Important Jargon When discussing events in the market place, economists use specific terms to distinguish between movement along a demand curve and a shift in a demand curve. A movement along a demand curve is referred to as a change in the quantity demanded. A shift in the demand curve, on the other hand, is referred to as a change in demand.

Movement from point A to C is called a change in demand… Movement from point A to C is called a change in demand… Page 75

Movement from point A to B is called a change in the quantity demanded… Movement from point A to B is called a change in the quantity demanded… Page 75

Concept of Consumer Surplus An important extension of the market demand curve is the concept of consumer surplus, or economic well being consumers derive in the market. The demand curve reveals the willingness of consumers to pay a certain price for a corresponding quantity. Page 77

Concept of Consumer Surplus An important extension of the market demand curve is the concept of consumer surplus, or economic well being consumers derive in the market. The demand curve reveals the willingness of consumers to pay a certain price for a corresponding quantity. They are willing to pay a higher price for a lesser quantity, but do not have to given the level of supply coming onto the market in a given period. Thus, they realize a “savings”. Page 77

Concept of Consumer Surplus An important extension of the market demand curve is the concept of consumer surplus, or economic well being consumers derive in the market. The demand curve reveals the willingness of consumers to pay a certain price for a corresponding quantity. They are willing to pay a higher price for a lesser quantity, but do not have to given the level of supply coming onto the market in a given period. Thus, they realize a “savings”. We will use this concept later in Chapter 8 when we discuss market equilibrium. Page 77

FG Area ABC is the consumer surplus if price is $6. The demand curve implies they were willing to pay $10 for the 1 st unit, $9 for the second unit, etc. But they only had to pay $6 each for all 5 units! Area ABC is the consumer surplus if price is $6. The demand curve implies they were willing to pay $10 for the 1 st unit, $9 for the second unit, etc. But they only had to pay $6 each for all 5 units! Page 78

FG Area DACE is the gain in consumer surplus if the price falls to $5 Area DACE is the gain in consumer surplus if the price falls to $5 Page 78

FG Determining the level of consumer surplus Determining the level of consumer surplus

FG Page 78

FG

FG The level of consumer surplus is (H×L)/2, or (($11-$6)×5)/2=$12.50 The level of consumer surplus is (H×L)/2, or (($11-$6)×5)/2=$12.50

In Summary Consumer equilibrium for an individual for a given price and budget Individual consumer’s demand schedule Market demand curve Engel curves Change in demand vs. change in quantity demanded Consumer surplus

Chapter 5 examines the concept of elasticity, one of the most important concepts in all of economics….