1. AGEC/FNR 406 LECTURE 4 Collecting fragments of coal in a rail yard in China

2. Theory of Consumer Demand Lecture Goals: 1. Briefly review of demand theory 2. Discuss features of demand curves. 3. Identify importance of these concepts for environmental and resource economics.

3. Utility Because resources provide utility, individuals want them. Utility = “value” (not necessarily in $ terms) Four basic laws of demand 1. Consumers prefer more to less 2. Value rises at a decreasing rate 3. Consumers aim to balance consumption 4. Consumers face budget constraints

4. Example: utility from coal 0123456701234567 Units of coal utility Utility is increasing at a decreasing rate 60 50 40 30 20 10 0

5. Indifference curve: two forms of recreation Beach trips Ski trips At all points along the indifference curve, an individual is “indifferent” about receiving the corresponding bundles of goods.

6. Indifference curve: two forms of recreation Beach trips Ski trips Individuals substitute

7. Indifference curve: two forms of recreation Beach trips Ski trips Utility is increasing “more is better”

8. Utility Maximization Two part process Part 1 Beach trips Ski trips Budget Constraint: At all points along the budget constraint, an individual’s income is completely exhausted. Income P SKI Income P BEACH 0

9. Utility Maximization Two part process Part 2 Beach trips Ski trips Income P SKI Income P BEACH 0 Tangency: Tangency of budget constraint with the indifference curve identifies the point of optimal consumption for the individual. This corresponds to a single point (price-quantity combination) on the demand curve. # ski trips # beach trips

10. Points to ponder: 1 The fact that utility is increasing at a decreasing rate means that the first few units of an environmental improvement will have a larger impact on individuals (and society) than subsequent improvements. Examples: clean water, clean air, national parks, reductions in pesticide residue or pesticide exposure.

11. Points to ponder: 2 The mixture of environmental quality and consumer goods that we observe is the result of a lot of individual decisions about what tradeoffs are acceptable.

12. Points to ponder: 3 Consumers prefer more to less, but have finite resources and are forced to make tradeoffs. This pattern is also repeated at the level of society.

13. Points to ponder: 4 The budget constraint depends on both income and prices. When prices change, this will cause a shift in patterns of consumption due to “income” and “substitution” effects.

14. Points to ponder: 5 Higher incomes mean we can enjoy more environmental improvements, if we choose to. Poor individuals and poor countries are generally more sensitive to the tradeoffs that environmental improvements require.