Econ 201
Lecture 1.5
Consumer Demand Theory
1-9-2009
Overview
•
•
•
•
Basic behavioral assumptions
Marginal Value or Marginal Willingness-to- Pay
First Law of Demand
Total WTP, Total Amount Paid, Consumer
Surplus
• Individual and Market Demand Curves
• Factors that Shift Demand Curves
• More useful websites
Basic Behavioral Postulates
1.
For each person some goods are scarce
- have to make choices (core of the economic problem)
2.
Each person desires many goods and services
- tradeoffs
3.
Each person is willing to forsake some of an economic good to
get more of other economic goods
- Opportunity costs – cost of foregone good to acquire another one
4.
More one has of any good, the lower it personal marginal value
- Diminishing marginal value
5.
Not all people have the same tastes and preferences
- Not all people get the same value from consuming a good
- Provides a basis for exchange/trade even if everyone had same amount of
goods
6.
People are innovative and rational
- People learn and behave in their own best self-interest (or at least are not
systematically irrational – Becker)
First Law of Demand
• First law of demand,
– The lower a good’s price it, the greater the
quantity demanded (by an individual or the
market)
• Demand
– Entire schedule: quantity demanded at various prices
• Quantity demanded
– The amount demanded at a given price
From the Demand Side
• First Law of Demand
– What Does Law Of Demand
Mean?
– all other factors being equal, as
the price of a good or service
increases, consumer demand for
the good will decrease and vice
versa.
– http://www.investopedia.com/term
s/l/lawofdemand.asp
Consumer’s Marginal Value
• Some basic definitions
– Total Willingness-to-pay: “value in use”
• Maximum total amount you would be willing to pay for x units
of the good than go without?
– Equals the area under the demand curve up to x units
Individual's Demand Curve
Total Value of 4 uni
Price per unit
$12.00
$10.00
$8.00
$6.00
Price
$4.00
$2.00
$0.00
1
2
3
4
5
6
7
Quantity Demanded
8
9
10
All the things a demand curve tells
you about value of the good
Demand Curve is
Also Marginal Value
and Avg Revenue
Average Price (price
per unit)
Demand Curve
$12
$10
$8
$6
$4
$2
$0
CS
Amount Paid
1
2
3
4
5
6
7
Quantity Demanded
Total WTP =
CS + Amt Paid
8
9
10
In Class Example
Avg P*Qd
TV(Q-1)+MV(Q)
Tot Val- Tot Paid
Avg Pric Qty Dem Tot Amt Paid Tot Value (WTP) Marg Val Cons Surp
$10
1
$10
$10
$10
$0
$9
2
$18
$19
$9
$1
$8
3
$24
$27
$8
$3
$7
4
$28
$34
$7
$6
$6
5
$30
$40
$6
$10
$5
6
$30
$45
$5
$15
$4
7
$28
$49
$4
$21
$3
8
$24
$52
$3
$28
$2
9
$18
$54
$2
$36
$1
10
$10
$55
$1
$45
Also = Avg Rev
Also = MV(Q)
TV(Q)-TV(Q-1)
Buy Rules
• Consumer will buy a good as long as:
– Total Willingness-to-Pay > Amount Paid
• There is always some consumer surplus, or incentive for
consumer
• Consumer Surplus ≡ Difference () between maximum
amount that you are willing-to-pay and what you have to pay
– CS ≡ Total WTP – Average Price x Qty Purhased
• Consumer will choose how much to buy
(quantity demanded):
– Marginal Value >= price paid for the last unit
• For Perfect Competition: price same for all units -> price paid
for last unit = average price
What Does a Demand
Curve Tell You?
• A Demand Curve is also
– A Marginal Value Curve
• Tells you what the consumer’s marginal value of
the last (incremental/additional) unit is
– An Average Revenue Curve
• Tells you what the average price needs to be in
order to sell x units
Individual Demand versus
Market Demand
• Individual Demand curve
– One individual’s willingness-to-pay or demand
• Market Demand curve
– The sum of all individuals demand curves in
the market
An Example
Individual and Market Demand
Price
Tom
Harry
Dick
Market
$10
1
1
2
4
$9
1
2
3
6
$8
2
3
4
9
Tom
$7
2
4
5
11
Harry
$6
3
5
6
14
$5
3
6
7
16
$4
4
7
8
19
$3
4
8
9
21
$2
5
9
10
24
$1
5
10
11
26
Market Demand = Sum of Tom +
Dick + Harry
Dick
Market
Quantity Demanded
Market Demand:
Maybe a little bit different
• Market Demand may be kinked as new
buyers enter at different price points
Shift of the Entire Curve
• Shift out/right of the Demand Curve
– WTP increases for all Qd
• Shift in/left of the Demand Curve
– WTP decreases for all levels of Qd
Shift out/right
Shift in/left
D2
Factors That Can Shift Demand
• Individual and Market Demand Curves
– Income
– Price of Substitutes
– Price of Compliments
– Product Quality
– Future Prices
– Taste and Preferences
• Market Demand Curves
– Population (market)
Factors That Can Shift Demand
• Income
– Normal good
• As income rises, quantity demanded increases at a
given price -> Demand curve shifts out
• Superior good – percent of budget spent on good
increases more than percent increase in income
– Demand curve shift is very large
– Inferior good
• As income rises, quantity demanded decreases at
a given price
– Demand curve shifts in
Factors That Can Shift Demand
• Substitutes
– Goods that are similar to the “good in question” (or
being analyzed)
• E.g., Pepsi/Coke
• Shifts in Demand Curve
– If price of substitute increases, then demand for “GIQ”
shifts out as it becomes relatively less expensive
– If price of substitute decreases, then demand for
“GIQ” shifts in as it becomes relatively more
expensive
– “closer” the substitute -> more demand curve shifts
(i.e., greater cross-price elasticity)
– For substitutes: relative price matters!
Factors That Can Shift Demand
• Complements
– Goods that are “jointly consumed” with “GIQ”, e.g.
coffee & cream
• Demand Curve shifts
– Price of complement increases, then demand for
“GIQ” shifts in as total cost of consumption has
increased
– Price of complement decreases, then demand for
“GIQ” shifts out as total cost of consumption has
decreased
– For complements: total cost of consumption matters!
Factors That Can Shift Demand
• Product Quality
– Better or improved product quality increases (relative) demand
• Demand curve shifts out
• Future price (hedge market) of the good
– If the price is expected to go up in the future -> increases current
demand (shift out/right)
• Cheaper to consume today and stockpile
– If the price is expected to decrease in the future -> decrease
current demand (shift in/left)
• Wait to buy (christmas/after christmas sales)
• Taste and Preferences
– Always assumed constant unless you have empirical proof (new
MRI imaging)
Factor that Affects the ONLY
Aggregate Market Demand Curve
• As the population/number of buyers (Nb)
increases -> Market Demand curve shifts
outward
Key Assumptions
Demand Curve
• For a given (individual’s) demand curve
– These factors are held constant (ceteris paribus):
• Price of:
– substitutes,
– complements,
– future price of the good
• income,
• quality, and
• taste and preferences
• And for a market demand curve:
– number of buyers (Nb)
• Only price and quantity demanded are
allowed to vary
A Short Quiz
Seattle Times Oct 3, 2007
Olympic National Park officials are suggesting raising the price of an entrance pass
for motorists — good for seven days — from $15 to $25 starting in 2009, with the
fee for individuals such as cyclists climbing from $5 to $12. Season passes would
increase from $30 to $50
But public response, particularly from tourist-dependent local businesses has been
generally negative said a spokeswoman for Olympic National Park.
1.
Illustrate the effect of the increase of the price for park passes on
the demand for trips to the park
2.
Illustrate how the park fee increase would affect the demand for
other tourist-related businesses, e.g., hotels, restaurants.
A Take Home Problem
Price
Indiv 1
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
Indiv 2
1
2
3
4
5
6
7
8
9
10
Indiv 3
0
0
1
1
2
2
3
3
4
4
Indiv 4
0
1
2
3
4
5
6
6
6
6
Total Rev Total WTP Cons Surp
0
1
1
2
2
3
3
4
4
5
Useful Websites
– Understanding differences between factors
that cause shifts in demand or supply
• http://hspm.sph.sc.edu/COURSES/ECON/SD/SD.h
tml
– Basics of demand and supply
• http://www.investopedia.com/university/economics/
economics3.asp
– Cobweb theorem
• http://www.bized.co.uk/current/mind/2004_5/25100
4.ppt
Price
(£)
The Cobweb Theorem
S
11
The
Assume
Farmers
the
respond
falls
initial
£5
by
equilibrium
and
planning
farmers
This
In price
acreates
‘divergent
atomassive
cobweb’
- to
price
increase
react
is
by
£7
cutting
supply,
and
the
plans
ten
quantity
months
for
turkey
9.
shortage
also termed
of 9 an
million
unstable
turkeys If
demand
later,
production.
the rises,
supply
the
months
of
shortage
turkeys
later,
is
and
cobweb
the
price
- Ten
theis
price
forced
tends
up
–to15
pushes
million.
supply
At
the
the
this
price
market
level,
upequilibrium.
to
there
will
£11be
will
per
8
and
move
soon
away
the
process
from
continues!
turkey.
be
million.
a surplus of turkeys and the
A divergent
price
drops. cobweb leads to
price instability over time.
7
5
D
8
9
15
17
D1
Quantity Bought and Sold
(millions)
Cobweb Theorem
• http://www.bized.co.uk/current/mind/2004_5/251004.ppt
• Hungarian-born economist Nicholas Kaldor (1908-1986)
• Simple dynamic model of cyclical demand with time lags
between the response of production and a change in
price (most often seen in agricultural sectors).
• Cobweb theory is the process of adjustment in markets
• Traces the path of prices and outputs in different
equilibrium situations. Path resembles a cobweb with the
equilibrium point at the center of the cobweb.
• Sometimes referred to as the hog-cycle (after the
phenomenon observed in American pig prices during the
1930s).
What We’ve Learned
• Sell rule for firms (Qs: P=MC)
– Firms will supply y units up to the point where the MC
of producing the next/last unit (yth) is just equal to the
price it receives for the good
– First law of supply: supply curves will be upward
sloping
• Buy rule for consumers (Qd: P=MV)
– Consumers will buy x units up to the point that price
equals MV for the last (xth) unit
• First law of demand: demand curves are downward sloping
• Negative slope  diminishing marginal value of consuming
next unit