Lecture 3 : demand and consumer behavior.
In this lecture, we will learn about the intricacies of consumer behavior. Important new concepts
such as cardinal versus ordinal utility, diminishing marginal utility, and demand price elasticities are
introduced. Ultimately, these concepts will help us better understand the nature of the demand
curve in economics, particularly why the demand curve slopes downward and has an inverse
relationship to price as well as why the demand curve shifts.
We will also come to understand why increasing the price of a product may not always result in
higher profits for a firm or business. This is one of the most crucial insights of microeconomics.
Key Questions for Lecture Three: Demand and Consumer Behavior
1. Consumer choice boils down to what three things?
The three things would be a) The pleasure people get from consuming the good, b) The price they
have to pay for it, c) The income available to them for buying the good.
2. What is the difference between a cardinal and ordinal measure of utility?
Basic idea is that cardinal measure is the actual measure of utility which is impossible, and ordinal
utility just ranks things against each other.
3. What is the difference between total versus marginal utility?
Total utility of the consumption increases with per unit of consumption with a decreasing slope, aka
after a threshold consuming more of the same good will not produce more utility for the customer.
The science of why we get bored with one thing, it’s just diminishing return of utility.
4.
Explain the law of diminishing marginal utility.
After a threshold customer satisfaction doesn’t increase with more goods consumed, rather the
marginal utility decreases.
5. State the utility-maximizing rule or the equimarginal principle.
The customers with a fixed income will get maximum satisfaction when the marginal utility of the last
dollar spent on each good, is equal to the marginal utility of the last dollar spent in any other good.
6. When is utility maximized?
When the marginal utility of all products are same. If price of a good increases, customers will get
more satisfaction from consuming other goods, which is called the substitution effect. The portion of
the purchase of one good, because of his reduction in his income is called the ‘’income effect”.
7. What is the difference between real and nominal income?
Real income is what we have in banks, nominal income is that real income +inflation. Inflation
reduces customer’s purchasing power.
8. What does the price elasticity of demand measure? Write out the formula.
Price elasticity is basically how does the consumer demand of the product change with the
changes in price. Price elasticity = percent change in quantity demanded/percent change in
price.
9. Why do we use percentages rather than absolute amounts in measuring consumer
responsiveness?
a) It helps to eliminate the units of the price or quantity
b) Helps to compare between different type of products.
10. Define and illustrate elastic and inelastic demand.
If the quantity demanded changes with price, it’s elastic, if it doesn’t, it’s inelastic, if it changes 1%
with 1% price change, it’s unit elastic.
11. What are the four major determinants of price elasticity of demand? Explain how each affects
demand elasticity.
Substitutions : more substitutions means more elasticity
Categorization/definition : there’s no substitute for gas, but there are substitutions for chevron gas.
The broader the definition of a product, e.g., gas versus Chevron gas:
The less elastic its demand will be
Income : other things equal, the higher the price of a good compared to your budget, the higher the
elasticity is going to be.
Time : in a longer time horizon, things get more elastic as more substitutions appear and the product
generation might become cost efficient.
12. Suppose your business sells widgets and demand for your product is relatively price elastic.
What would you do to raise your total revenues?
Lower the price to maximize revenue. Revenue = price * quantity sold
13. Why do many airlines offer fare discounts to people who stay over on a Saturday night?
To differentiate between business travelers who are price inelastic, vs pleasure travelers who are
elastic to charge two prices.
14. Why don't most new cars sell at their sticker price?
To differentiate between comparison buyers and show-off buyers.
15. Why do many farmers go bankrupt when crops are plentiful?
Price inelasticity because if lots of people are selling prices at a competitive lower price, some of
them will get bankrupted when the customers aren’t trying to buy from any specific one’s because of
relatively low level of inelasticity.
16. If the government imposes a sales tax on a product that is highly elastic, what will happen to
total tax revenues?
It will fall.
Lecture Four: Supply and Production TheoryHelp
In this lecture, we move from the demand curve to the supply curve as we take up the task of
understanding the theory of production. We shall see that the analysis of supply and production is
more complicated than the analysis of demand. This is because in the supply process, people first
offer the factors of production that they control to the market. These factors of production are then
transformed by firms into goods that consumers want.
There are a number of very important ideas that we want to come to grips with in this lecture: the
difference between short run and long run costs, marginal cost and the law of diminishing returns,
economies of scale and the shapes of various cost curves, and economic versus accounting profits.
We will also learn about the law of demand and supply price elasticities.
Key Questions for Lecture Four: Supply and Production Theory
1. Illustrate the production function algebraically and explain its components.
Q= F(K,L,R) where Q= quantity of production, K= required capital, L=number of employees, R=
everything else like energy supply,raw materials etc. F= current technology.
2. What does the production function specify?
Production function specifies the maximum output that can be produced with given inputs with the
current state of technology.
3. Define the short run. Define the long run
The short run is when companies can change their output by only changing the variable factors such
as labor and materials but they don’t have to change the fixed inputs such as capital.
The long run is a period sufficiently long enough, when everything can be changed.
4. What is the difference between fixed versus variable costs? Provide several examples of each.
Fixed cost, are the costs that does not change with the level of output, such as time I guess, and
they are also called overhead. Variable costs change with the level of output.
6. Define marginal cost.
Cost of increasing one more unit of product. Marginal costs first fall then rise.
7. Explain the law of diminishing returns
In the short run, variable factors like labor can be changed, which means adding labors will increase
output but they will have less capital to work with, which also means that after sometime, the
marginal product of each additional worker must decrease, this is the law of diminishing returns.
8. Define marginal product and total product.
The marginal product of an input, is the output that’s generated by adding one extra unit of input
(which is variable) holding all the things as constant. Total product is the total output. At one point
the total product keeps increasing but at a decreasing(slower) rate. Marginal product curve goes
down and marginal cost curve goes up in the law of diminishing return system.
9. Define and illustrate average fixed cost, variable cost and total cost.
Average fixed costs(FC/output) go downward and almost goes to zero, average variable
costs(VC/output) goes upwards and almost meats the average total cost curve. As larger units gets
produced, the fixed costs gets spread over them, so it goes down to zero, and the average variable
cost curve AVTC.
10. The long run average cost curve is the envelope of what? Illustrate this.
The long run average cost curve is the envelope of the average short run cost curves
11. Explain the difference between economies of scale, diseconomies of scale and constant returns
to scale. Illustrate each with the appropriate cost curve.
Economics of scale exist when the per unit output cost of all input variables decreases as out put
increases.
Diseconomies of scale exist when the per unit of output costs of all input variables increases as
output increases
13. An industry characterized by increasing returns to scale is called what?
A natural monopoly which results in market failure.
14. Define minimum efficient scale.
The smallest level of output where the firm can minimize long run average costs.
15. Define both the law of supply and the price elasticity of supply.
When the price of a good increases, the quantity of that good supplied will increase. Price elasticity
of supply = percent change in quantity supplied/percent change in price.
16. What is the difference between economic versus accounting profits? Explain why this difference
is important.
Economic profit considers both opportunity costs and explicit costs and profits but accounting profit
only considers the explicit ones.