The Demand Side of the The Demand Side of the Market Market - PowerPoint PPT Presentation

Econ Dept, UMR Presents The Demand Side of the The Demand Side of the Market Market

Starring Starring N Utility Theory N Consumer Surplus N Elasticity

Featuring Featuring The MU/ P Rule N The MU/ P Rule N The Meaning of Value N The Meaning of Value N Four Elasticities: N Four Elasticities: N Price Elasticity of Demand O Price Elasticity of Demand O O Income Elasticity Income Elasticity O Cross Price Elasticity O Cross Price Elasticity O O Price Elasticity of Supply Price Elasticity of Supply O The Elasticity-TR relationship N The Elasticity-TR relationship N

In Three Parts In Three Parts Consumer Choice Theory Consumer Choice Theory Consumer Surplus Consumer Surplus Elasticity Elasticity

Part 2 Consumer Surplus Consumer Surplus or, or, Do You Get What You Pay Do You Get What You Pay For? For? and and Resolution of the Paradox of Resolution of the Paradox of Value Value

Do You Get What You Pay For? Do You Get What You Pay For? N Generally, NO Generally, NO N N You get more than what you pay for, You get more than what you pay for, N else why buy? else why buy? N Only on the margin you get what you Only on the margin you get what you N pay for pay for

We need to wrestle with We need to wrestle with another concept to discover another concept to discover the meaning of Value the meaning of Value Consumer Surplus Consumer Surplus

A Consumer’s Surplus A Consumer’s Surplus N The difference between the maximum a The difference between the maximum a N person is willing to pay for a good or person is willing to pay for a good or benefit and the cost to the person benefit and the cost to the person N Example: Do you get what you pay for? Example: Do you get what you pay for? N I’m willing to pay $9 for a 12 pack O I’m willing to pay $9 for a 12 pack O Bud is on sale for $4 a case O Bud is on sale for $4 a case O O I pay $4 for something I would be I pay $4 for something I would be O willing to pay $9 for. I get more than willing to pay $9 for. I get more than what I pay for. That surplus is called what I pay for. That surplus is called My Consumer Surplus My Consumer Surplus

My Consumer Surplus My Consumer Surplus Graphically Graphically P My Consumer Surplus for $10 my 1st case = (8-4)*1 + (2*1)/2 = $5.00 $8 S $4 d 0 Q/t 3 1

My Consumer Surplus My Consumer Surplus P This is my Consumer $10 Surplus for two CS = (2*2) + cases of Bud (4*2)/2 = $8/t $8 $6 S $4 d 0 Q/t 3 1 2

My Consumer Surplus My Consumer Surplus P This is my Consumer $10 Surplus for three CS = (6*3)/2 = cases of Bud $9/t $8 $6 S $4 d 0 Q/t 3 1 2

Consumer Surplus Consumer Surplus CS is the area under The area of this P the market demand triangle is the total S curve and above the Consumer Surplus price line--the difference between the maximum consumers are P* willing to pay and what they do pay D 0 Q/t Q*

Now we can shed light on the Now we can shed light on the Meaning of Value Meaning of Value N The Paradox of Value has a long history The Paradox of Value has a long history N N From Plato to Adam Smith to the last From Plato to Adam Smith to the last N years of the 1800s years of the 1800s N “Price is surely a measure of value, but “Price is surely a measure of value, but N why then is the price of something that why then is the price of something that is essential to live, like water, have a is essential to live, like water, have a very low price but something that is very low price but something that is perhaps frivolous, like diamonds have a perhaps frivolous, like diamonds have a very high price?” very high price?”

Or, as Adam Smith wrote in 1776 Or, as Adam Smith wrote in 1776 N “The things which have the greatest value in “The things which have the greatest value in N use have frequently little or no value in use have frequently little or no value in exchange; and on the contrary, whose which exchange; and on the contrary, whose which have the greatest value in exchange have have the greatest value in exchange have frequently little or no value I use. Nothing is frequently little or no value I use. Nothing is more useful than water: but it will purchase more useful than water: but it will purchase scarce any thing; scarce anything can be had scarce any thing; scarce anything can be had in exchange for it. A diamond, on the in exchange for it. A diamond, on the contrary, has scarce any value in use; but a contrary, has scarce any value in use; but a very great quantity of other goods may very great quantity of other goods may frequently be had in exchange for it.” WofN , frequently be had in exchange for it.” WofN , p.28. p.28.

Paradox of Value Paradox of Value N The paradox was resolved when the The paradox was resolved when the N concept of marginal utility was concept of marginal utility was introduced in the late 1800s introduced in the late 1800s N There are two senses of value--Total There are two senses of value--Total N Value (Total Utility) and Marginal Value (Total Utility) and Marginal Value (Marginal Utility) Value (Marginal Utility) N Maximization Theory gives us the Maximization Theory gives us the N MU/ P rule MU/ P rule N Price is a measure of marginal value Price is a measure of marginal value N N Area under demand is total value Area under demand is total value N

Price, a Measure of Marginal Value Price, a Measure of Marginal Value N MU/ P rule MU/ P rule N for all goods, bought B for all goods, N MU MU A A / P / P A = MU = MU B B / P / P B bought N A B = = N Cross multiply and we get: MU Cross multiply and we get: MU A / MU B A / MU N P A / P B P A / P B Utility can’t be measured, but we Marginal N Marginal Utility can’t be measured, but we N do see value on the margin in the form of do see value on the margin in the form of market prices market prices N If P If P A = $10 and P B = $5, we infer another unit A = $10 and P B = $5, we infer another unit N of A would be worth twice as much to society of A would be worth twice as much to society as a unit of B as a unit of B

Total Value Total Value N This is trickier This is trickier N N And must be estimated, but value And must be estimated, but value N defined as Willingness to Pay can be defined as Willingness to Pay can be estimated as estimated as N the area under demand curves the area under demand curves N

The End You are ready to go on to Part III