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

The Demand Side of the The Demand Side of the Market Market

Econ Dept, UMR Presents

N Utility Theory N Consumer Surplus N Elasticity

Starring Starring

Featuring Featuring

N NThe MU/ P Rule

The MU/ P Rule

N NThe Meaning of Value

The Meaning of Value

N NFour Elasticities:

Four Elasticities:

O OPrice Elasticity of Demand

Price Elasticity of Demand

O OIncome Elasticity

Income Elasticity

O OCross Price Elasticity

Cross Price Elasticity

O OPrice Elasticity of Supply

Price Elasticity of Supply

N NThe Elasticity-TR relationship

The Elasticity-TR relationship

In Three Parts In Three Parts

Consumer Choice Theory Consumer Choice Theory Consumer Surplus Consumer Surplus Elasticity Elasticity

Consumer Surplus Consumer Surplus

• r,
• r,

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

Part 2

Do You Get What You Pay For? Do You Get What You Pay For?

N N Generally, NO

Generally, NO

N N You get more than what you pay for,

You get more than what you pay for, else why buy? else why buy?

N N Only on the margin you get what you

Only on the margin you get what you 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 N The difference between the maximum a

The difference between the maximum a 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 N Example: Do you get what you pay for?

Example: Do you get what you pay for?

O OI’m willing to pay $9 for a 12 pack

I’m willing to pay $9 for a 12 pack

O OBud is on sale for $4 a case

Bud is on sale for $4 a case

O OI pay $4 for something I would be

I pay $4 for something I would be 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

S d Q/t P $4 3 1 $10

My Consumer Surplus for my 1st case = (8-4)*1 + (2*1)/2 = $5.00

$8

My Consumer Surplus My Consumer Surplus

S d Q/t P 3 1 2 $10 $8

This is my Consumer Surplus for two cases of Bud

$4

$6

CS = (2*2) + (4*2)/2 = $8/t

My Consumer Surplus My Consumer Surplus

S d Q/t P 3 1 2 $10 $8

This is my Consumer Surplus for three cases of Bud

$4

$6

CS = (6*3)/2 = $9/t

Consumer Surplus Consumer Surplus

S D Q/t P Q* P*

The area of this triangle is the total Consumer Surplus CS is the area under the market demand curve and above the price line--the difference between the maximum consumers are willing to pay and what they do pay

Now we can shed light on the Now we can shed light on the

Meaning of Value Meaning of Value

N 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 years of the 1800s years of the 1800s

N N “Price is surely a measure of value, but

“Price is surely a measure of value, but 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 N “The things which have the greatest value in

“The things which have the greatest value in 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.” frequently be had in exchange for it.” WofN

WofN,

, p.28. p.28.

Paradox of Value Paradox of Value

N N The paradox was resolved when the

The paradox was resolved when the concept of marginal utility was concept of marginal utility was introduced in the late 1800s introduced in the late 1800s

N N There are two senses of value--Total

There are two senses of value--Total Value (Total Utility) and Marginal Value (Total Utility) and Marginal Value (Marginal Utility) Value (Marginal Utility)

N N Maximization Theory gives us the

Maximization Theory gives us the MU/ P rule MU/ P rule

N 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

Price, a Measure of Marginal Value Price, a Measure of Marginal Value

N N MU/ P rule

MU/ P rule

N N MU

MUA

A/ P

/ PA

A

= MU

= MUB

B/ P

/ PB

B

for all goods,

for all goods,

bought

bought

N N Cross multiply and we get: MU

Cross multiply and we get: MUA

A/ MU

/ MUB

B =

=

P PA

A/ P

/ PB

B

N N Marginal

Marginal

Utility can’t be measured, but we

Utility can’t be measured, but we 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 N If P

If PA

A = $10 and P

= $10 and PB

B = $5, we infer another unit

= $5, we infer another unit

• f A would be worth twice as much to society
• f A would be worth twice as much to society

as a unit of B as a unit of B

Total Value Total Value

N N This is trickier

This is trickier

N N And must be estimated, but value

And must be estimated, but value defined as Willingness to Pay can be defined as Willingness to Pay can be estimated as estimated as

N N the area under demand curves

the area under demand curves

The End

You are ready to go on to Part III