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Derivation of. The Demand Curve. Preview of 4 Coming Attractions. Today: Derivation of the Demand Curve Consumers ( Buyers ) Next: Derivation of the Supply Curve Firms ( Sellers ) Later: Double Auction Market Buyers and and sellers come together

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Derivation of

The Demand Curve


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Preview of 4 Coming Attractions

  • Today: Derivation of the Demand Curve

    • Consumers (Buyers)

  • Next: Derivation of the Supply Curve

    • Firms (Sellers)

  • Later: Double Auction Market

    • Buyers and and sellers come together

  • Still later: Competitive Equilibrium Model


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Why study the derivation of the demand curve?

  • Helps explain why a competitive market works well.

  • Helps determine the position of the demand curve and the sensitivity of quantity demanded to price.


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A brief digression on elasticity

  • Elasticity is a measure of how sensitive one variable (e.g. quantity demanded) is to another variable (e.g. price).

  • Definition: the price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price e= (% Q)/(%P)


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Where we are going

  • Start with an individual consumer

    • maybe you, maybe me, but could be anyone

  • Derive demand curve for that individual

    • focus on marginal utility or marginal benefit

  • Add up demand curves for many such individuals to get market demand curve


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General economic principle

People

make purposeful choices

with limited resources

When applied to the behavior of consumers

People

maximize utility

subject to a budget constraint

Assumption about consumer behavior


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Utility: a numerical indicator of preferences

  • Marginal Utility

  • Diminishing Marginal Utility


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Marginal conditions for utility maximization

Ratio of marginal utilities equals ratio of prices for any two goods

(MUG/MUB) = (PG/PB)

Explanation of Diamond Water Paradox

First pointed out by Adam Smith



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An Important Conclusion: MB = P

The consumer chooses an amount such that the marginal benefit (MB) equals price (P)

When I see a demand curve, I think of the marginal benefit to consumers

WGAD: Why do economists put the quantity on the horizontal axis?


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Consumer Surplus

Willingness to pay is usually greater than the price

for example my willingness to pay for a pair of eyeglasses is much more than the price

Consumer surplus is the area under the demand curve and above the price


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Market Demand Curve

Consider all consumers in the market

Add up quantity demanded by all individuals at each price to get market demand

Add horizontally


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