From Individual Demand to Consumer Surplus

1. From Individual Demand to Consumer Surplus Today: Deriving market demand from individual demand; using reservation prices to derive consumer surplus

2. Previously… • 7 core principles • Thinking like economists • Introduction to supply and demand • Equilibrium • A route choice experiment and its equilibrium • Deriving individual demand

3. Today • Using individual demands to derive market demand • Reservation price • Consumer surplus

4. Recall individual demand • Last time, we went through the assumptions that gave us a downward-sloping individual demand curve • We will use “horizontal addition” to derive market demand from all individual demands

5. Example: Individual demand to market demand • Suppose Pat and Shannon have the following demand schedules for apples

6. Example: Individual demand to market demand • How do we get the market demand from individual demands? • We add them up

7. Some graphing reminders • Some reminders of graphs • Label axes • Label dollar amounts, quantities, etc. • To save space, all quantity numbers here are apples

8. Graphing demands:Shannon (left) & Pat (right)

9. Total demand

10. How can we graph demand with only the graphs? • Another method of graphing total demand from individual demand is a method called horizontal addition • We horizontally add quantities demanded from each person AT A GIVEN PRICE

11. Price greater than $3 • When price is greater than $3, Shannon is the only person demanding a positive quantity • Thus, the top half of Shannon’s demand curve is the same as the market’s

12. At $3, 6 + 0 units are demanded

13. At $0, 12 + 9 units are demanded

14. Bottom half of the demand curve • At $3, 6 units are demanded • At $0, 21 units are demanded • Bottom half of demand curve connects (6, $3) and (21, $0)

15. Reservation price and consumer surplus • How “well off” are we when we buy something? • Calculate consumer surplus by using demand curve and reservation price

16. Reservation price • Reservation price is the highest price a person is willing to pay for a good or service • Note that reservation price for the nth unit corresponds to a particular point of a demand curve

17. Let’s return to part of Shannon’s demand • Shannon’s reservation price for 6th apple is $3

18. Core principle: Efficiency • Today, we calculate consumer surplus to help on our quest to efficiency

19. Calculating consumer surplus • Consumer surplus (CS) for the nth unit is the vertical difference between the demand curve and the price paid • We will calculate CS two ways • Discretely • Approximate using area under demand curve

20. Back to Shannon

21. If P = $3… • At P = $3, Shannon demands 6 apples • To calculate total consumer surplus for Shannon, we simply add CS for each unit purchased

22. CS for 6 units purchased • CS is the sum of the six dollar amounts in the right column, or $7.50

23. CS from demand curves • CS can be approximated by calculating the area under the demand curve and above the price The area of this triangle is a good approximation of CS

24. CS from demand curves • Height of triangle is ($6 – $3), or $3. • Length of triangle is (6 – 0), or 6 • Area of triangle is one-half times length times height • CS = $9 The area of this triangle is a good approximation of CS

25. This concludes demand • What have we learned? • How individual demand is derived • Utility • The rational spending rule • Deriving market demand from individual demand • Consumer surplus