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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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Presentation Transcript
slide1

Derivation of

The Demand Curve

preview of 4 coming attractions
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
why study the derivation of the demand curve
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.
a brief digression on elasticity
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)
where we are going
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
assumption about consumer behavior
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
utility a numerical indicator of preferences
Utility: a numerical indicator of preferences
  • Marginal Utility
  • Diminishing Marginal Utility
marginal conditions for utility maximization
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

an important conclusion mb p
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?

consumer surplus
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

market demand curve
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