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Background to Demand

Background to Demand. Background to Demand. Marginal Utility Theory. UTILITY THEORY. Concepts total u tility marginal utility diminishing marginal utility total and marginal utility curves. Darren’s utility from consuming crisps (daily). Packets of crisps. TU in utils. 0 1 2

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Background to Demand

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  1. Background to Demand

  2. Background to Demand Marginal Utility Theory

  3. UTILITY THEORY • Concepts • total utility • marginal utility • diminishing marginal utility • total and marginal utility curves

  4. Darren’s utility from consuming crisps (daily) Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 Utility (utils) Packets of crisps consumed (per day)

  5. Darren’s utility from consuming crisps (daily) TU Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 Utility (utils) Packets of crisps consumed (per day)

  6. Darren’s utility from consuming crisps (daily) TU MU in utils Packets of crisps TU in utils - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 7 11 13 14 14 13 Utility (utils) Packets of crisps consumed (per day)

  7. Darren’s utility from consuming crisps (daily) TU MU in utils Packets of crisps TU in utils - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 7 11 13 14 14 13 Utility (utils) MU Packets of crisps consumed (per day)

  8. Darren’s utility from consuming crisps (daily) DTU = 2 DQ = 1 MU = DTU / DQ TU Utility (utils) MU Packets of crisps consumed (per day)

  9. Darren’s utility from consuming crisps (daily) TU DTU = 2 DQ = 1 Utility (utils) MU = DTU / DQ = 2/1 = 2 MU Packets of crisps consumed (per day)

  10. MARGINAL UTILITY THEORY • The optimum level of consumption: the one-commodity version • consumer surplus (total and marginal) • marginal consumer surplus: MU – P • total consumer surplus: TU – TE

  11. Consumer surplus MU, P P1 MU O Q1 Q

  12. Consumer surplus MU, P P1 Total consumer expenditure MU O Q1 Q

  13. Consumer surplus MU, P Total consumer surplus P1 Total consumer expenditure MU O Q1 Q

  14. MARGINAL UTILITY THEORY • The optimum level of consumption: the one-commodity version • consumer surplus (total and marginal) • marginal consumer surplus: MU – P • total consumer surplus: TU – TE • When is total utility maximized?

  15. Deriving an individual person’s demand curve Consumption at Q1 where P1 = MU a P1 Q1 MU, P MU = D O Q

  16. Deriving an individual person’s demand curve Consumption at Q2 where P2 = MU b P2 Q2 MU, P a P1 MU = D O Q1 Q

  17. Deriving an individual person’s demand curve Consumption at Q3 where P3 = MU c P3 Q3 MU, P a P1 b P2 MU = D O Q1 Q2 Q

  18. MARGINAL UTILITY THEORY • Limitations of the one-commodity version • marginal utility affected by consumption of other goods • Optimum combination of goods • the equi-marginal principle MUA/MUB = PA/PB • deriving a demand curve

  19. Background to Demand Indifference Analysis

  20. INDIFFERENCE ANALYSIS • Indifference curves • constructing an indifference curve

  21. Constructing an indifference curve Pears Point Oranges a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Combinations of pears and oranges that Clive likes the same amount as 10 pears and 13 oranges

  22. Constructing an indifference curve Pears Point Oranges a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Pears Oranges

  23. Constructing an indifference curve a Pears Point Oranges a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Pears Oranges

  24. Constructing an indifference curve a Pears Point Oranges b a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Pears Oranges

  25. Constructing an indifference curve a Pears Point Oranges b a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 c Pears d e f g Oranges

  26. INDIFFERENCE ANALYSIS • Indifference curves • the shape of an indifference curve • diminishing marginal rate of substitution

  27. Deriving the marginal rate of substitution (MRS) a b 26 DX = 1 6 7 MRS = 4 DY = 4 MRS = Y/X Units of good Y Units of good X

  28. Deriving the marginal rate of substitution (MRS) c 9 DX = 1 13 14 a MRS = 4 DY = 4 b 26 MRS = Y/X DX = 1 Units of good Y MRS = 1 d DY = 1 6 7 Units of good X

  29. INDIFFERENCE ANALYSIS • Indifference curves • an indifference map

  30. An indifference map I5 I4 I3 I2 I1 The further out the curve, the higher the level of utility Units of good Y An indifference curve shows all combinations of X and Y that give a particular level of utility. Units of good X

  31. INDIFFERENCE ANALYSIS • Indifference curves • constructing an indifference curve • the shape of an indifference curve • diminishing marginal rate of substitution • an indifference map • The budget line • constructing a budget line

  32. A budget line Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Assumptions PX = £2 PY = £1 Budget = £30

  33. A budget line Point on budget line a a Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Units of good Y Assumptions PX = £2 PY = £1 Budget = £30 Units of good X

  34. A budget line a Point on budget line a b Units of good X 0 5 10 15 Units of good Y 30 20 10 0 b Units of good Y Assumptions PX = £2 PY = £1 Budget = £30 Units of good X

  35. A budget line a Point on budget line a b c Units of good X 0 5 10 15 Units of good Y 30 20 10 0 b Units of good Y c Assumptions PX = £2 PY = £1 Budget = £30 Units of good X

  36. A budget line a Point on budget line a b c d Units of good X 0 5 10 15 Units of good Y 30 20 10 0 b Units of good Y c Assumptions PX = £2 PY = £1 Budget = £30 d Units of good X

  37. INDIFFERENCE ANALYSIS • The budget line • effect of a change in income

  38. Effect of an increase in income on the budget line Assumptions PX = £2 PY = £1 Budget = £30 Units of good Y Units of good X

  39. Effect of an increase in income on the budget line Assumptions PX = £2 PY = £1 Budget = £40 n m 16 7 Units of good Y Budget = £40 Budget = £30 Units of good X

  40. INDIFFERENCE ANALYSIS • The budget line • effect of a change in price

  41. Effect on the budget line of a fall in the price of good X Assumptions PX = £2 PY = £1 Budget = £30 Units of good Y Units of good X

  42. Effect on the budget line of a fall in the price of good X Assumptions PX = £2 PY = £1 Budget = £30 Units of good Y Units of good X

  43. Effect on the budget line of a fall in the price of good X Assumptions PX = £1 PY = £1 Budget = £30 Units of good Y Units of good X

  44. Effect on the budget line of a fall in the price of good X a Assumptions PX = £1 PY = £1 Budget = £30 Units of good Y B2 B1 c b Units of good X

  45. Practice Problem #1 • Supposethat Martha has $150 to spendoncandy and the compositegood. Supposethatcandycost $2.50 per bag and the compositegoodcosts $1 per unit. • Sketch Martha’s budget constraint. Label all the axis. • What is the opportunitycost, in terms of candy, of an additionalunit of the compositegood?

  46. Practice Problem #1 Continued • Supposethat Martha has $150 to spendoncandy and the compositegood. Supposethatcandy still cost $2.50 per bag. But now, the compositegoodcosts $1.50 per unit. • Use the same diagram and sketch howMartha’s budget constraintchanges. Label all the axis. • What is the opportunitycost, in terms of candy, of an additionalunit of the compositegood given the new budget constraint?

  47. Practice Problem #1 Continued • Supposethatcandy still cost $2.50 per bag and the compositegoodcosts $1.50 per unit. But Martha has been given a raise and nowspends $225. • Sketch howMartha’s budget constraintchanges. Label all the axis. • What is the opportunitycost, in terms of candy, of an additionalunit of the compositegood given the new budget constraint?

  48. INDIFFERENCE ANALYSIS • The optimum consumption point

  49. Finding the optimum consumption Units of good Y O Units of good X

  50. Finding the optimum consumption Units of good Y I5 I4 I3 I2 I1 O Units of good X

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