Topic 5 - Demand: The Benefit side of the Market

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Demand - The Benefit Side of the Market

As discussed in topic 3 the demand curve is the relationship between quantity demanded and all costs (price). The law of demand states that people do less of what they want to do as the cost of doing it rises.

Origins of Demand

  • Tastes/preferences are a determinant of the consumers reservation price (biological, shaped by culture)
  • Either stable (food) or volatile (fads)
  • Peer influence (social factors)
  • Network effects, reservation prices may increase as users of the good increases

Translating Wants into Demands

[1] Utility measures the satisfaction people get from the consumption of a good or service.

  • Rational people will allocate income to achieve maximum utility
  • Marginal utility - the change in utility from an additional unit of the good

This example [2] demonstrates these concepts. please note the marginal utility is meant to be between the rows.

Utils1.jpg


As can be seen, marginal utility tends to decrease as we consume more of the same good (especially with food - become bloated).

There is a tendency for the additional utility gained from consuming an additional unit of a good in a given period of time to diminish as consumption rises. Alice should consume 5 sausages where her utility is maximised and marginal benefit = 0 (next sausage has a negative marginal benefit)

Allocating Fixed Income Between 2 Goods

Beef And Venison Example

[3]

  1. Budget = $400, Beef = $1/kg, Venison = $2/kg
    • If you are currently at 200kg of beef and 100kg of Venison, and the marginal utility of beef = 12 and the marginal utility of venison is = 16 then;
      • Beef gives 12 utils per $, whilst venison only gives 8 utils per $
        • You should reduce venison intake and consume more beef

For divisible goods the formula for finding the maximum utility is

MUF.jpg

Rational Spending Rule

  • Substituting: If prices rise, consumers substitute to less-expensive goods, Only real prices count not nominal
  • Income: The wealthy buy larger houses, private schooling etc. Because total utility rises as consumption rises


Individual And Market Demand Curves

The market demand curve is the horizontal addition (summation) of individual demand curves.

HZA1.jpg

Consumer Surplus

Consumer Surplus is the area between the price level, price axis and demand curve.

References

  1. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  2. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  3. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
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