2 Markets Demand and Supply

7/31/2019 2 Markets Demand and Supply

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Backgroundto Demand


2/110

Background to Demand

Marginal Utility Theory


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Total and marginal utility

meaning of total utility

marginal utility: TU/Q

diminishing marginal utility

total and marginal utility curves

MARGINAL UTILITY THEORY


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-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Packetsof crisps

TU

in utils

01

23456

07

1113141413

Utility(utils)

Packets of crisps consumed (per day)

Darrens utility from consuming crisps (daily)


5/110

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Packetsof crisps

TU

in utils

01

23456

07

1113141413

Utility(utils)


TU



6/110

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Packetsof crisps

TU

in utils

01

23456

07

1113141413

MU

in utils

-7

4210

-1

Utility(utils)


TU



7/110

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Packetsof crisps

TU

in utils

01

23456

07

1113141413

MU

in utils

-7

4210

-1

Utility(utils)


TU

MU



8/110

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6MU

TU= 2

Q= 1

MU = TU / Q

Utility(utils)


TU



9/110

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6MU

MU = TU / Q= 2/1 = 2

Utility(utils)


TU

TU= 2

Q= 1



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The optimum level of consumption: the one-commodity version

consumer surplus (total and marginal)

marginal consumer surplus: MU

P

total consumer surplus: TU TE



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MU

P1

Q1O

MU, P

Q

Consumer surplus


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Total

consumerexpenditure MU

P1

Q1O

MU, P

Q

Consumer surplus


13/110

Total

consumerexpenditure MU

Totalconsumer

surplusP1

Q1

MU, P

QO

Consumer surplus


14/110

The optimum level of consumption: the one-commodity version

consumer surplus (total and marginal)

marginal consumer surplus: MU

P

total consumer surplus: TU TE

maximising consumer surplus: P = MU

Marginal utility and the demand curve



15/110

MU = D

MU, P

QO Q1

P1a

Consumption atQ1

where P1 = MU

Deriving an individual persons demand curve


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Q2O

P1

Q1

a

P2

b

Consumption at Q2where P2= MU

MU, P

Q

MU = D


D i i i di id l d d


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P2

Q2O

P1

Q3Q1

a

P3c

Consumption at Q3where P3= MU

b

MU, P

Q

MU = D



18/110

Limitations of the one-commodity versionmarginal utility affected by consumption of

other goods

marginal utility of money not constant Optimum combination of goods

the equi-marginal principle

MUA/MUB= PA/PB

deriving a demand curve



19/110


Risk, Uncertainty andInsurance


20/110

Demand under conditions of risk anduncertainty

defining risk and uncertainty

types of odds

risk attitudes

Diminishing marginal utility of income andattitudes towards risk taking

RISK, UNCERTAINTY AND INSURANCE

T t l tilit f i


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TU

5000 10 000 15 0000

Income ()

Totalutility

U1

Total utility of income

a

T t l tilit f i


22/110

TU

5000 10 000 15 0000

U2

U1

a

b

Income ()

Totalutility


T t l tilit f i


23/110

TU

5000 10 000 15 0000

U3

U2

U1

a

b

c

Income ()

Totalutility


Total tilit of income


24/110

TU

5000 10 000 15 0000 8000

U3

U2

U1

U4

a

b

c

Income ()

Totalutility

d



25/110

Insurance: a way of removing risks

How insurers spread risks

the law of large numbers

importance of the independence of risks

Problems for insurers

adverse selection

moral hazard

RISK, UNCERTAINTY AND INSURANCE


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Indifference Analysis


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Indifference curves constructing an indifference curve

INDIFFERENCE ANALYSIS

Constructing an indifference curve


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Pears

3024201410

8

6

Oranges

678

101315

20

Point

abcdef

g

Combinations of pears andoranges that Clive likes

the same amount as

10 pears and 13 oranges




29/110

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

Pe

ars

Oranges

Pears

3024201410

8

6

Oranges

678

101315

20

Point

abcdef

g




30/110

a

Pe

ars

Oranges

Pears

3024201410

8

6

Oranges

678

101315

20

Point

abcdef

g


0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22



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a

b

Pe

ars

Oranges

Pears

3024201410

8

6

Oranges

678

101315

20

Point

abcdef

g


0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22



32/110

a

b

c

d

ef

g

Pears

Oranges

Pears

3024201410

8

6

Oranges

678

101315

20

Point

abcdef

g


0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22


33/110

Deriving the marginal rate of substitution (MRS)


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0

10

20

30

0 10 206

26

7

Unitso

fgoodY

Units of good X

a

bY= 4

X= 1

MRS= 4

MRS= Y/X




35/110

0

10

20

30

0 10 20

a

b

Unitso

fgoodY

Units of good X

26

6 7

d

Y= 4

X= 1

Y =1

X= 1

MRS= 1

MRS= 4

13

14

9

c

MRS= Y/X



36/110

An indifference map


37/110

0

10

20

30

0 10 20

Unitso

fgoodY

Units of good X

I1I2

I3

I4

I5

An indifference map


38/110


the shape of an indifference curve

diminishing marginal rate of substitutionan indifference map

The budget line

constructing a budget line


A budget line


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Units of

good X

05

1015

Units of

good Y

3020100

Assumptions

PX=2

PY= 1Budget = 30

A budget line

A budget line


40/110

Unitso

fgoodY

Units of good X

a

Units of

good X

05

1015

Units of

good Y

3020100

Assumptions

PX=2

PY= 1Budget = 30

Point on

budget line

a

A budget line

0

10

20

30

0 5 10 15 20

A budget line


41/110

Unitso

fgoodY

Units of good X

a

b

Units of

good X

05

1015

Units of

good Y

3020100

Point on

budget line

ab

Assumptions

PX=2

PY= 1Budget = 30

A budget line

0

10

20

30

0 5 10 15 20

A budget line


42/110

Unitso

fgoodY

Units of good X

a

b

c

Units of

good X

05

1015

Units of

good Y

3020100

Point on

budget line

abc

Assumptions

PX=2

PY= 1Budget = 30

A budget line

0

10

20

30

0 5 10 15 20

A budget line


43/110

Unitso

fgoodY

Units of good X

a

b

c

d

Units of

good X

05

1015

Units of

good Y

3020100

Point on

budget line

abcd

Assumptions

PX=2

PY= 1Budget = 30

A budget line

0

10

20

30

0 5 10 15 20


44/110




The budget line


effect of a change in income


Effect of an increase in income on the budget line


45/110

Unitso

fgoodY

Units of good X

Assumptions

PX=2

PY= 1Budget = 30


0

10

20

30

40

0 5 10 15 20



46/110

Unitso

fgoodY

Units of good X

Assumptions

PX=2PY= 1

Budget = 40

Budget

= 40

Budget= 30

16

7

0

10

20

30

40

0 5 10 15 20

m

n

ect o a c ease co e o t e budget e


47/110




The budget line


effect of a change in income

effect of a change in price


Effect on the budget line of a fall in the price of good X


48/110

0

10

20

30

0 5 10 15 20 25 30

g p g

Unitso

fgoodY

Units of good X

Assumptions

PX=2PY= 1

Budget = 30



49/110

0

10

20

30

0 5 10 15 20 25 30

g p g

Unitso

fgoodY

Units of good X

Assumptions

PX=2PY= 1

Budget = 30



50/110

0

10

20

30

0 5 10 15 20 25 30

g p g

Unitso

fgoodY

Units of good X

Assumptions

PX=1PY= 1

Budget = 30



51/110

Unitso

fgoodY

Units of good X

Assumptions

PX=1PY= 1

Budget = 30

B1

B2

a

b0

10

20

30

0 5 10 15 20 25 30

c


52/110

The optimum consumption point


Finding the optimum consumption


53/110

d g t e opt u co su pt o

Unitsof

goodY

Units of good X

O


54/110



55/110

I1I2

I3

I4I5

UnitsofgoodY

O

Units of good X

Budget line

g p p



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I1I2

I3

I4I5

UnitsofgoodY

O

Units of good X

r

v

s

u

Y1

X1

t

g p p



57/110

The optimum consumption pointequating the marginal rate of substitution with

the price ratio

MRS = MUA/MUB= PA/PB




58/110

I1I2

I3

I4I5

UnitsofgoodY

O

Units of good X

r

v

s

u

Y1

X1

t

g p p


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60/110


the price ratio


The effect of a change in income

the incomeconsumption curve


Effect on consumption of a change in income


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UnitsofgoodY

O

Units of good X

B1 I1

a


62/110

Effect on consumption of a change in income


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I2

UnitsofgoodY

O

Units of good X

B1 B2 B3 B4 I1

I3

I4


64/110


65/110

Deriving an Engel curve from an income-consumption curve


66/110

Bread

B1 B2 B3

I3

I2I

1

CDs



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B1 B2 B3

I3

I2I

1

Income-consumptioncurve

CDs

Bread



68/110

B1 B2 B3

I3

I2I

1

Income-consumptioncurve

CDs

Bread

Incom

e()



69/110

B1 B2 B3

I3

I2I

1

Income-consumptioncurveB

read

Incom

e()

CDs

Qb1

Qcd1

a



70/110

B1 B2 B3

I3

I2I

1


read

Incom

e()

CDs

Qb1

Y1

Qcd1

Qcd1

a

a


71/110



72/110

B1 B2 B3

I3

I2I

1


read

Incom

e()

CDs

Qb3Qb2Qb1

Y3

Y2Y1

Qcd3Qcd2Qcd1

Qcd3Qcd2Qcd1

ab

c

ab c



73/110

B1 B2 B3

I3

I2I

1


read

Incom

e()

CDs

Qb3Qb2Qb1

Y3

Y2Y1

Qcd3Qcd2Qcd1

Qcd3Qcd2Qcd1

Engel curve

ab

c

ab c


74/110



75/110

B1 B2 B3

I3

I2I

1


read

Incom

e()

CDs

Qb3Qb2Qb1

Y3

Y2Y1

Qcd3Qcd2Qcd1

Qcd3Qcd2Qcd1

Engel curve

ab

c

ab c



76/110


the price ratio


The effect of a change in income

the incomeconsumption curve

the Engel curve

income elasticity of demand and the incomeconsumption curve

the effect of a rise in income on the demandfor an inferior good



77/110

Effect of a rise in income on the demand for an inferior good


78/110

UnitsofgoodY

(norm

algood)

O

I2

I1B1

B2

a

b

Units of good X

(inferior good)

Effect of a rise in income on the demand for an inferior good


79/110

UnitsofgoodY

(norm

algood)

O

Income-consumption curve

I2

I1B1

B2

a

b

Units of good X

(inferior good)



80/110

The effect of changes in price the priceconsumption curve



81/110

30

Effect of a fall in the price of good X


82/110

UnitsofgoodY

Units of good X

Assumptions

PX=2PY= 1Budget = 30

B1 I10

10

20

30

0 5 10 15 20 25 30

j

30

Effect of a fall in the price of good X


83/110

UnitsofgoodY

Units of good X

B1 I1

j

Assumptions

PX

=1PY= 1

Budget = 30

0

10

20

30

0 5 10 15 20 25 30

a30Effect of a fall in the price of good X


84/110

UnitsofgoodY

Units of good X

Assumptions

PX

=1PY= 1

Budget = 30

B1 I1 B2

a

j

0

10

20

30

0 5 10 15 20 25 30

I2

k

30 aEffect of a fall in the price of good X


85/110

0

10

20

30

0 5 10 15 20 25 30

UnitsofgoodY

Units of good X

B1 I1 B2

a

j

I2

Price-consumption curve

k



86/110


deriving the individual's demand curve


Deriving a demand curve from a price-consumption curve


87/110

B1I1

Expenditur

eon

allothergo

ods

Units of good X

a



88/110

I2

B1 B2I1

Expenditur

eon

allothergo

ods

Units of good X

a b

Fall in theprice of X



89/110

I2

B1 B2I1

Expenditur

eon

allothergo

ods

Units of good X

a b

Further falls inthe price of X



90/110

B1 B2 B3

I3I2

I1

I4

B4

Expenditur

eon

allothergo

ods

Units of good X

a b c d

Further falls inthe price of X



91/110

B1 B2 B3

I3I2

I1

I4

B4

Expenditur

eon

allothergo

ods

Units of good X

Price-consumptioncurve

a b c d



92/110

B1 B2 B3

I3I2

I1

I4

B4

Expenditur

eon

allothergo

ods

Units of good X

a Price-consumptioncurve

b c d

Priceofg

oodX

Units of ood X

P1

Q1

a


93/110



94/110



Income and substitution effects of a pricechange


95/110

Income and substitution effects: normal good


96/110

Units

ofgoodY

I1

I2

I3

I4

I5

I6

B1

f

QX1Units of Good X



97/110

Units

ofgoodY

I1

I2

I3

I4

I5

I6

B2

h

B1

QX1

f

Rise in the priceof good X

Units of Good XQX3



98/110

Units

ofgoodY

B2

Substitutioneffect

B1

QX1

h

fI

1

I2

I3

I4

I5

I6

QX

2

B1a

Substitution effectof the price rise

g

Units of Good XQX3



99/110

Units of Good X

Units

ofgoodY

I1

I2

I3

I4

I5

I6

Substitutioneffect

Incomeeffect

QX1

h

f

g

B2 B1

QX2QX3

B1a

Income effect ofthe price rise



100/110




a normal good

an inferior good


101/110

Income and substitution effects: Inferior (non-Giffen) good


102/110

Units of Good X

Units

ofgoodY

f

QX1

B2

QX3

I1

I2


h

B1



103/110

Units of Good X

Units

ofgoodY

f

QX1

B2

h

QX2

I1

I2

Substitution effect

B1a


B1

g



104/110

Units of Good X

Units

ofgoodY

f

QX1

B2

g

QX2QX3

I1

I2

Substitution effect

h

Income effect

B1a


B1



105/110

The effect of changes in price

the priceconsumption curve



a normal good

an inferior good

a Giffen good (a special type of inferior good)

Income and substitution effects: Giffen good


106/110

Units of Good X

Units

ofgoodY

B1

f

QX1

I1

I2



107/110

Units of Good X

Units

ofgoodY

f

QX1

B2

QX3

I1

I2


h

B1



108/110

Units of Good X

Units

ofgoodY

f

QX1

B2

h

QX3

I1

I2

QX2

B1a

g

Substitutioneffect


B1



109/110

Units of Good X

Units

ofgoodY

f

QX1

B2

h

QX3

I1

I2

g

QX2

SubstitutioneffectIncome effect


B1

B1a



110/110

The effect of a change in price on thedemand for other goods

The usefulness of indifference analysis

superiority of using ordinal measures

limitations of indifference analysis

Documents

2 Markets Demand and Supply