Chapter3 Slides

Chapter 3: Demand in a Perfectly Compe66ve Market

© Playconomics, LHS 1

Demand Curve for an Individual

•  2 : -‐ soda and other goods

-‐  1st soda can brings 2 uBls, -‐  2nd soda can brings 4/3 uBls, -‐  3rd soda can brings 1 uBl…

-‐  1 unit of other goods brings 1 uBl (constant) •  Price: and Budget =$4


? # of soda cans & other goods that max Isa’s sa6sfac6on?


Defini6ons: U6lity represents the saBsfacBon that an individual derives from consuming a given good or taking a certain acBon. It is measured in u"ls per unit of "me.



Defini6ons: Decreasing Marginal U6lity captures the fact that the uBlity from consuming an extra unit of a given good decreases with the number of units that have been previously consumed.



≥ <

GO! Take the ac6on Don’t take the ac6on



Cost-‐Benefit Principle: The Cost-‐Benefit Principle states that an acBon should be taken if the marginal benefit is greater than the marginal cost.


Quan66es Demanded




Defini6on: The Quan6ty Demanded by a consumer represents the quanBty of a given good or service that maximizes the uBlity experienced by the individual consuming it.



Defini6on: The Demand Curve represents the relaBonship between the price of a good or service and the quanBty demanded of that good or service.

Vary the price of soda cans to see how the demand of soda cans would change with it (?)


Demand Curve for an Individual If Pcan= $4 the quan6ty demanded is Q*

can = 0 (Point A)


If Pcan= $2 the quan6ty demanded is Q*can = 1 (Point B)


Law of Demand: The tendency for a consumer to demand more of a certain good or service when the price of that good or service decreases.



Why did the demand for soda ! when price "?

•  other goods became cheaper (relaBve to the price of soda) than before and so Isa decided to consume more of them à

•  an increase in the price soda makes Isa poorer in terms of her purchasing power à



Defini6on: The Subs6tu6on Effect captures the change in the quanBty demanded of a given good following a change in its relaBve price. ! priceà SubsBtuBon Effect " quanBty consumed. " priceà SubsBtuBon Effect ! quanBty consumed.



Defini6on: The Income Effect captures the changes in the quanBty demanded of a given good following the reducBon in the consumer’s purchasing power.

! priceà Income Effect ? quanBty consumed.

" price à Income Effect ? quanBty consumed.



Income Effect: For a normal good, ! in income à ! quanBty consumed. " in income à " quanBty consumed. For an inferior good, ! in income à " quanBty consumed. " in income à ! quanBty consumed.



Subs6tu6on Effect + Income Effect: Usually the SubsBtuBon Effect dominates so " price à ! overall quanBty consumed. ! price à " overall quanBty consumed. For a Giffen good (very rare), " in price à " overall quanBty consumed!!



Demand curve can be interpreted

: Start from a certain Price and then use the demand curve to derive the QuanBty of goods that the consumer is willing to buy at that price .

: Start from a given QuanBty, find the associated Price on the demand curve à the maximum amount of money the consumer is willing to pay for the marginal unit of the good, also called Consumer Reserva-on Price (or Willingness to Pay)


From a Discrete to a ConBnuous Model


From a Discrete to a Con6nuous Model



ΔP # ?? ΔQ # move along the demand curve

Demand Curve = MB curve (for consumer)

Δ preferences (mk6ng, price of other goods) # shi9 of the demand curve



Defini6on: Two goods are Subs6tutes when an " in the price of one causes an " in the quanBty demanded of the other. Two goods are Complements when a ! in the price of one causes an " in the quanBty demanded of the other.



What :

•  Successful campaign •  Decrease in the •  An increase in the •  An increase in for a normal good •  A decrease in for an inferior good •  A posiBve shif in for a good •  (about éin future prices that push the buyers to try to purchase the goods early)

• 


Price ElasBcity of Demand

Defini6on: The Price Elas6city of Demand represents the percentage change in the quan"ty demanded resul"ng from a very small percentage change in price. It also measures the responsiveness of the demand to changes in price.


Price ElasBcity of Demand Elas6cityA = (1/slope) x (PA/QA)

Elas6cityA < 0 … Why?

"P # !Q !P # "Q


Elas6cityA = (ΔQ/QA) / (ΔP/PA)

(Conven6on: When we report the elas6city we always use its absolute value)


Law of Demand: Demand curves have the tendency of being downward sloping.



Defini6on: Elas6c Demand: Demand is elasBc when the price elasBcity of demand is greater than 1. Unit Elas6c Demand: Demand is unit elasBc when the price elasBcity of demand is equal to 1. Inelas6c Demand: Demand is inelasBc when the price elasBcity of demand is less than 1.



What changes the elas6city of demand:

•  •  •  • 


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Chapter3 Slides