IX Lecture Notes: October 3, 2007; Problem Set 2 Due Quiz from Fall 2006 on Blackboard I. Consumer's Demand Theory II. Exchange Among Primitives Yezer Does Anthropology III. The Paradox of Value: Diamonds v. Water IV. Consumer's Surplus and Marketing I. Consumer's Demand Theory A. Problem: what produces demand curves? B. Maximizing utility when prices are equal 1. The "equal marginal utility principle" 2. If prices are equal, equate marginal utilities U(Bagles) Total Utility U(Apples) Total Utility MU=0
Apples/week Utility/Apple Utility/Bagel
Bagels/week
MU=0 MU(B) Equal marginal utility if PA = PB, consume A*,B*
A* Apples/week B* Bagels/week D. Maximizing utility when prices are unequal
1. MU/price = marginal utility of last dollar spent 2. Maximize utility by equating the marginal utility of the last dollar spent on each item consumed 3. Set MUApples/PApples = MUBagels /PBagels to maximize 4. Or: MUApples/MUBagels = PApples/PBagels to maximize 5. Marginal rate of Substitution = price ratio E. Intuition about this result: if grapes cost twice much consume until MU of grapes is twice MU apples! F. Why does demand curve slope down? 1. Price falls, you must lower MU by buying more 2. Price rises, you must raise MU by buying less II. Exchange Among Primitives Yezer Does Anthropology A. Gathers have grain, MUGrain low, MUMeat high A. Hunters have meat, MUGrain high, MUMeat low C. Gather's exchange grain for meat until.... 1. MUGrain/MUMeat same for both groups 2. Exchange in markets Eliminates Diversity! 3. Everyone has same the ratio of MU's for goods that they consume if they face the same price ratio! D. Today, imagine meeting outside a grocery store 1. Exchange of groceries won't happen... because.. 2. Ratios of MU's have been equated to price ratios III. The Paradox of Value: Diamonds versus Water A. Water is "free" but essential, diamonds costly but hardly necessary to sustain life. B. Resolution: price reflects MARGINAL not TOTAL utility. Last unit of water gives little utility but last unit of diamonds gives substantial satisfaction. IV. Consumer's Surplus & Marketing
A. Total benefit, total expenditure and price 1. Price reflects marginal benefit 2. Price x quantity = total expenditure 3. Area under demand curve = total benefit 4. Consumer's surplus = total benefit - expenditure B. Example: buying donuts for $.40 each 1. Consumer's surplus = total benefit - expenditure $/Donut .8 .7 Consumer Surplus Triangle .6 0.4(4.5)/2 = $1.80/2 = $0.90 .5 .4 .3 .2 .1 0 DDONUTS 1 2 3 4 5 6 7 8 9 Donuts Per Week C. "Donuts of the week" club for $2.50 & PDonuts = 0 1. Consumer's surplus = benefit of 9Donuts club fee 2. CS = 0.8(9)/2 2.50 = $3.60 2.50 = $1.10 2. Compare CS of $.40 per donut with $2.50 for club.. $0.90 < $1.10 so join the club & eat 9 donuts/week! D. Economics of the "giant economy size" 1. Economics of quantity discounts - stepwise supply E. Multi-part pricing and selection among consumers 1. Economics of cover charges & membership fees F. Note: market solutions maximize consumer surplus