lectureOutline05 - Introduction to Economics Topic 5:...

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ECO 100Y Introduction to Economics Topic 5: Consumer Theory – Basic Concepts Source: LR12, LR11 and LR10, Chapter 6 1 Topic 5: Consumer Theory - Basic Concepts ECO 100 W.G. Wolfson Consumer Theory Some Questions: Why do demand curves have a negative slope? Are demand curves always negatively-sloped? How do “relative price effects” and “income effects” help to explain a demand curve? To answer these questions, we study the behaviour of individual households (consumers) according to 2 models: Utility Theory Indifference Theory ECO 100 W.G. Wolfson 2 Topic 5: Consumer Theory - Basic Concepts 1 2
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Utility Theory Assumptions Satisfaction can be measured Requires units of satisfaction (“jollies”) Consumer wishes to maximize satisfaction One-Good Utility Theory Focus on one commodity alone (Good X) Consumer can acquire as much as desired The consumer’s Total Utility Schedule (TU) is known Marginal Utility can be calculated: MU = TU / X MU (eventually) declines 3 Topic 5: Consumer Theory - Basic Concepts ECO 100 W.G. Wolfson One-Good Utility Theory Quantity Total Utility (jollies) 0 0 1 10 2 18 3 24 4 28 5 30 6 30 7 28 Marginal Utility (jollies) 10 8 6 4 2 0 -2 ECO 100 W.G. Wolfson 4 Topic 5: Consumer Theory - Basic Concepts 3 4
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Deriving The Consumer’s Demand Schedule Quantity Marginal Utility (jollies) 0 1 10 2 8 3 6 4 4 5 2 6 0 7 -2 Suppose Good X is free (P X = $0) Suppose P X = $1 Consumer needs to weigh gain in satisfaction from consuming a unit of X vs. the loss in satisfaction from giving up $1 to acquire it Implies a need to value $1 in “jolly” terms Suppose $1 is “equivalent to” 1 jolly Repeat for P X = $2 3 points on the D schedule have now been derived Negatively-sloped D arises from diminishing MU ECO 100 W.G. Wolfson 5 Topic 5: Consumer Theory - Basic Concepts Consumer Surplus Arises from a market in which a single price is charged (paid) for all units Evident that the consumer is willing to pay more for the units prior to the last one The MU of these units is larger Difference between total $ amount willing to pay and total $ amount actually paid is called Consumer Surplus ECO 100 W.G. Wolfson 6 Topic 5: Consumer Theory - Basic Concepts 5 6
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Calculating Consumer Surplus (CS) Q D Price CS if P=$2 (Integer estimate) 0 $6 - 1 $5 $3 2 $4 $2 3 $3 $1 4 $2 $0 $6 If P = $2, the “integer estimate” for CS is $6 CS is properly calculated as the area under the Demand curve above the price If P = $2, CS = $8 Note that a higher price reduces CS An excise tax will reduce CS ECO 100 W.G. Wolfson 7 Topic 5: Consumer Theory - Basic Concepts
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This note was uploaded on 05/13/2008 for the course ECO 100 taught by Professor Indart during the Fall '08 term at University of Toronto- Toronto.

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lectureOutline05 - Introduction to Economics Topic 5:...

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