Chap_05 - Chapter 5 Demand: The Benefit Side of the Market...

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Chapter 5 Demand: The Benefit Side of the Market Purpose: To acquaint students with explanations regarding the shape, location, and content of the demand curve and to show the principles of utility maximization. Issues related to consumer surplus are introduced. Length: 23 pages Time required to read: One and one-half hours. This is a relatively easy chapter to read. There are few new technical concepts and most of the discussion centers on familiar themes. Many students will find reading this chapter to be quite enjoyable. Number of lectures required for understanding: Slightly more than one 50-minute period. The major concepts have already been introduced, so this chapter is intended to add depth and detail. New material centers on the rational spending rule, utility maximization, and consumer surplus. Classes that are weak in math – algebra and geometry – may require extra time. Summary: The expanded discussion of demand is introduced by a story relating to an offer of “free” ice cream at a university celebration. The point is that even when the ice cream is free, there is a “cost” in terms of the time required to stand in line. Waiting is a price and the longer the wait, the higher the “price” in these terms. The ‘Law of Demand” is presented in an abstract form: “ People do less of what they want to do as the cost of doing it rises.” (Frank and Bernanke) The tone of the chapter quickly moves to a more traditional discussion of demand that centers on the relationship between the price of a good and the quantity of that good that is taken off the market. The factors that determine demand – tastes, peer pressure, culture, religion, and the like – are all gathered and represented by the price in more
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disciplined considerations. The differences between needs (absolute necessities to maintain life) and wants (items and experiences that are desired but not needed to sustain life) are discussed and made clear through reference to needs and wants related to the availability and use of water in California and in New Mexico. The economist’s use of “utility” is introduced and described as the reason that people translate wants into demand. The history of the concept is mentioned as are efforts by non-economists to provide an empirical measure of utility. Utility is further refined by concepts relating to marginal utility and the law of diminishing marginal utility. Graphs and formulas are used to show how a consumer can maximize total utility by allocating money between two goods until the “rational spending rule” MU 1 /P 1 = MU 2 /P 2 is satisfied. Arguments and explanations relating to the income effect and the substitution effect are revisited (from Chapter 3) and expanded. A comprehensive example uses words, graphs, and mathematical manipulations to show one person purchasing two goods in different proportions until the rational spending rule and is finally satisfied. This leads into a section that provides several real world examples of income and substitution effects. A graphic demonstration shows the relationship between an individual demand curve and
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Chap_05 - Chapter 5 Demand: The Benefit Side of the Market...

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