chapter 5 - Demand:TheBenefit SideoftheMarket KafuWong 1...

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1 Ka-fu Wong University of Hong Kong Demand: The Benefit  Side of the Market
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2 The Law of Demand People do less of what they want to do as the cost of  doing it rises. The cost of an activity, good, or service involves not just  monetary costs, but non-monetary costs as well. Waiting in the line is  a kind of   nonmonetary cost
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3 Recall  The Cost-Benefit Principle An individual (or a firm or a society) should take an  action if, and only if, the extra benefits from taking the  action are at least as great as the extra costs. Should I do activity x? C(x) = the costs of doing x  B(x) = the benefits of doing x If ES(x) = B(x) - C(x) > 0, do x; otherwise don't. Example of x: consuming an additional unit of sushi.
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4 The Law of Demand The benefit of an activity equals the highest price we’d be willing to  pay to pursue it (i.e., the reservation price). As the cost of an activity rises and exceeds the reservation price,  less of the activity will be pursued.  Our “tastes” or “preferences”, and income determine our benefit. How is “tastes” or “preferences” determined? Biology Culture Peer Influences
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5 Translating Wants into Demand How should we allocate our incomes among the various  goods and services that are available?
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6 Recall  Rules for allocating resources The general rule for allocating a resource efficiently  across different production activities is:   Allocate each unit of the resource to the production  activity where its marginal benefit is highest.   For a resource that is perfectly divisible, and for  activities for which the marginal product of the resource  is not always higher in one than in the others, the rule  is: Allocate the resource so that its marginal benefit is  the same in every activity.  
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7 Measuring Wants: The Concept of Utility Utility The satisfaction people derive from their  consumption activities Assumption (rationality) People allocate their income to maximize their  satisfaction or total utility.
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8 Example 5.1.   Taiji’s Total Utility from Sushi Consumption Pieces of sushi /hour Utils/hour 1 3 4 5 6 0 2 150 140 120 90 50 Pieces /hr Total U /hr 0 0 1 50 2 90 3 120 4 140 5 150 6 140 How many pieces of sushi should Taiji consume if the sushi is “free ”?
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9 Example 5.2. Taiji has been waiting outside a sushi shop for an hour.   Now he is in the front of the line.  He decides to  consume 20 pieces of sushi at the price of $10 each.
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