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Unformatted text preview: Chapter 10 Applications of Consumer Demand Preparation. In this note you will encounter the following ideas: Rational choice. The Law of Demand. Maximum Willingness-to-Pay. Food stamps. Black market. Market price as a measure of value. Consumers Surplus as a measure of value. The Diamond-Water Paradox. Consult the index of your textbook and review what your book has to say about these topics before coming to class. Motivation. This lecture note demonstrates how important observations on con- sumers demands are explained in a unified and coherent way by the theory of rational consumer choice described in the previous lecture note. What does coherent mean? It means that we want just the one theory to be able to explain sensibly all of these observations. Lets think of some things that need to be explained. First, the Law of Demand says that market demand curves slope downwards. How does the theory explain that? Second, it is a fact that rich people will typically pay a higher per unit price for most commodities than will poor people. You might say that this is not surprising since rich people have more money and so can afford higher prices. This is true, but it 261 262 CHAPTER 10. APPLICATIONS OF CONSUMER DEMAND does not explain why rich people choose to accept higher prices. After all, anybody, rich or poor, loses some consumption opportunity every time a scarce dollar is spent. Why should rich people tolerate losing scarce dollars at a faster rate per consumption unit (by paying higher prices) than do poor people? What explanation does the theory of rational consumer choice offer? Third, poor people in the United States can apply to receive food stamps. A food stamp is a ticket issued by the US Government that can be used as money at a grocery store but only for the purchase of specific basic types of food ( e.g. for bread, but not for alcohol or caviar). For many years there has existed a thriving black market in food stamps. The market exists because some recipients of food stamps choose to trade some of their stamps for cash, even though the cash received is significantly less that the monetary value of the food items that could have been acquired at a grocery store. Why would a person choose, in effect, to throw money away? Especially, why would a poor person choose to do this? Fourth, some commodities considered to be essential are food, clean water and electricity. The per unit prices of these commodities are low - a few dollars buys a simple meal, a weeks water and electricity consumption for a typical household. In contrast there are other very expensive commodities that are inessential - a Ferrari sports car, a mink fur coat, a big diamond necklace and a 53-inch high-definition television set are examples. How can the theory of rational consumer choice explain why some essentials seem to have such low values attached to them when at the same time some inessentials seem to be highly valued?time some inessentials seem to be highly valued?...
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- Spring '08