Microeconomics (PGP-I)

Session 4

Joysankar Bhattacharya
 Individual Demand Curve

 The consumer is maximizing utility at every point along the

demand curve

As the price of X falls, it causes the consumer to move down

and to the right along the demand curve as utility increases in that
direction.

The demand curve is also the “willingness to pay” curve – and

willingness to pay for an additional unit of X falls as more X is
consumed.

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 The Market Demand Function

Defined:
The Market Demand Function tells us
that the quantity of a good all
consumers in the market are willing to
buy is a function of various factors.

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Market Demand as the Sum of Individual Demands
Catherine’s demand + Nicholas’s demand = Market demand
Price of Price of Price of
Ice-Cream Ice-Cream Ice-Cream
Cones Cones Cones

$3.00 DCatherine $3.00 $3.00

DNicholas
2.50 2.50 2.50

2.00 2.00 2.00

1.50 1.50 1.50 DMarket

1.00 1.00 1.00

0.50 0.50 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 0 2 4 6 8 10 12 14 16 18

Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

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 The Market Demand Curve

Defined:
The Market Demand Curve plots the
aggregate quantity of a good that consumers
are willing to buy at different prices,
holding constant other demand drivers such
as prices of other goods, consumer income,
quality.

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 The Law of Demand

Defined:
The Law of Demand states that the
quantity of a good demanded decreases
when the price of this good increases.

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 Demand Curve Rule

Defined:
A move along the demand curve for a
good can only be triggered by a change in
the price of that good.

Any change in another factor that affects

the consumers’ willingness to pay for the
good results in a shift in the demand
curve for the good.
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 Shifts of the Demand Curve

The Demand Curve shifts when factors other than own

price change

 If the change increases the willingness of consumers to

acquire the good, the demand curve shifts right

 If the change decreases the willingness of consumers to

acquire the good, the demand curve shifts left

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 The Demand for Cars

We always graph P on vertical axis and Q on horizontal axis, but

we write demand as Q as a function of P… If P is written as
function of Q, it is called the inverse demand.

Markets defined by commodity, geography, time.

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 Market Supply

Tells us that the quantity of a good

supplied by all producers in the market
depends on various factors

Plots the aggregate quantity of a good that

producers are willing to sell at different
prices.

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 Market Supply as the Sum of Individual Supplies
Ben’s supply + Jerry’s supply = Market supply
Price of Price of Price of
Ice-Cream Ice-Cream Ice-Cream
Cones Cones Cones
SBen
$3.00 $3.00 $3.00 SMarket
SJerry
2.50 2.50 2.50

2.00 2.00 2.00

1.50 1.50 1.50

1.00 1.00 1.00

0.50 0.50 0.50

0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 0 2 4 6 8 1012141618
Quantity of Quantity of Quantity of
Ice-Cream Cones Ice-Cream Cones Ice-Cream Cones

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 The Law of Supply

Defined:
The Law of Supply states that the
quantity of a good offered increases when
the price of this good increases.

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 Supply Curve Rule

Defined:
A move along the supply curve for a good
can only be triggered by a change in the
price of that good.

Any change in another factor that affects

the producers’ willingness to offer for the
good results in a shift in the supply curve
for the good.
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 The Law of Supply

The Supply Curve shifts when factors other than own price change

 If the change increases the willingness of producers to

offer the good at the same price, the supply curve shifts right

 If the change decreases the willingness of producers to

offer the good at the same price, the supply curve shifts left

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 Market Equilibrium

• Market Equilibrium
• is a price such that, at this price, the quantities demanded and
supplied are the same.
• is a point at which there is no tendency for the market price to
change as long as exogenous variables remain unchanged.

Demand and supply curves intersect at equilibrium

Sup
ply m and
De

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 Example: Market Equilibrium for Cranberries

Qd = 500 – 4p
Qs = -100 + 2p

p = price of cranberries (dollars per barrel)

Q = demand or supply in millions of barrels per year
The equilibrium price of cranberries is calculated by equating demand to supply:
Qd = Qs … or…

500 – 4p = -100 + 2p …
solving

p* = $100
Plug equilibrium price into either demand or supply to get equilibrium quantity:
Q* = 500 – 4(100) = 100 units
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Market Equilibrium for Cranberries

Q* = 100

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 Excess Demand/Supply

Excess Demand: A situation in which the quantity demanded

at a given price exceeds the quantity supplied.

Excess Supply: A situation in which the quantity supplied at a

given price exceeds the quantity demanded.

If there is no excess supply or excess demand, there is no

pressure for prices to change and thus there is equilibrium.

When a change in an exogenous variable causes the demand

curve or the supply curve to shift, the equilibrium shifts as
well.

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 Excess Demand/Supply
Excess supply
Price (dollars S
when price is $5
per bushel)

5.00

E
4.00

3.00

Excess demand
D
when price is $3

8 9 11 13 14

Quantity (billions of bushels per year)

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Shifts in Demand, Supply Unchanged

Demand Increases:

P Q

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Shifts in Supply, Demand Unchanged

Supply Decreases:
PQ

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 Three Steps

 Decide whether the event shifts the supply curve, the

demand curve, or, in some cases, both curves.

 Decide whether the curve shifts to the right or to the

left.

 Use the supply-and-demand diagram

• Compare the initial and the new equilibrium.
• Effects on equilibrium price and quantity.
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 Consumer Surplus

• The individual’s demand curve can be seen as the

individual’s willingness to pay curve.

• On the other hand, the individual must only

actually pay the market price for (all) the units
consumed.

• Consumer Surplus is the difference between what

the consumer is willing to pay and what the
consumer actually pays.

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 Consumer Surplus

Definition: The net economic benefit to the

consumer due to a purchase (i.e. the willingness to
pay of the consumer net of the actual expenditure on
the good) is called consumer surplus.

The area under an ordinary demand curve and

above the market price provides a measure of
consumer surplus

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Four Possible Buyers’ Willingness to Pay

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 The Demand Schedule and the Demand Curve

Price of Albums

Demand
John’s willingness to pay
$100
Paul’s willingness to pay
80
70
George’s willingness to pay
50

Ringo’s willingness to pay

0 1 2 3 4
Quantity of Albums

The table shows the demand schedule for the buyers. The graph shows the
corresponding demand curve. The height of the demand curve reflects buyers’
willingness to pay.
 Measuring Consumer Surplus with the Demand Curve

(a) Price = $80 (b) Price = $70

Price of Price of
Albums Albums John’s consumer
John’s consumer surplus ($30)
$100 surplus ($20) $100
Paul’s consumer
80 80 surplus ($10)
70 70

50 50
Total consumer
surplus ($40)

Demand Demand

0 1 2 3 4 0 1 2 3 4
Quantity of Albums Quantity of Albums
In panel (a), the price of the good is $80, and the consumer surplus is $20. In panel
(b), the price of the good is $70, and the consumer surplus is $40.
 Demand Curve

• The demand curve measures how many people would

want to by the commodity at any particular price

• The demand curve slopes down; as the price of the

commodity decreases more people will be willing to
buy.

• If there are many people and their reservation prices

differ only slightly from person to person, the
demand curve would slope smoothly downward
 How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P1 (b) Consumer Surplus at Price P2
Price Price
A A Additional consumer surplus
to initial consumers

Initial
Consumer
Consumer surplus
consumer
surplus C surplus C to new consumers
P1 P1
B B
F
P2
Demand D E Demand

0 Q1 0 Q1 Q2
Quantity Quantity
Initial price P1, Quantity Q1, Consumer surplus is the area ABC.
New lower price P2, Quantity Q2,
Consumer surplus rises and becomes ADF.
Increase : 1) from initial buyers BDEC and 2)from new buyers CEF
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 Consumer Surplus
Consumer Surplus and Demand
Consumer Surplus Generalized
For the market as a whole, consumer
surplus is measured by the area under the
demand curve and above the line
representing the purchase price of the
good.

Here, the consumer surplus is given by

the yellow-shaded triangle and is equal to
1/2 × ($20 − $14) × 6500 = $19,500.
Applying Consumer Surplus
When added over many individuals, it measures the aggregate
benefit that consumers obtain from buying goods in a market.
Consumer Surplus

G = .5(10-3)(28) = 98

H+I= 28 +2 = 30

CS2 = .5(10-2)(32) = 128

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 Network Externalities

• If one consumer's demand for a good changes

with the number of other consumers who
buy the good, there are network externalities.
 Network Externalities

• Bandwagon effect: A positive network

externality that refers to the increase in each
consumer’s demand for a good as more
consumers buy the good.

• Snob effect: A negative network externality

that refers to the decrease in each consumer’s
demand as more consumers buy the good.
 Bandwagon effect

PX D60

Bandwagon Effect:
D30
• (increased quantity
demanded when more
A consumers purchase)
20
•
B C
10 • •
Pure Market Demand
Price
Effect
Bandwagon Effect

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 Snob Effect

PX

Market Demand Snob Effect:

• (decreased quantity
demanded when more
A consumers purchase)
•
C B
900
• • D1000

D1300

Snob Effect

Pure Price Effect X (units)