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From Individual Demand to Consumer Surplus. Today: Deriving market demand from individual demand; using reservation prices to derive consumer surplus. Previously…. 7 core principles Thinking like economists Introduction to supply and demand Equilibrium - PowerPoint PPT Presentation
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From Individual Demand to Consumer Surplus
Today: Deriving market demand from individual demand; using
reservation prices to derive consumer surplus
Previously…
7 core principles Thinking like economists Introduction to supply and demand Equilibrium A route choice experiment and its
equilibrium Deriving individual demand
Today
Using individual demands to derive market demand
Reservation price Consumer surplus
Recall individual demand
Last time, we went through the assumptions that gave us a downward-sloping individual demand curve
We will use “horizontal addition” to derive market demand from all individual demands
Example: Individual demand to market demand Suppose Pat
and Shannon have the following demand schedules for apples
Price
Shannon’s quantity demande
d
Pat’s quantity demande
d
$6 0 0
$5 2 0
$4 4 0
$3 6 0
$2 8 3
$1 10 6
$0 12 9
Example: Individual demand to market demand
How do we get the market demand from individual demands?
We add them up
Price
Shannon’s
quantity demand
ed
Pat’s quantity demand
ed
Total deman
d
$6 0 0 0
$5 2 0 2
$4 4 0 4
$3 6 0 6
$2 8 3 11
$1 10 6 16
$0 12 9 21
Some graphing reminders Some reminders
of graphs Label axes Label dollar
amounts, quantities, etc.
To save space, all quantity numbers here are apples
Graphing demands:Shannon (left) & Pat (right)
Total demand
How can we graph demand with only the graphs?
Another method of graphing total demand from individual demand is a method called horizontal addition
We horizontally add quantities demanded from each person AT A GIVEN PRICE
Price greater than $3 When price is
greater than $3, Shannon is the only person demanding a positive quantity
Thus, the top half of Shannon’s demand curve is the same as the market’s
At $3, 6 + 0 units are demanded
At $0, 12 + 9 units are demanded
Bottom half of the demand curve At $3, 6 units are
demanded At $0, 21 units
are demanded Bottom half of
demand curve connects (6, $3) and (21, $0)
Reservation price and consumer surplus
How “well off” are we when we buy something?
Calculate consumer surplus by using demand curve and reservation price
Reservation price
Reservation price is the highest price a person is willing to pay for a good or service
Note that reservation price for the nth unit corresponds to a particular point of a demand curve
Let’s return to part of Shannon’s demand Shannon’s
reservation price for 6th apple is $3
Price Shannon’s quantity
demanded
$6 0
$5 2
$4 4
$3 6
Core principle: Efficiency
Today, we calculate consumer surplus to help on our quest to efficiency
Calculating consumer surplus
Consumer surplus (CS) for the nth unit is the vertical difference between the demand curve and the price paid
We will calculate CS two ways Discretely Approximate using area under
demand curve
Back to ShannonPrice Shannon’s
quantity demanded
$6 0
$5 2
$4 4
$3 6
Quantity
Reservation price
1st unit $5.50
2nd unit $5
3rd unit $4.50
4th unit $4
5th unit $3.50
6th unit $3
If P = $3… At P = $3,
Shannon demands 6 apples
To calculate total consumer surplus for Shannon, we simply add CS for each unit purchased
Quantity
Reservation price
CS
1st unit $5.50 $2.50
2nd unit $5.00 $2.00
3rd unit $4.50 $1.50
4th unit $4.00 $1.00
5th unit $3.50 $0.50
6th unit $3.00 $0.00
CS for 6 units purchased CS is the sum of
the six dollar amounts in the right column, or $7.50
Quantity
Reservation price
CS
1st unit $5.50 $2.50
2nd unit $5.00 $2.00
3rd unit $4.50 $1.50
4th unit $4.00 $1.00
5th unit $3.50 $0.50
6th unit $3.00 $0.00
CS from demand curves CS can be
approximated by calculating the area under the demand curve and above the price
The area of this triangle is a good approximation of CS
CS from demand curves Height of triangle
is ($6 – $3), or $3. Length of triangle
is (6 – 0), or 6 Area of triangle is
one-half times length times height
CS = $9
The area of this triangle is a good approximation of CS
This concludes demand
What have we learned? How individual demand is derived Utility The rational spending rule Deriving market demand from
individual demand Consumer surplus