Lecture notes week 3

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Economics for Management Studies
Gordon Cleveland

Week #3 Demand and Utility Review from last week: Demand and Supply in a Competitive Market Behaviour of buyers and behaviour of sellers are both affected by the price of the good. Movements in price will bring these planned behaviours together in equilibrium. Graphically, changes in price cause movements along demand and supply curves. Changes in any underlying factor cause shifts in these demand or supply curve. For demand curves, these underlying factors include price of a substitute, price of a complement, consumer incomes, population and tastes. For supply curves, the underlying factors are the price of labour, the price of capital, the price of other inputs, and technology. ExplainingExploring Demand Curves Why are demand curves negatively sloped? How do we interpret a point on the demand curve? How do we interpret an area under the demand curve? How do demand curves relate to behaviour of consumers and well-being of consumers? The following points are some of the answers that economists give to the question of why people consume. N Demand curves reflect the utility (or well-being, or satisfaction, or happiness) of consumers measured in dollars. N Demand curves can be used to measure the willingness-to-pay for a good by consumers. N Individuals who consume are making decisions designed to maximize their own well-being (utility), with the income they have available. N Utility is usually not measured in dollars, it is measured in utils An example for these points is as follows: Imagine Fred has a utility function for hamburgers per month where Q = # of hamburgers. We assume (a bit unusual, but convenient) that U is measured in dollars (the value of well-being to Fred). Freds utility function U = 20Q - Q 2 U is total utility Draw and label the total utility function. Notice its shape. Perhaps you can see that dUdQ = 20 - 2Q dUdQ is marginal utility Marginal utility always refers to derivatives Marginal utility is positive, but as Q increases, this gets smaller (it diminishes d UdQ < 0 - this is called [the assumption of] diminishing marginal utility) Draw and label the marginal utility function. Notice its shape. Marginal utility is downward sloping Fred wants to maximize his net gain from consuming hamburgers. He gains utility from consuming hamburgers, but () Fred has to pay for the hamburgers. The net gain is the difference between these is called Consumer Surplus (CS) www.notesolution.com
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