Consumer

Equilibrium
and Market
Demand
Chapter 4
 Discussion Topics
 What are the conditions that describe
your initial purchase decision?
 What makes you change your purchase
decision?
 A representation of the law of demand
 What is meant by tastes and
preferences
 Use of consumer surplus for benefit
2 calculation
 Measurement and
Interpretation of
Consumer Equilibrium
(Purchase Decision)

3
 Consumer Equilibrium
Remember that utility represents the level
of satisfaction obtained from alternative
bundles (or collection) of goods
Assume the consumer wants to maximize
utility given his/her limited budget
 We also assume that utility only impacted by
the consumption of market goods (i.e. price
exists)
How can we represent this problem
graphically and mathematically?
Page 54
 Consumer Equilibrium
Good 2
Point A is consumer equilibrium
lity → Slope of Indifference Curve
U ti
g U4 = Slope of Budget Line
s in
rea →MRS12= – P1/P2
c
In U
2 → At A, MU1/MU2 = P1/P2
→ At A, on the boundary of the budget
A set and on highest indifference curve
G2 *

Budget Constraint ($C*)

U3

U1 U1 < U2 < U3 < U4

G1 * Good 1
Previously: Slope of Indifference Curve =MRS
Slope of budget line = price ratio
5 Page 54
 Consumer Equilibrium
Good 2 ty
 Point A can be interpreted as
li
ti the combination of goods that
gU U4
s in generates
rea
c
In U  The maximum utility (U3)
2
 While being limited by a
A fixed budget ($C*)
G2 *

U3

U1
G1 * Good 1

6 Page 54
 Consumer Equilibrium
Good 2  Point A can also be interpreted
C 3* C1*< C2*< C3* as the combination of goods
that generates
C2*  The minimum cost ($C*)
 While generating a desired
C1 *
A level of utility (U3)
G2 *

U3

Good 1
G1 *

Why are these parallel shifts

of the budget constraint?
7 Page 54
 Consumer Equilibrium
We can rearrange the above equilibrium
conditions:
MU1 P1 MU1 P1 MU1 MU 2
     
MU 2 P2 MU 2 P2 P1 P2
 → the marginal utility derived from last
dollar spent on each good, MUi/Pi, is identical
 This can be expanded to include all goods and
services purchased by the consumer

Lets extend this to the textbook example of

8 tacos vs. hamburger consumption Page 54
  Utility is maximized by
Consumer Equilibrium buying
 5 tacos @ $0.50
$5 initial budget  2 hamburgers @
$1.25
 Total expenditures
equals the weekly
budget of $5.00

9 Page 54
 Consumer Equilibrium

 Points B and D exceed

the $5 budget
 How can you tell?

10 Page 54
 Consumer Equilibrium

Point C does not

maximize utility
How can you
tell?

Page 54
11
 Consumer Equilibrium
 What happens to the above
consumer equilibrium when the price
of one of the products changes?
 Will consumption of both goods
change even though only 1 price
impacted?
 Lets assume the price of Hamburgers
(PH) changes
 $5.00
 $1.25 (Current Price)
 $1.00
12 Page 54
 Effect of Price Changes
11 Under original budget line ED:
10 E  Price of Hamburgers (PH) = $1.25
 Price of Tacos (PT) = $0.50
Taco Consumption per Week

9
 Income = $5.00
8
 Equilibrium:
7  5 Tacos
6  2 Hamburgers
A
5
4
3
2
1
D

1 2 3 4 5 6
Hamburger Consumption per Week
13 Page 54
 Effect of Price Changes
Budget Line when PH decreases from $1.25, EF:
11  Price of Hamburgers (PH) = $1.00
E
10
 Price of Tacos (PT) = $0.5010
Taco Consumption per Week

9  Income = $5.00
8  Equilibrium moves from A to B:
7  4 Tacos
6  3 Hamburgers
A
5
4 B
3
2
1
D F
1 2 3 4 5 6
Hamburger Consumption per Week
14 Page 54
 Effect of Price Changes
Budget Line when PH increases to $5.00, EG:
11  Price of Hamburgers (PH) = $5.00
10 E  Price of Tacos (PT) = $0.50
 Income = $5.00
Taco Consumption per Week

9
8
 Equilibrium moves from A to C:
 5 Tacos
7  0.5 Hamburger
6
C A
5
4 B
3
2
1
G D F
1 2 3 4 6
Hamburger Consumption per Week
15 Page 54
 Effect of Price Changes
Line CAB represents a consumer
11 demand schedule for hamburgers
10 E  Shows how the consumer responds to
Taco Consumption per Week

9 changes in a good’s price

8  ↑ in price, ↓ in quantity demanded
7  Other prices and total expenditures do not
6
C A change
5
4 B Only hamburger price changing
3
2
1
D F
1 2 3 4 6
Hamburger Consumption per Week
16 Page 54
 Effect of Price Changes
 Lets collect the equilibrium points for the three
hamburger price scenarios
Equilibrium PH QH
Point ($/lb) (No.)
C $5.00 0.5
A $1.25 2.0
B $1.00 3.0
 We can then graph the quantity purchased at each
price level
 Vertical axis is price
 Horizontal axis is quantity
 Graph referred to as the demand curve for
17 hamburgers Page 54
 Consumer Equilibrium
 This graph shows the demand curve
for hamburgers
PH($/Burger)
What is the relationship between
C price and quantity demanded?
$5.00 ̶

Pts. C, A and B correspond

to same points on Slide 16

A
$1.25 ̶
B
$1.00 ̶

QH(No. of Burgers)
̶

̶
̶

0.5 2.0 3.0

18 Page 54
 Effect of an Income Change
Original Budget Line, KJ:
11  Price of Hamburgers (PH) = $1.25
10 K  Price of Tacos (PT) = $0.50
 Income = $5.00
Taco Consumption per Week

9
8
7
Original Equilibrium:
6
5
A 5 tacos/2 hamburgers
4
3
2
1
J
1 2 3 4 5 6
Hamburger Consumption per Week
19 Page 54
 Effect of an Income Change
13
G
12 Budget Line KJ: Income = $5.00
11 Budget Line GF: Income = $6.00
10 K
Taco Consumption per Week

9 New Both hamburgers and tacos

8 Equilibrium are normal goods as budget
7
B increased from $5 to $6/week
6
Normal goods are goods
5 A
4
whose demand increases
3 with higher budget (income)
Original
2 Equilibrium and decreases with lower
1 budget (income)
F
J
1 2 3 4 5 6
Hamburger Consumption per Week
20 Page 54
 Effect of an Income Change
16 E Budget Line KJ: Income = $5.00
15 Budget Line GF: Income = $6.00
14
Budget Line ED: Income = $8.00
13
12
11
G
Tacos become an inferior good
10 K
when budget (income) increased
to $8/week
Taco Consumption per Week

9
8  Inferior goods are goods whose
7 demand ↓ with ↑ in the budget and ↑
B
6 with ↓ in the budget
A C
5
4
3
2
1
F D
J
21 1 2 3 4 5 6 Page 54
 Effect of an Income Change
13
 We can plot demand
12 G levels under alternative
11
budgets (income)
10 K  Referred to as an Engel
Taco Consumption per Week

9
Curve
8
7
6 B
A C
5
4
3
2
1
F D
J
1 2 3 4 6
22 5 Page 54
 Effect of an Income Change
Hamburger Engel Curve Tacos Engel Curve

Typical shape of a normal Example of an Engel curve for

good’s Engel curve over all a good that is an inferior good
23 income levels at higher income (budget) levels Page 58
 Measurement and
Interpretation of
Market Demand

24
 Concept of Market Demand
The above model of consumer
behavior focused on a single
individual

We can extend the above model to one

where we refer to overall or total
market demand for a city, county,
state, country, etc.

25
 Concept of Market Demand

Notice the
kink @ $2

 The market demand curve for a good is the horizontal summation of

demand schedules for all the consumers in the particular market

 In the above example with PH = $1.50

 Paula purchases 2 hamburgers/week while
 Beth purchases 1 hamburger
 → market demand = 3 hamburgers @ a price $1.50/hamburger
26 Page 59
 Demand Curve Description
When discussing events in the market place
economists use specific terms to distinguish
between movement along a demand curve vs.
a shift in a demand curve
Movement along a demand curve referred to
as a change in quantity demanded
Only 1 demand curve, just a different point on it
Alternatively a shift in the demand curve
referred to as a change in demand
Need not be a parallel shift in the demand curve

27
 Movement from point
A to C is referred to as
a change in demand

Movement from
point A to B is
called a change in
quantity demanded

28 Page 61
 Demand Curve Description
 Reasons for a change in a demand curve
 Change in household income
 Change in population characteristics
 Number of children
 Change in marital status
 Household composition
 Price of substitutes
 Change in anything other then own-
price

29
 Concept of Consumer Surplus
A characteristic of market demand
curve
 Concept of consumer surplus (CS) or
economic well-being
 CS is derived from consumption and the
fact we have a negatively sloped demand
curve (with respect to its own-price)

A demand curve reveals the willingness

of consumers to pay a certain price for
a particular quantity of a good
30 Page 63-64
 Concept of Consumer Surplus
 As we showed earlier, consumers are
willing to pay a higher price for a lesser
quantity $/unit
P2 > P1
B
Why do consumers P2 Q 2 < Q1
want to pay less/unit A
when consuming more? P1

Q2 Q1
Q
 Actually do not have to pay the higher price
given the level of supply coming into the
market
 → Consumers realize a savings
31 Page 63-64
 Quantifying Consumer Surplus
$
11 B Area ABC is the consumer surplus
10 when market price is $6.
9
 Demand curve implies consumers are
8
willing to pay $10 for the 1st unit, $9 for
7 C
the 2nd unit, etc.
6
A
 Only had to pay $6 each for all 5 units
5 E
4
D  Area DACE is the gain
3 in consumer surplus if
2 the price falls to $5
1

0 Q
1 2 3 4 5 6 7 8 9 10 11
32 Page 63
 Quantifying Consumer Surplus
$
11
B The level of consumer
10 surplus with a linear
9 demand curve is
7
8
[(Height × Length)/2] =
A
6
C ([$11-$6]×5)/2=$12.50
5
D E Height
4
3 Again, why do we
2 have a consumer
1 surplus?

0 Q
1 2 3 4 5 6 7 8 9 10 11
33 Page 63
 In Summary
Consumer equilibrium for an
individual for a given price and budget
Individual consumer’s demand
schedule
Market demand curve
Engel curves
Change in demand vs. change in
quantity demanded
Consumer surplus
Chapter 5 examines the
concept of an elasticity, one of
the most important concepts in
all of economics….