 Instructor: Nguyen Thi Minh Thu

 Contact: thuntm@ftu.edu.vn
0902172177
 Assessment
 Attendance: 10%
 Midterm 1: 15% (True/false questions, problems)
 Midterm 2: 15% (True/false questions, problems)
 Final exam: 60%
 Textbooks

 Pyndick, Rubinfeld, Microeconomics (any ed.), Pearson

 Perloff, J.M., Microeconomics (any ed.), Pearson
4 4 DON’Ts

 BE LATE

 CHAT

 SLEEP

 USE PHONE

Nguyen Thi Minh Thu, FIE, FTU

5 QUESTION 1

1. You can buy a book at the store next door for

$15 or at Dinh Le bookstore for just 5$. Where
would you buy?
2. You can buy a laptop at the store next door for
$1,000 or at Dinh Le store for $990. Where
would you buy?
6 QUESTION 2

 Suppose that the Youth Union holds a prom

and 100 students confirm to attend.
 Each will have to pay 200,000 VND to cover
payment for food (150,000 VND each) and
music band.
 One hour before the party, one classmate
shows up and asks to join. However, this guy
just has 180,000 VND.
 What is your decision?
Chapter 1: Demand
Theory

Nguyen Thi Minh Thu

 Chapter outline

1. Demand analysis
2. Demand estimation
3. Demand forecast
Demand analysis

1.1 Consumer choice

1.2 Revealed preference
1.3 Characteristics demand
1.4 Network externality
 1.1 Consumer choice

1.1.1 Consumer preferences

1.1.2 Budget Constraints
1.1.3 Optimal choice
1.1.4 Substitution Effect and Income Effect
 Consumer Preferences

Basic Assumptions
1. Completeness
2. Transitivity
3. Non-satiation
 Consumer Preferences

 marginal utility (MU) Additional satisfaction

obtained from consuming one additional unit of a good.
 diminishing marginal utility Principle that as more
of a good is consumed, the consumption of additional
amounts will yield smaller additions to utility.
 Indifference curves
 indifference curve: Curve representing all
combinations of market baskets that provide a
consumer with the same level of satisfaction.
 An indifference map is a set of indifference
curves that describes a person's
preferences.
 Indifference Curves
 Indifference Curves
Cannot Intersect Y
 Indifference Curves slope
downwards.
A
 Indifference Curves are
convex to the origin, ΔY
B
reflecting a diminishing C
marginal rate of D

substitution. 14
X
ΔX
 INDIFFERNCE CURVE
15

 Marginal rate of substition of

good X for good Y, denoted Y
as MRSXY, reflects the
amount of good Y the
consumer has to give up to
consume an extra unit of Y1 A
good X holding the same ΔY
level of utility. Y2 B
IC
ΔX

0 X1 X2 X

Nguyen Thi Minh Thu, FIE, FTU

 INDIFFERENCE CURVE
17

ΔTUX = MUX * ΔX Y

ΔTUY = MUY * ΔY
ΔTU = ΔTUX + ΔTUY = 0
Y1 A
MUX * ΔX+ MUY * ΔY=0
ΔY
Y2 B
IC
ΔX

0 X1 X2 X

Nguyen Thi Minh Thu, FIE, FTU

INDIFFERENCE CURVE
18

 From equation (1), we have

Y MU X
 IC’s slope = 
X MU Y
Nguyen Thi Minh Thu, FIE, FTU
 Budget Constraints
 budget constraints Constraints that consumers face
as a result of limited incomes.
 budget line All combinations of goods for which the
total amount of money spent is equal to income.
 Budget Constraints
 Px* X + PY * Y= I
 The slope of the budget line Y
equals the price ratio.
 The vertical and horizontal I/PY

intercepts represent the

maximum amounts of good Y
and X that the consumer can
afford.
 Any point beyond the budget
line is unaffordable. BL
0 I/PX X

20
 OPTIMAL CHOICE
21

 At point M Y

IC’s slope= BL’s slope I/PY

 - MUX/ MUY = - PX/PY A

MUX/ PX = MUY/PY M

The marginal utility of U2

B
a dollar spent on each BL
good is the same. 0 I/PX X

Nguyen Thi Minh fall, FIE, FTU

 Corner Solution

 corner solution Situation in which the

marginal rate of substitution for one good
in a chosen market basket is not equal to
the slope of the budget line.
Corner Solutions
23

When a corner solution

arises, the consumer
maximizes satisfaction
by consuming only one
of the two goods.

0 X
 Application

 Which kind of aid do you prefer, cash or voucher?

Entertainment

A
L

B N Education
 Lagrangian Method

 Lagrangian method is the strategy to find the

local maxima/ minima subject to constraints.
 Consumers are supposed to aim at maximizing
Utility subject to budget constraints.
 L = U(X,Y) – λ.(I – X.PX – Y.PY) max
Necessary conditions
From the above equations, it can
be infered that:
 Effect of Income changes

 An increase in income, with the prices of all

goods fixed, causes consumers to alter
their choice of market baskets.
 The baskets that maximize utility for
various income levels trace out the price-
consumption curve.
 Y
Income Consumption Curve

29 I2/PY BL2 An increase in a person’s

income can lead to less
M3 consumption of one of the
I1/PY two goods being purchased.
M2
The ICC bends backward
M1 between M2 and M3

BL1
U1
0 X1 X3 X2 X

PX

P0
D2

D1 D3

0 X
 Effect of price changes
 A change in the price of a good, with
income and the price of the other
fixed leads to
- The pivot of the budget line
 Change in relative prices of the two
goods
 Generate both income effect and
substitution effect.
 Effect of price changes
 substitution effect Change in consumption of
a good associated with a change in its price,
with the level of utility held constant.
 income effect Change in consumption of a
good resulting from an increase in purchasing
power, with relative prices held constant.
 The total effect of a change in price is given
theoretically by the sum of the substitution effect
and the income effect.
Effects of Price change
32

 BL0: Hypothetical Budget line Y

BL0
tangent to the initial indifference
curve and parallel with the new
budget line. BL2 U
2
M0
 M1 – M0: The move caused by
M1
change in relative prices keeping U1
M2
real income(satisfaction) constant.
SE BL1
 M0 – M2: The move caused by IE
0
change in purchasing power while X2 X0 X1 X
keeping the relative prices PX
constant. P2
P1

X X X
Effect of price changes
33

X IS AN INFERIOR
Y

M0
BL2

M1
M2 U1

U BL1
BL0
0 2
X
IE TE

SE
Effect of price changes
34

GIFFEN GOOD
Y

M2

M1

TE M0
BL2
SE BL0
0 IE X
 Revealed Preference

1. Rationality:
The consumer is assumed to behave rationally, in that he
prefers bundles of goods that include more quantities of
the commodities.
2. Transitivity:
If in any particular situation A > B and B > C, then A > C.
 Revealed Preference

3. The revealed preference axiom:

The consumer, by choosing a collection of goods in any

one budget situation, reveals his preference for that
particular collection.

The chosen bundle is revealed to be preferred among all

other alternative bundles available under the budget
constraint.
 Revealed Preference

4. Consistency:
The consumer behaves consistently, that is, if he chooses
bundle A in a situation in which bundle B was also
available to him, he will not choose B in any other
situation in which A is also available.
38 Consistency
When the budget line is BL0, the consumer choose A
Y over B.

Therefore, when the budget line is BL1, although

both A and B are available to him/her, he/she will not
choose both.

BL0 A

BL1
0
X
REVEALED PREFERENCE
39

Y Because the consumer is consistent, M0

A
must be in the right of M1.
In case of a normal good, M2 must be in the
G
right of M2
M1

M2
M0
BL1 BL2
BL0
0
C X
B F
 Characteristics Demand

 The theory is developed by Kelvin Lancaster in 1966.

 He argued that consumers not only make choices
between quantities of distinct goods but also between
similar goods with different combinations of
characteristics.
 It states that consumers derive utility from the
characteristics of the goods and seek to maximize
utility.
 Characteristics demand
41

X2 Pear
Peach
(Sweetness)

A B

M
F
Apple
C

G
0
X1
(Crunch)
 Network Externality

 network externality When each individual’s

demand depends on the purchases of other
individuals.
 A positive network externality exists if the quantity
of a good demanded by a typical consumer
increases in response to the growth in purchases
of other consumers.
 If the quantity demanded decreases, there is a
negative network externality.
 Positive Network Externality:
Bandwagon Effect

 A bandwagon effect is a positive

network externality in which the D1
quantity of a good that an
individual demands grows in 50
response to the growth of
purchases by other individuals.
 In this case, as the price of the 30
product falls from $50 to $30, the
bandwagon effect causes the Pure Price
Effect
demand for the good to shift to the
right. 43
20 40 60

Bandwagon Effect
Negative Network Externality: Snob Effect

70
 The snob effect is a D1

negative network
externality in which the
quantity of a good that
30
an individual demands
Price Effect
falls in response to the
growth of purchases by 44
15 30 55
other individuals
Snob Effect
 Demand Estimation

 Statistical Approach to Demand

Estimation
 Interview Approach
 Experimental Approach
 Statistical Approach to Demand Estimation

 Linear Demand Estimation

QD = aP + b
Eg: P1 = 55 Q1 = 1200
P2 = 45 Q2= 1500
 a = -30,b = 2850
 Statistical Approach to Demand Estimation

 Iso-elastic Demand Estimation: price elasticity and the income

elasticity are constant
Q = A P b Ic
Or log(Q) = logA + blog(P) + c log(I)
 Interview Approach

 Interviews: select a group of people and ask each person a series

of questions, such as how much of a product they might be willing
to buy at a given price, what features they like, etc.

 The results are used to offer information and advice to managers to

enable them to make more informed decisions.
 Interview Approach
 Shortcomings
 The problem of the sample: If the participants do not represent the target
group, the sample is biased and the results may not be meaningful.
 If the response rate is low, the data collected are not representative of
the group.
 The respondent might not tell the truth
 In face to face interview, the answers may be influenced by the
interviewer.
 Misunderstanding of the questions
 The respondent may not have sufficient knowledge about the product to
answer.
 Consumer Experiments
 Invite a group of people to consumer clinic.
 Participants may be asked to spend “play” money in a shopping
environment
 Pros: provide useful information about product characteristics and
the combination of characteristics that consumers prefer.
 Cons: The results of such artificial experiments have to be assessed
carefully because the may not reflect what the respondent would
actually do in real situation.
DEMAND FORECAST

1. Time series
2. Moving average
3. Exponential Smoothing
4. Barometric method
 52 Time series
 Time series are composed of four components:
 Trend
 Seasonality (S)
 Irregular movement
 Cyclical element
TIME SERIES
53

 Additive relationship
Xt = St + It +Tt + Ct

 Multiplicative relationship
Xt = St . It . Tt . Ct
 54
Observed value Trend (Tt) (St+It)
Time period(t) (Xt)

2010 Spring 2419 2848 -429

Summer 2947 2907 40
Fall 3396 2967 429
Winter 3515 3026 489
2011 spring 2742 3086 -344
summer 3127 3146 -19
fall 3978 3205 773
winter 2439 3265 -826
2012 spring 2686 3324 -638
summer 3493 3384 109
fall 4185 3444 741
3920 3503 417
Period
55
Observed (Xt) Trend (Tt) (St+It)

2013 spring 2690 3563 -873

summer 3598 3622 -24
fall 4317 3682 635
winter 4035 3742 293
2014 spring 3069 3801 -732
summer 3337 3861 -524
fall 4439 3920 519
winter 4242 3980 262
2015 spring 2910 4040 -1130
summer 3923 4099 -176
fall 4809 4182 627
winter 4570 4218 352
 56

 Supposed Ct = 0
  S+I = X – T
 Regress T to t
 T= f(t): T= 2787,9 + 59,7t
 R2= 0,8555
 57
 Seasonal and irregular elements for each season are as
follows:
spring = -691
summer = -99
fall = 624
winter = 165
 spring 2017
 t= ( 2017 – 2010) * 4 +1 = 29
 Q = (2787,9 + 59,7 * 299) – 691 = 3828.2
Moving average
58

 Based on last x periods

 Smoothes out random fluctuations

 RMSE ( Root mean square error)

Where

At: Actual value

Ft: Forecast value

N: Number of period
Quarter Actual 3 period A- F (A-F)2 5 period A-F (A-F)2
59 market average average
share

1 20 - - - - - -
2 22 - - - - - -
3 23 - - - - - -
4 24 21,67 2,33 5,4288 - - -
5 18 23,00 -5,0 25,000 - - -
6 23 21,67 1,33 1,7689 21,4 1,6 2,56
7 19 21,67 -2,67 7,1289 22,0 -3,0 9,00
8 17 20,00 -3,0 9,0000 21,4 -4,4 19,36
9 22 19,67 2,33 5,4289 20,2 1,8 3,24
10 23 19,33 3,67 13,4689 19,8 3,2 10,24
11 18 20,67 -2,67 7,1289 20,8 -2,8 7,85
12 23 21,00 2,00 4,0000 19,8 3,2 10,24
Tổng 78,3534 Tổng 62,48
13 ???? 21,33 20,6
60
 Moving average of 3 last periods
RMSE = 2,95
 Moving average of 5 last periods
RMSE = 2,99
 Market share for quarter 13th is F13 = 21,33
Exponential Smoothing

 Ft+1 = w At + (1-w) Ft
 Where A is the actual value of period t, and w is its
weight.

 Find the weight with which the

RMSE is the least.
 62 BAROMETRIC METHOD
 In barometric method, demand is predicted on the basis of past events or
key variables occurring in the present.

 For example the demand for 1st grade textbook can be forecast based on the
number of children born 6 years ago.