Econ Dept, UMR Presents TheThe DemandDemand SideSide ofof thethe MarketMarket StarringStarring u Utility Theory u Consumer Surplus u Elasticity FeaturingFeaturing uThe MU/P Rule uThe Meaning of Value uFour Elasticities: vPrice Elasticity of Demand vIncome Elasticity vCross Price Elasticity vPrice Elasticity of Supply uThe Elasticity-TR relationship InIn ThreeThree PartsParts Consumer Choice Theory Consumer Surplus Elasticity Part 2 ConsumerConsumer SurplusSurplus or,or, DoDo YouYou GetGet WhatWhat YouYou PayPay For?For? andand ResolutionResolution ofof thethe ParadoxParadox ofof ValueValue DoDo YouYou GetGet WhatWhat YouYou PayPay For?For? u Generally, NO u You get more than what you pay for, else why buy? u Only on the margin you get what you pay for WeWe needneed toto wrestlewrestle withwith anotheranother conceptconcept toto discoverdiscover thethe meaningmeaning ofof ValueValue ConsumerConsumer SurplusSurplus AA Consumer’sConsumer’s SurplusSurplus u The difference between the maximum a person is willing to pay for a good or benefit and the cost to the person u Example: Do you get what you pay for? v I’m willing to pay $9 for a 12 pack v Bud is on sale for $4 a case v I pay $4 for something I would be willing to pay $9 for. I get more than what I pay for. That surplus is called My Consumer Surplus MyMy ConsumerConsumer SurplusSurplus GraphicallyGraphically P My Consumer Surplus for $10 my 1st case = (8-4)*1 + $8 (2*1)/2 = $5.00 S $4 d 0 Q/t 1 3 MyMy ConsumerConsumer SurplusSurplus P This is my Consumer $10 Surplus for two CS = (2*2) + $8 cases of Bud (4*2)/2 = $8/t $6 S $4 d 0 Q/t 1 2 3 MyMy ConsumerConsumer SurplusSurplus P This is my Consumer $10 Surplus for three CS = (6*3)/2 = $8 cases of Bud $9/t $6 S $4 d 0 Q/t 1 2 3 ConsumerConsumer SurplusSurplus CS is the area under The area of this P the market demand triangle is the total S curve and above the Consumer Surplus price line--the difference between the maximum P* consumers are willing to pay and what they do pay D 0 Q/t Q* NowNow wewe cancan shedshed lightlight onon thethe MeaningMeaning ofof ValueValue u The Paradox of Value has a long history u From Plato to Adam Smith to the last years of the 1800s u “Price is surely a measure of value, but why then is the price of something that is essential to live, like water, have a very low price but something that is perhaps frivolous, like diamonds have a very high price?” Or,Or, asas AdamAdam SmithSmith wrotewrote inin 17761776 u “The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, whose which have the greatest value in exchange have frequently little or no value I use. Nothing is more useful than water: but it will purchase scarce any thing; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.” WofN, p.28. ParadoxParadox ofof ValueValue u The paradox was resolved when the concept of marginal utility was introduced in the late 1800s u There are two senses of value--Total Value (Total Utility) and Marginal Value (Marginal Utility) u Maximization Theory gives us the MU/P rule u Price is a measure of marginal value u Area under demand is total value Price,Price, aa MeasureMeasure ofof MarginalMarginal ValueValue u MU/P rule u MUA/PA = MUB/PB for all goods, bought u Cross multiply and we get: MUA/MUB = PA/PB u Marginal Utility can’t be measured, but we do see value on the margin in the form of market prices u If PA = $10 and PB = $5, we infer another unit of A would be worth twice as much to society as a unit of B TotalTotal ValueValue u This is trickier u And must be estimated, but value defined as Willingness to Pay can be estimated as u the area under demand curves The End You are ready to go on to Part III.