Consumer Surplus and Equilibrium
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Transcript of Consumer Surplus and Equilibrium
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8/3/2019 Consumer Surplus and Equilibrium
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2004 Prentice Hall Publishing Ayers/Collinge, 1/e1
CONSUMER
SURPLUS
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The concept of Consumer
surpluswas first introduced by
Marshall.Consumer surplus
measures the differencebetween what a person is
prepared to pay for a
commodity and the amount he
actually is required to pay.
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The amount that the consumer is
willing to pay for the first unit of the
good he buys is termed as consumers
marginal value . THIS VALUE
DECREASE AS MORE AND MORE
UNITS ARE BOUGHT. A consumer
who maximizes marginal value will
buy to that extent where marginal
value equals price.
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The demand schedule of the product Q is given
below .Estimate the demand Function. If the price is6, What is consumer surplus
Price QUANTITY
5 25
6 20
7 15
8 10
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If the demand function for an individual is
P= 16- 0.4Qfor a good . Calculate consumer
surplus for an individual if Q= 20.
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Indifference Curves andIndifference Curves and
equilibrium of consumerequilibrium of consumer
In economic terms, when people areIn economic terms, when people areindifferentindifferentto the choices before them,to the choices before them,they obtain the same amount of utilitythey obtain the same amount of utility
from each of those choices.from each of those choices. AnAn indifference curveindifference curve shows theshows the
combinations of two goods that providecombinations of two goods that providean individual with equal amounts ofan individual with equal amounts ofutility.utility.
An indifference curve slopes downward.An indifference curve slopes downward.
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Assumptions Consumers tastes can be examined with
ordinal utility.
Tastes of consumers are consistent.
More of a commodity is preferred to less.
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Indifference CurvesIndifference Curves
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Characteristics of Indifference
Curves They are generally negatively sloped.
They cannot intersect each other.
The entire set of indifference curve is calledan indifference map.
Indifference curves are usually convex to
the origin. Convexity results from or is areflection of a decreasing marginal rate ofsubstitution.
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The Marginal Rate of SubstitutionThe Marginal Rate of Substitution
The marginal rate of substitutionThe marginal rate of substitution is the quantityis the quantity
of one good that must be given up as theof one good that must be given up as the
consumption of the other good increases byconsumption of the other good increases by
one unit and total utility remains constant.one unit and total utility remains constant.
The marginal rate of substitution can beThe marginal rate of substitution can be
expressed as:expressed as:
Marginal rate ofMarginal rate of
substitutionsubstitution==
Change in the consumption of one goodChange in the consumption of one good
Change in the consumption of another goodChange in the consumption of another good
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The Marginal Rate of SubstitutionThe Marginal Rate of Substitution
DiminishesDiminishes
The marginal rate of substitution is an approximation forThe marginal rate of substitution is an approximation for
the absolute value of the slope of an indifference curve.the absolute value of the slope of an indifference curve.
(A) (B) (C) (D)
BETWEEN
POINTS:
CHANGE IN
CONSUMPTION
OF JUMBOSHRIMP
CHANGE IN
CONSUMPTION
OF CHICKENWINGS
MARGINAL
RATE OF
SUBSTITUTION= (C/B)
A and B (2-1) = 1 (5-8) = -3 3
B and C (3-2) = 1 (3-5) = -2 2
C and D (4-3) = 1 (2-3) = -1 1
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Indifference MapsIndifference Maps
AnAn indifference mapindifference map shows a set of indifferenceshows a set of indifferencecurves.curves.
AnAn indifference curveindifference curve shows combinations of two goodsshows combinations of two goodsthat are equally preferred by the consumer.that are equally preferred by the consumer.
They slope downward and are convex to the origin, notThey slope downward and are convex to the origin, notstraight lines.straight lines.
They can be characterized by the marginal rate ofThey can be characterized by the marginal rate ofsubstitution, an approximation to the absolute value ofsubstitution, an approximation to the absolute value ofits slope. That slope varies along an indifference curve.its slope. That slope varies along an indifference curve.
A consumer s indifference map will have manyA consumer s indifference map will have manyindifference curves, each indicating a different level ofindifference curves, each indicating a different level ofutility. Higher utility is shown by indifference curvesutility. Higher utility is shown by indifference curvesfarther from the origin.farther from the origin.
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Indifference MapsIndifference Maps
More is
better
Good 1
Good 2
Indifference
curves
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Some special types of indifferent
curves Horizontal(X is neutral)
Vertical(Y is neutral)
Negatively sloped straight (MRSxy is
constant)goods are perfect substitute.
Concave to origin. (MRSxy is increasing)
L-shaped(Complementary goods)
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Budget ConstraintsBudget Constraints
TheThe budget constraintbudget constraintis a curve that shows a consumersis a curve that shows a consumers
consumption possibilities for two goods.Given the income ofconsumption possibilities for two goods.Given the income of
consumer and price of two commodityconsumer and price of two commodity
Consumer choice is limited by the amount of money thatConsumer choice is limited by the amount of money thatpeople can spend and the prices of the goods they buy.Pxpeople can spend and the prices of the goods they buy.Px
.Qx+Py.Qy=I.Qx+Py.Qy=I
Points outside the budget constraint require more incomePoints outside the budget constraint require more income
than is currently available and thus cannot be purchasedthan is currently available and thus cannot be purchasednow.now.
The slope of the budget constraint in absolute value termsThe slope of the budget constraint in absolute value terms
equals the ratio of the prices of the two goodsequals the ratio of the prices of the two goods..
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Equation for budget constrain M= Px.X+ Py.Y
Y= M/Py Px/ Py.X
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Budget ConstraintsBudget Constraints
The budget constraint will bea downward-sloping straightline, withthe
slopeequalto -(price of one good/price ofanothergood).
The slope of Rays budget
constraintis
-(price of shrimp/price of wings)
= -1/.25 = -4.
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Budget ConstraintsBudget Constraints
The budget constraint will shiftin a
parallelmannerifincome changes
orwill pivotif one ofthe prices
changes.In theexamples shown,a decrease
in income shifts the budgetconstraintinward.
Alternatively,ifthe shrimp price
doubles,the budget constraint pivots
inward untilitintersects the shrimp axis
athalfthe numberof shrimp that couldpreviouslyhave been purchased.
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Utility Maximization and
Consumers Equilibrium A consumer is in equilibrium when, given
personal income and price constraints, the
consumer maximizes total utility or
satisfaction from his or her expenditure. In
other words, a consumer is in equilibrium
when, given his or her budget line, theperson reaches the highest possible
indifference curve.
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Price Effect , Income Effect , Substitution
Effect
Income Consumption Curve
Price consumption curve
Derivation of demand curve
Price effect- Income and consumption effect
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Class of 2007
A
consumer has a monthly budget ofRs. 200 for buying commodities A and
. Prices ofA and B are Rs 2 and Rs 3
respectively. His utility function is U=4AB
With the objective of maximizing the
utility , determine how the consumer
would allocate the budget .
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Class of 2008
If an individual consumersutility function is
U= X1X2
Money income is Rs 20, while
the price are P1= Rs 2.00 andP2= Rs 8.00 , determine the
utility maximizing choice .
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Class of 2007
Assume that the utility function ofMr. Ray is U= q1q2and price of the
commodity q1 ,P1= Rs 2 and price
of the commodity q2,P2 = 5and theincome of Mr. Ray is Rs 100. Point
out two utility maximizing condition
and also find the optimal
commodity purchases that
maximizes the Utility of Mr Rai.
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Sheela has a monthly income of Rs 1000 that
she allocates among two goods : Wheat flour
and vegetables .
a. Suppose wheat flour costs Rs 10 per Kg and
Vegetables cost Rs 5 per kg . Draw her budget
constraint .
b. Suppose also her utility function is given by the
equation u (W,V)= 2W+ V . What combination
of wheat and vegetables should she buy tomaximize her utility( Wheat and vegetables are
perfect substitute )
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If the utility function of a consumer is U=
X2+Y2+XY. Income of the consumer is Rs
500. If the price of the commodity X is Rs 2and commodity Y Rs 3 , then find out the
optimum quantity X and Y.
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The following table shows the MU OF X and Y of an individual
Units MUx MUy
1 16 152 14 13
3 11 12
4 10 85 9 6
6 8 5
7 7 4
8 6 3
9 5 2
10 3 1
11 1 0
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Suppose the price of X and Y are Rs 2. Individual hasincome Rs 20 and spends all his income .
a. State the equilibrium condition for the individual
b. If commodity Y is saving how would theequilibrium condition will be affected
c. Suppose the MU of fourth unit of Y was 7 utils
rather than 8. What effect it would have on theequilibrium condition .
d. Suppose the MU increased of X as consumerconsumes more of X While MU of Y remainsunchanged
e. Over what range of the MU function do consumersoperate