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Microeconomics 1000
Lecture 1
Demand and willingness to
pay
Copyright © 2004 South-Western
Teacher
• Vincenzo Denicolò
• Room 104, Astley Clarke Building
• E-mail address: [email protected]
• Office hours: Thursdays 2p.m. – 4 p.m.
Copyright © 2004 South-Western
Timetable
(but check course web page for possible changes!)
Week
starting on
Wednesday 11a.m.
Thursday 11a.m.
Friday 10a.m.
2
(Oct. 10th)
X
X
X
3
(Oct. 17th)
X
X
4
(Oct. 24th)
5
(Oct. 31st)
X
X
6
(Nov. 7th)
X
X
7
(Nov. 14th )
X
X
X
8
(Nov. 21st)
No
lectures
this week
9
(Nov. 28th)
X
X
X
10
(Dec. 5th)
X
X
11
(Dec. 12th)
X
X
X
Copyright
© 2004
South-Western
Copyright
© 2004
South-Western
Exam
• 30 multiple choice questions
• 1 essay (to be chosen out of 4 titles)
Copyright © 2004 South-Western
Classes and Tutorials
• Staring from week 3 (the next week) you will
have to attend also classes and tutorials
• Classes discuss multiple choice questions
• Tutorials will cover more complex exercises
Copyright © 2004 South-Western
Textbook
• N Gregory Mankiw and Mark P. Taylor,
Economics, 2010, South-Western Cengage
Learning. ISBN 978 1 4080 2126 2
• Website:
http://www.cengage.co.uk/mankiw_taylor_special
• chapters 1-2 are introductory chapters that should be
read before the course starts
• Exercise 1 serves as a review of this preliminary
material
Copyright © 2004 South-Western
Alternative textbook
• Paul Krugman and Robin Wellas, Economics,
2009, Worth Publishers (or the
Microeconomics only version)
Copyright © 2004 South-Western
Microeconomics…
• Typical microeconomic issues
• Strategic behaviour of firms (e.g., why did
Microsoft decide to bundle Windows and Internet
Explorer?)
• Determinants of the demand for specific goods
(e.g., why has health expenditure been increasing
over time?)
• Effect of specific taxes (e.g., why is alcohol
generally taxed more heavily than milk, and what
effect does this have on alcohol consumption?)
Copyright © 2004 South-Western
And Macroeconomics (II semester)
• Typical macroeconomic issues:
• Why is UK per capita income today ten times as
large as in 1850?
• Why is UK per capita income ten times as large as
Bolivia’s?
• What determines the inflation rate?
• What are the consequences of large fiscal deficits?
Copyright © 2004 South-Western
That is:
• Microeconomics studies the behaviour of single
economic agents (firms, consumers), and the
way in which they interact in the market place
• Macroeconomics studies the behaviour of
aggregate variables (national income, the
average level of prices, imports and exports)
Copyright © 2004 South-Western
Market economy
• Our main aim is to understand how a market
economy works
• In a market economy, the allocation of
resources (in other words, who does what and
who gets what) is determined by the market
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A few definitions
• Market: the set of trades concerning a particular
good
• Equilibrium: a situation in which no economic
agent would want to change his or her
behaviour, even if he or she is given the
opportunity to
• Efficiency: the property of not being further
susceptible of improvement
Copyright © 2004 South-Western
Demand and willingness to pay
• We start from the case of an indivisible good
• To begin with, we further assume that the buyer
wants at most one unit of it (e.g., a movie, or an
economic textbook)
• The willingness to pay is the maximum amount
of money the buyer is willing to pay
Copyright © 2004 South-Western
Wtp and price
• Note: in general, w.t.p. ≠ price, which is what
the buyer actually pays (if he purchases the
good)
• We shall denote wtp by the letter v, and price
by the letter p
• Thus, v ≠ p
• However, for a rational buyer who purchases
the good, we can be sure that v ≥ p
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What determines wtp?
• There are two main determinants of the wtp of a
buyer for a good:
• His preferences
• His income
• These will be studied in greater detail in
Lecture 15
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Uses of wtp
• Two uses of the w.t.p.
• To assess the value of the good to the buyer, and
hence how much he gains from trade
• To determine buyer’s behaviour (i.e. his demand for
the good)
Copyright © 2004 South-Western
Gains from trade
• The buyer’s benefit from trade is v – p; this is
called consumer surplus or consumer rent
• The implicit assumption is that the w.t.p. is a
good measure of the value of the good to the
consumer
• However, recall that the w.t.p. depends also on
the consumer’s income
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Demand
• If the buyer is rational, he will demand (that is,
he is willing to purchase) the good if and only if
p ≤ v (if p = v the buyer is actually indifferent
between purchasing or not)
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Demand schedule
• Now imagine that there are several potential
buyers (e.g., A, B, C and D) with different
w.t.p.’s, vA, vB, vC and vD
• If necessary, rename buyers so that
v A ≥ vB ≥ vC ≥ vD
• Suppose all buyers behave rationally
Copyright © 2004 South-Western
price
20
vA
Consumer rent: 20 – 17 = 3
17
p
vB
12
vC
8
vD
3
O
1
2
3
4
quantity
Copyright © 2004 South-Western
price
20
vA
Consumer rent: (20 – 5) + (12 – 5) +
(8 – 5) = 25
vB
12
vC
8
p
5
3
O
vD
1
2
3
4
quantity
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price
With a large number of buyers, we
can approximate the demand
schedule by a smooth curve, the
demand curve
quantity
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Summary
• The demand schedule is a table that represents for each
value of the price the total quantity consumers are willing
to purchase at that price
• The demand function is the relation between quantity and
price
• The demand curve represents the demand function
(notice that the dependent variable, quantity, is represented
on the horizontal axis, contrary to standard mathematical
convention)
Copyright © 2004 South-Western
Summary
• If the price goes down
• Demand goes up (the number of consumers i such
that vi ≥ p can only increase, or at most stay
constant, if p decreases)
• Consumer surplus goes up (more consumers are
served, and each of them gains more from trade)
Copyright © 2004 South-Western
Many units
• Assume again that the good is indivisible, but
now suppose the consumer may consume more
than one unit (e.g., shirts)
• Successive units may be seen as separate goods
• Let v(n) denote the total w.t.p. for n units
• Then, v(n) – v(n – 1) is the willingness to pay
for the nth unit (the marginal willingness to
pay)
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Optimal consumption
• Assumption: the marginal w.t.p. is decreasing
in n
• Assumption (rationality): the consumer chooses
n so as to maximise his net benefit from trade,
v(n) – n×p
• Optimal behavioural rule: consume one more
unit as long as
marginal w.t.p. ≥ price
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Example
• Suppose
v(1) = 20
v(2) = 32 so v(2) – v(1) = 12
v(3) = 40 so v(3) – v(2) = 8
v(4) = 43 so v(4) – v(3) = 3
• We obtain exactly the same demand schedule as in our
original example with four different consumers
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Figure 1 Catherine’s Demand Schedule and Demand
Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price ...
2.00
1.50
1.00
0.50
6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
0 1 2 3 4 5
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© 2004
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© 2004South-Western
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