Slide 1Econ 410: Micro TheoryApplications of Market DemandWednesday, September 19th, 2007Slide 2Problem Set Q&A Reminders Due Friday Chapter 3 Problems: Questions for Review, #6, #12, Exercises, #5, #7, #10, #15 Chapter 4 Problems (Appendix):#2, #4, #5 Problems from Chapter 4 will be worth 2 points each, while problems from Chapter 3 will be worth 1 point each. Hints Ordinal vs. Cardinal Utility Showing demand functions are equivalentSlide 3Consumer Surplus The difference between the amount that a consumer is willing to pay for a good and its market price is known as consumer surplus. Consumer surplus measures the ability of a market to make people better off Calculating Consumer Surplus If we know the market demand for a good, consumer surplus can be easily calculated.Slide 4A Classroom Experiment… How much would you be willing to pay for an “A” in this class? Answer honestly – all responses will be kept anonymous Take your individual budget constraints into account Using this information, we can create a market demand curve for an “A” If we know the market demand and the market-clearing price, we can calculate consumer surplusSlide 5A Classroom Experiment… What does the classroom demand for an “A” look like? Suppose Lauren is willing to set the price of an “A” at $50. How would we find the total consumer surplus in this market? How much would Lauren receive from the class in total? How would we illustrate this graphically?Slide 6Applying Consumer Surplus The measurement of consumer surplus has important implications for economics and public policy When examining a policy, economists can use cost-benefit analysis to determine the total benefits and costs to society Consumer surplus can be used as one measure of these benefits Connections to Welfare EconomicsSlide 7Network Externalities So far, we have always assumed that the demand for a good is internal to an individual The consumption of a good by one person does not affect the demand of a different consumer However, there are certain cases in which the demand of one individual can depend on the demand of others These goods are said to have networkexternalities associated with themSlide 8Network Externalities A positive network externality implies that quantity demanded will increase in response to purchases by other consumers. Example – Text Messaging A negative network externality implies that quantity demanded will decrease in response to purchases by other consumers. Example - DiamondsSlide 9 This positive network externality occurs when there is a desire to be in style, to have a good because almost everyone else has it, or to indulge in a fad Example – Tickle-Me Elmo The initial demand for cigarettes, drugs, and alcohol could be a bandwagon effect C'mon, everyone else is doing it….The Bandwagon EffectSlide 10The “Snob” Effect This negative network externality occurs when there is a desire be unique, or own goods that not many other people have. Example – Hand-made goods The quantity demanded of a “snob” good is higher the fewer people who own it. What are some other examples of network externalities?Slide 11Demand in the “Real World” Estimating actual demand curves happens frequently in the real world Companies may estimate demand for their product or the product of a competitor in order to determine a profit-maximizing price Governments might estimate the demand for a good to find out the benefits and costs of a particular policy Example – Food Stamps How do people actually do this?Slide 12Demand in the “Real World” Statistically Estimating Demand When attempting to estimate the demand for a good, it is crucial to understand the product market. How mistakes are made Suppose university officials wish to estimate the demand for season tickets for UNC basketball tickets. Also suppose, for simplicity, that this is a free market with no free student ticketsSlide 13Demand in the “Real World” The officials observe the quantities demanded at various prices and estimate the following function: Qd= a-b(Price of Tickets)Quantity (in thousands)Price0 5 10 15 20 25$60$40$20$100$80D1Slide 14Demand in the “Real World”DGD1D2 But, suppose the available data is from three separate years, each which had a different number of Duke games? What might demand actually look like?D3Quantity (in thousands)Price0 5 10 15 20 25$60$40$20$100$80For this reason, demandestimation is a skill thatrequires a great deal of careand knowledge about whatis being studied.Slide 15For next time… Read in your textbook: Pages 136-138 Sections 5.1 and 5.2 Problem Set Make sure you label all graphs clearly and show your work. Announcements Recall from your syllabus that there will be no class on Friday, September 28th. However, there will be a quiz next Wednesday on the topics covered in class in Chapter
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