1. Consumer Equilibrium and Market Demand
Chapter 4

2. Discussion Topics Conditions for consumer equilibrium
Changes in equilibrium
The law of demand
Tastes and preferences
Consumer surplus 2

3. Measurement and Interpretation of Consumer Equilibrium3

4. Consumer Equilibrium
Remember that utility represents the level of satisfaction with alternative bundles or collection of goods
Assume the consumer wants to maximize utility given his/her limited budget
Utility only impacted by the level of consumption of market goods
How can we represent this problem graphically and mathematically?
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5. Consumer Equilibrium Point A is consumer equilibrium
→ Slope of Indifference Curve
= Slope of Budget Line
→MRS12= – P1/P2
→ At A, MU1/MU2 = P1/P2
→ At A, on the boundary of the budget set and on highest indifference curve
Good 2
Increasing Utility U4 U2 A
G2*
Budget Constraint ($C*) U3 U1
U1 < U2 < U3 < U4
G1*
Good 1
Previously: Slope of Indifference Curve =MRS
Slope of budget line = price ratio 5
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6. Consumer Equilibrium
Point A can be interpreted as the combination of goods that generates
The maximum utility (U3)
While being limited by a fixed budget ($C*)
Good 2
Increasing Utility U4 U2 A
G2* U3 U1
G1*
Good 1 6
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7. Consumer Equilibrium
Point A can also be interpreted as the combination of goods that generates
The minimum cost ($C*)
While generating a desired level of utility (U3)
Good 2
C3*
C1*< C2*< C3*
C2*
C1* A
G2* U3
Good 1
G1*
Why are these parallel shifts of the budget constraint? 7
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8. Consumer Equilibrium
We can rearrange the above equilibrium conditions:
→ the marginal utility derived from last dollar spent on each good, MUi/Pi, is identical
This can be expanded to include all goods and services purchased by the consumer
Lets extend this to the textbook example of tacos vs. hamburger consumption 8
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9. Utility is maximized by buying 5 tacos @ $0.50 2 hamburgers @ $1.25
Total expenditures equals the weekly budget of $5.00
Consumer Equilibrium 9
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10. Points B and D exceed the $5 budget How can you tell?
Consumer Equilibrium
Points B and D exceed the $5 budget
How can you tell? 10
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11. Consumer Equilibrium Page 54 Point C does not maximize utility
How can you tell?
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12. Consumer Equilibrium
What happens to the above consumer equilibrium when the price of one of the products changes?
Will the consumption of both commodities change even though only 1 price impacted?
Lets assume the price of Hamburgers (PH) changes
$5.00
$1.25 (Current Price)
$1.00
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13. Effect of Price Changes
Budget Line ED:
Price of Hamburgers (PH) = $1.25
Price of Tacos (PT) = $0.50
Income = $5.00
Equilibrium:
5 Tacos
2 Hamburgers 11 E 10 9 8 7 6
Taco Consumption per Week A 5 4 3 2 1 D 1 2 3 4 5 6
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Hamburger Consumption per Week 13

14. Effect of Price Changes
Budget Line EF:
Price of Hamburgers (PH) = $1.00
Price of Tacos (PT) = $0.50
Income = $5.00
Equilibrium:
4 Tacos
3 Hamburgers 11 E 10 10 9 8 7 6
Taco Consumption per Week A 5 B 4 3 2 1 F D 1 2 3 4 5 6
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Hamburger Consumption per Week 14 14

15. Effect of Price Changes
Budget Line EG:
Price of Hamburgers (PH) = $5.00
Price of Tacos (PT) = $0.50
Income = $5.00
Equilibrium:
5 Tacos
0.5 Hamburger 11 E 10 9 8 7 6
Taco Consumption per Week C A 5 B 4 3 2 1 F D 1 2 3 4 6
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Hamburger Consumption per Week 15 15

16. Effect of Price Changes
Line CAB represents a consumer demand schedule for hamburgers
Shows how the consumer responds to changes in a good’s price
↑ in price, ↓ in quantity demanded 11 E 10 9 8 7 6
Taco Consumption per Week C A 5 4 B 3 2 1 F D 1 2 3 4 6
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Hamburger Consumption per Week 16 16

17. Effect of Price Changes
Lets collect the equilibrium points for the three hamburger price scenarios
We can then graph the quantity purchased at each price level
Vertical axis is price
Horizontal axis is quantity
Referred to as the demand curve for hamburgers
Equilibrium Point
PH ($/lb)
QH (No.) C
$5.00
0.5 A
$1.25
2.0 B
$1.00
3.0
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18. Consumer Equilibrium This graph shows the demand curve for hamburgers
PH($/Burger)
What is the relationship between
price and quantity demanded?
$5.00 ̶ C A
$1.25 ̶ B
$1.00 ̶ ̶ ̶ ̶
QH(Burgers)
0.5
2.0
3.0
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19. Effect of an Income Change
Budget Line KJ:
Price of Hamburgers (PH) = $1.25
Price of Tacos (PT) = $0.50
Income = $5.00 11 K 10 9 8 7
Original Equilibrium 6
Taco Consumption per Week A 5 4 3 2 1 J 1 2 3 4 5 6
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Hamburger Consumption per Week 19 19

20. Effect of an Income Change13 G 12
Budget Line KJ: Income = $5.00
BudgetLline GF: Income = $6.00 11 10 K 9
New
Equilibrium
Both hamburgers and tacos are normal goods as budget increased from $5 to $6/week
Normal goods are goods whose demand increases with higher budget (income) and decreases with lower budget (income) 8 7 6
Taco Consumption per Week B 5 A 4 3
Original
Equilibrium 2 1 J F 1 2 3 4 5 6
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Hamburger Consumption per Week 20 20

21. Effect of an Income Change
Budget Line KJ: Income = $5.00
Budget Line GF: Income = $6.00
Budget Line ED: Income = $8.00 16 E 15 14 13 12 G
Tacos become an inferior good when budget (income) increased to $8/week
Inferior goods are goods whose demand ↓ with ↑ in the budget and ↑ with ↓ in the budget 11 10 K 9 8 7 B 6
Taco Consumption per Week A 5 C 4 3 2 1 D F J 21 1 2 3 4 5 6 21
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22. Effect of an Income Change
We can plot demand levels under alternative budgets (income)
Referred to as an Engel Curve 13 12 G 11 10 K 9 8 7 B 6
Taco Consumption per Week A 5 C 4 3 2 1 D F J 22 1 2 3 4 5 6 22
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23. Equilibrium Impacts of Income Changes
Hamburger Engel Curve
Tacos Engel Curve
Typical shape of a normal good’s Engel curve over all income levels
Example of an Engel curve for a good that is an inferior good at higher income (budget) levels
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24. Measurement and Interpretation of Market Demand24

25. Concept of Market Demand
The above model of consumer behavior has focused on a single individual
We can extend the above model to one where we refer to overall or total market demand for a city, county, state, country, etc. as a whole 25

26. Concept of Market Demand
Notice the
kink
The market demand curve for a good is the horizontal summation of demand schedules for all the consumers in the particular market
In the above example with PH = $1.50
Paula purchases 2 hamburgers/week while
Beth purchases 1 hamburger
→ market demand = 3 a price $1.50/hamburger 26
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27. Demand Curve Description
When discussing events in the market place economists use specific terms to distinguish between movement along a demand curve vs. a shift in a demand curve
Movement along a demand curve referred to as a change in quantity demanded
Only 1 demand curve, just a different point on it
Alternatively a shift in the demand curve referred to as a change in demand
Need not be a parralel shift in the demand curve 27

28. Movement from point A to C is referred to as a change in demand
Movement from point A to B is called a change in quantity demanded
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29. Demand Curve Description
Reasons for a change in a demand curve
Change in household income
Change in population characteristics
Number of children
Change in marital status
Household composition
Price of substitutes 29

30. Concept of Consumer Surplus
A characteristic of market demand curve
Concept of consumer surplus (CS) or economic well-being
CS is derived from consumption and the fact we have a negatively slope demand curve
A demand curve reveals the willingness of consumers to pay a certain price for a particular quantity of a good 30
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31. Concept of Consumer Surplus
As we showed earlier, consumers are willing to pay a higher price for a lesser quantity
Actually do not have to pay the higher price given the level of supply coming into the market
→ Consumers realize a savings $
P2 > P1
Q2 < Q1 B P2 A P1 Q Q2 Q1 31
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32. Quantifying Consumer Surplus$
Area ABC is the consumer surplus when price is $6.
Demand curve implies consumers are willing to pay $10 for the 1st unit, $9 for the 2nd unit, etc.
Only had to pay $6 each for all 5 units 11 B 10 9 8 7 A C 6 5 D E
Area DACE is the gain in consumer surplus if the price falls to $5 4 3 2 1 Q
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33. Quantifying Consumer Surplus$
The level of consumer
surplus is [(H × L)/2], or
(($11-$6)×5)/2=$12.50 11 B 10 9 8 7 A C 6 5 D E 4 3 2 1 Q
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34. In Summary
Consumer equilibrium for an individual for a given price and budget
Individual consumer’s demand schedule
Market demand curve
Engel curves
Change in demand vs. change in quantity demanded
Consumer surplus

35. Chapter 5 examines the concept of an elasticity, one of the most important concepts in all of economics….