Supply and demand

• Demand


  The maximum quantity of a good that an individual wishes to purchase given the price of the good, ceteris paribus, during a given period of time
• Consumer Theory


  The study of how people decide to spend their money based on their individual preferences and budget constraints
• Budget constraint


  The different bundles that the consumer can afford
• Consumption bundle


  Represents what a consumer would like to consume and contains different quantities of various goods
• Utility


  The final objective of consumption, representing what a consumer achieves by consuming a particular consumption bundle
• A consumer prefers one bundle of goods to another if the utility she gets from the former is greater than the utility she gets from the latter
• Cardinal Utility


  A utility that determines the satisfaction of a commodity used by an individual and can be supported with a numeric value
• Ordinal Utility


  Defines that satisfaction of user goods can be ranked in order of preference but cannot be evaluated numerically
• Three basic assumptions about human behavior

  • Utility maximization
  • Non-satiation
  • Decreasing marginal utility
• Utility maximization


  Individuals make calculated decisions when shopping, purchasing products that bring them the greatest benefit
• Non-satiation


  People are seldom satisfied with one trip to the shops and always want to consume more
• Decreasing marginal utility


  Consumers lose satisfaction with a product the more they consume it
• Main ingredients of Consumer Theory

  • The consumer’s tastes and utility
  • The behavioural assumption that consumers are rational
  • The consumer’s income
  • The prices at which goods can be bought
• Total utility


  The total amount of satisfaction from all the units consumed of a good or service
• Marginal utility


  The change in the level of total utility that results from a one unit change in consumption

  
• Diminishing marginal utility of consumption

  Occurs when consuming additional small quantities of the good increases total utility but at a decreasing rate
• Utility Function


  A mathematical function representing the utility or preferences of an individual
• Utility of Income


  The total utility or satisfaction achieved with an individual's income
• Marginal Utility of consumption


  The change in utility resulting from a change in an individual's consumption
• Marginal Utility of Income


  The change in utility resulting from a change in an individual's income
• Willingness to pay (WTP)


  The maximum amount an individual is willing to sacrifice to procure a good
• Maximum willingness to pay at the margin


  The maximum that an individual is willing to pay to consume an additional unit of the good or service
• Value in use


  The maximum willingness to pay for a particular quantity of a good
• Value in exchange


  The amount actually paid for the quantity consumed
• Consumer surplus


  The difference between willingness to pay for a good and the price that consumers actually pay for it
• Inverse demand function


  Plots price on the vertical axis and quantity on the horizontal axis

  
• The price elasticity of demand is always negative along a downward-sloping demand function

  
• With linear demand functions, the price elasticity of demand gets less negative as Q increases

  
• Own price elasticity of demand

  Measures the sensitivity of the quantity of a good demanded to a change in its own price

  
• Elastic demand


  If the own price elasticity of demand is less than -1, demand is relatively sensitive to changes in price

  
• Inelastic demand


  If own price elasticity of demand lies between -1 and 0, demand is relatively insensitive to changes in price

  
• Perfectly inelastic demand


  If the own price elasticity of demand is 0, quantity demanded does not change at all with a change in price

  
• Unitary elastic demand


  If the price elasticity of demand equals -1, demand is unitary elastic

  
• Perfect elastic demand


  Quantity demanded will increase to infinity when the price decreases

  
• Relatively elastic demand


  More change in the quantity demanded than in the price of that good or service

  
• Perfectly inelastic demand


  Quantity demanded remains constant regardless of price
• Relatively inelastic demand


  More change in the price of a good than in the demand for that good
• Income elasticity of demand

  Measures the sensitivity of the demand for a good with respect to a change in a person’s income

  
• Inferior good


  A good for which demand falls with an increase in income
• Normal good


  A good for which an increase in income increases the quantity demanded