Lecture Notes: Understanding the Demand Curve

Overview

• Key Focus: Understanding the origin of the demand curve in economics.
• Supply and Demand Model: Basic economic model introduced last class.
• Objective: Explore the underlying factors of demand and supply curves.

Demand Curve Origins

• Consumer Choices: Demand curve arises from consumer decision-making.
• Two Components:
  • Consumer preferences (what people want).
  • Budget constraint (what they can afford).
• Utility Maximization: Fundamental model for understanding demand.
  • Happiness maximized given preferences and budget constraints.

Three-Step Approach

1. Preferences: Modeling what people like.
2. Utility Functions: Mathematical representation of preferences.
3. Budget Constraints: To be discussed next time.

Today's Focus

• Unconstrained Choice: Ignoring budget limitations.
• Preference Assumptions:
  1. Completeness: Preferences exist over any set of goods.
  2. Transitivity: If A > B and B > C, then A > C.
  3. Non-Satiation: More is always better than less.

Indifference Curves

• Definition: Graphical representation of preferences.
  • Points along which a consumer is equally happy.
• Properties:
  1. Consumers prefer higher curves.
  2. Curves are downward sloping.
  3. Curves never cross (violates transitivity).
  4. Only one curve through each consumption bundle (completeness).

Utility Functions

• Definition: Mathematical representation of preferences.
  • Example: U = √(Pizza * Cookies)
• Ordinal Nature: Utility is about ranking, not measuring.*

Marginal Utility

• Definition: Derivative of utility function w.r.t one element.
• Diminishing Marginal Utility: Additional units bring less satisfaction.

Marginal Rate of Substitution (MRS)

• Definition: Slope of the indifference curve.
• Relation to Utility: MRS = -MU_C/MU_P
• Diminishing MRS: As more of a good is consumed, willingness to substitute decreases.

Real-World Application

• Pricing Strategy: Reflects diminishing marginal utility (e.g., soda sizes).
• Bulk Buying: Cost efficiencies vs utility consideration.

Additional Topics

• Addictive Goods: Utility shifts with addiction levels.
• Perishability: Affects utility over time.

Conclusion

• Next Lecture: Incorporate budget constraints into consumer decision-making.