Lecture Notes: Demand Curve and Consumer Choices

Introduction

• Overview of the course: Focus on supply and demand curves.
• Importance of understanding the origins of supply and demand curves.
• Today's focus: Demand curve and how consumer choices relate to it.

Key Concepts

Utility Maximization

• Fundamental model of consumer decision-making: utility maximization.
• Two components of this model:
  • Consumer Preferences: What people want.
  • Budget Constraint: What consumers can afford.

Steps to Understanding Demand Curve

1. Preferences: Model people's tastes.
2. Utility Function: Mathematically represent preferences.
3. Budget Constraints: Discuss in the next lecture.

Assumptions About Preferences

1. Completeness: Consumers have preferences over all goods; they can express indifference but not uncertainty.
2. Transitivity: If A > B and B > C, then A > C.
3. Non-satiation: More is always better than less, implying consumers prefer more of a good.

Graphical Representation of Preferences

Indifference Curves

• Definition: Graphical maps of preferences showing combinations of goods among which a consumer is indifferent.
• Example of choices between pizza and cookies:
  • Choice A: 2 pizzas, 1 cookie
  • Choice B: 1 pizza, 2 cookies
  • Choice C: 2 pizzas, 2 cookies
• Properties of Indifference Curves:
  1. Consumers prefer higher indifference curves (more is better).
  2. Indifference curves are downward sloping.
  3. Indifference curves never cross (violates transitivity).
  4. One indifference curve per consumption bundle (based on completeness).

Transition to Utility Functions

• Utility function represents stable preferences mathematically.
• Example utility function for pizza and cookies:
  • U(pizza, cookies) = √(pizza
  • cookies)
• Utility: Ordinal concept; can rank preferences but not measure them.
• Marginal Utility: The additional satisfaction from consuming one more unit of a good.

Diminishing Marginal Utility

• Marginal utility decreases as quantity increases.
• Graphical representation shows that each additional cookie provides less additional utility than the previous one.
• Focus on marginal decisions in economics: "Do you want the next cookie?"

Relationship Between Indifference Curves and Utility

• Marginal Rate of Substitution (MRS): Rate at which a consumer is willing to substitute one good for another, illustrated by the slope of the indifference curve.
• Key insight: As you move along an indifference curve, the MRS diminishes due to diminishing marginal utility.

Convexity of Indifference Curves

• Indifference curves are convex to the origin, reflecting diminishing marginal utility.
• Concave curves would violate the principle of diminishing marginal utility.

Real-World Applications

• Price differentials in convenience stores: Consumers pay less per unit for larger sizes due to diminishing marginal utility.
• Example: Starbucks and McDonald's pricing strategies illustrate demand shifts based on consumer preferences.

Summary

• Understanding consumer preferences and the assumptions behind them is essential for modeling demand curves.
• Next lecture: Introduction to budget constraints.