When supply falls, equilibrium price rises and equilibrium quantity falls.

Example: What happens to equilibrium price and quantity in Figure 15 when demand and supply both rise?

 

 

Figure 15. Demand and supply both rise

Solution: Equilibrium price stayed the same—at $7—while equilibrium quantity rose from 50 to 70.

Example: Find the new equilibrium price and quantity in Figure 16.

 

 

Figure 16. Demand and supply both rise

Solution: The price is $6.25 and the quantity is 90. In this case, price went down (from $7) and quantity went up (from 50).

Example: Find the new equilibrium price and quantity in Figure 174.

Solution: Here we see that equilibrium price rose from $7 to $7.75, while equilibrium quantity rose from 50 to 85.

 

Figure 17. Demand and supply both rise

If demand and supply rise, then equilibrium quantity rises as well. Now what can we say about equilibrium price? In figure 12 it stayed the same, in figure 13 it fell, and in figure 14 it rose. We can say that:

- If the increase in demand is matched by the increase in supply, then price stays the same;

- If the increase in supply outweighs the increase in demand, then price falls;

- If the increase in demand outweighs the increase in supply, then price rises.

Example: What happens to equilibrium price and quantity when supply rises (from S₁ to S₂) and demand falls (from D₁ to D₂) in Figure 18?

 

 

Figure 18. Supply rises and demand falls

Solution: Equilibrium price falls from $20 to $18.50, while equilibrium quantity remains the same.

Example: Find the new equilibrium price and quantity in Figure 19.

Solution: Price falls from $20 to $19, and quantity rises from 25 to 30.

We see that quantity rises again, and that this time price falls.

 

 

Figure 19. Supply rises and demand falls

Example: Find the new equilibrium price and quantity in Figure 17.

Solution: Equilibrium price falls from $20 to $19 while equilibrium quantity falls from 26 to 22.

When supply rises and demand declines, equilibrium price declines.

We can say that:

- If the increase in supply is matched by the decrease in demand, then quantity stays the same;

- If the increase in supply outweighs the decrease in demand, then quantity rises;

- If the decrease in demand outweighs the increase in supply, then quantity falls.

 

Figure 20. Supply rises and demand falls

 

 

LECTURE 2: THE LOGIC OF CONSUMER CHOICE

 

1. Utility

2. Consumer Equilibrium: Diminishing Marginal Utility

3. Balancing Choices Among Goods

4. From Diminishing Marginal Utility to the Law of Demand

5. Indifference Curve Analysis

 

Utility

 

Utility isthe ability of a good to satisfy wants; the satisfaction obtained from the consumption of goods.

Principle of diminishing marginal utility: As people consume a good in greater and greater quantities, eventually they get less and less extra utility from further increases in consumption.

Marginal utility is the additional utility derived from consuming one more unit of some good or service.

Table 1

Hypothetical Demand Schedule for Hamburgers

Price	Quantity Demanded
$2.75
2.00
1.00
.25

Marginal utility: The change in total utility that results from the consumption of one more unit of a good; the change in total utility divided by the change in quantity consumed.

Table 2

Total Utility and Marginal Utility

Scoops of ice cream	Total utility Marginal utility (utils) (extra utils per scoop)
	6 6 11 5 15 4 18 3 20 2

Total utility is the utility you derive from consuming a certain number of units of a good or service. To get total utility, just add up the marginal utilities of all the units purchased. We've done that in Table 3.

Table 3

Hypothetical Utility Schedules

Units Purchased	Marginal Utility	Total Utility
	$2.75	$2.75
	2.00	4.75
	1.00	5.75
	.25	6.00

Total utility: The total amount of satisfaction obtained from the consumption of a particular quantity of a good, a summation of the marginal utility obtained from consuming each unit of a good.

 

Total

utility

 

0 1 2 3 4 5

(a) Total utility

Marginal

utility

 

0 1 2 3 4 5

(b) Marginal utility

Figure 1. Total Utility and Marginal Utility

(a) Total utility increases at a decreasing rate as more and more ice cream is consumed in one sitting.

(b) Marginal utility declines with each additional scoop of ice cream at one sitting.

 

Since we buy a good or service up to the point at which its marginal utility is equal to its price, we could form this simple equation:

Marginal utility

Price

We keep buying a good until itsMU declines to the price level. In fact, the same thing can be said about everything we buy. To generalize,

MU₁ = MU₂ = MU₃ = MU_n

P₁ P₂ P₃ P_n

Example: You are ravenously hungry, so you decide to do lunch. You're going to try something a little different this time—hamburgers, french fries, and a coke or two.

Table 4

Your Demand and Marginal Utility

Schedules for Hamburgers

Price	Quantity demanded	Marginal utility
$3		$3

 

Table 5

Your Demand and Marginal Utility

Schedules for French Fries

Price	Quantity demanded	Marginal utility
$1.50		$1.50
1.00
0.50		0.50

Table 6

Your Demand and Marginal Utility

Schedules for Cokes

Price	Quantity demanded	Marginal utility
$1.50		$1.50
0.50		0.50

Now let's put all these numbers into our formula:

MU₁ = MU₂ = MU₃

P₁ P₂ P₃

I'd like you to substitute the marginal utilities and prices of (1) hamburgers, (2) french fries, and (3) cokes:

$3 = $0.50 = $0.50

$3 $0.50 $0.50

Let's see how many burgers, fries, and cokes you'd chow down if burgers were $1, fries were $1, and Cokes were $1.50. You would have purchased three burgers, two fries, and one coke.

Now set up your MU/Price equation, substituting your fingers for burgers, fries, and cokes.

$1 = $1 = $1.50

$1 $1 $1.50

Why did you shift from one burger to three? Because their price came down. And why did you buy fewer fries and cokes? Because their prices rose. Now we come to that elusive point we've been trying to make. We're always maximizing our utility. We'll buy more and more of a particular good or service until its MU declines to its price (remember our law of diminishing marginal utility).

You maximized your utility by purchasing one hamburger when its price was $3, three fries at $0.50 each, and two cokes at $0.50 each. But when the price of hamburgers fell to $1, you bought three. And you bought just two orders of fries when their price rose to $1 and just one Coke at $1.50.

 

Consumer Surplus

Consumer surplus is the difference between what you pay for some good or service and what you would have been willing to pay.Usually, when you buy something, you actually would have been willing to pay even more.

Example: If the price of hamburgers were a quarter, four would be purchased and the consumer surplus would be the triangular area above the price line in Figure 2. The total consumer surplus would be based on the difference between what you paid for each hamburger (25 cents) and what you would have been willing to pay. You would have been willing to pay $2.75 for the first one, so your consumer surplus on the first hamburger is $2.50. You would have been willing to pay $2 for the second, so on that one your consumer surplus is $1.75. Similarly, on the third hamburger your consumer surplus is $1.00 - 0.25 = $0.75. On the fourth hamburger, since MU = Price (25 cents = 25 cents), there is no consumer surplus. Your total consumer surplus would be $2.50 + $1.75 + $.75 = $5. Looked at another way, your total utility derived from the four hamburgers is $6 and if you pay 25 cents for each four hamburgers, $6 minus $1 equals a consumer surplus of $5.

No one ever paid more than he or she was willing to pay; no one ever bought anything whose price exceeded its utility; and anyone who ever bought several units of the same product at a fixed price enjoyed a consumer surplus.

 

 

 

0.25

1 2 3 4

 

Figure 2. Consumer surplus