Further Remarks
Big Ideas in the Principles of Microeconomics


Why does California experience chronic water shortages?  Why does the European Common Market have in its warehouses a mountain of butter and lake of wine?


A few brief observations:
1. It is important to distinguish between wants and needs.
2. Utility is a concept used to represent the satisfaction that people derive from their consumption activities.
3. People try to allocate their incomes so as to maximize their utility.
4. Although total utility may increase with the amount consumed, the incremental increase in total utility (marginal utility) declines.

The Rational Spending Rule: Spending should be allocated across goods so that the marginal utility per dollar is the same for each good. The ratio of marginal utility to price should be the same for all goods.

The Law of Demand: People do less of what they want to do as the cost of doing it rises. Not everyone has the same reservation price.

Additional observations:
1. Extra income stimulates demand by enlarging the set of affordable combinations - by making it possible to buy more of each good than before.
2. When the price of a substitute or complement changes then the consumer must re-examine her purchases in order to restore the balance in the rational spending rule.

Inelastic DemandElastic Demand

Price Elasticity of  Demand
Elasticity and Total Expenditures
Determinants of Price Elasticity of Demand
substitution possibilities
budget share
Calculating price elasticity of demand
(change in Q/Q)/ (change in P/P)
(P/Q) (1/slope)
 Changing price elasticity of demand along a straight line demand curve
Income elasticity and cross price elasticity -
importance of signs
Special cases
perfectly elastic
perfectly inelastic

The Supply Graph

The Law of Supply: Supply curves are essentially an application of the law of increasing costs that we saw in the earlier remarks. Producers offer more of a product for sale when its price rises. Not every seller has the same reservation price.

Determinants of Supply
    Input Prices
    Number of Suppliers

Elasticity of Supply
    Flexibility of inputs
    Mobility of inputs
    Ability to produce substitute inputs

Graph of Supply and Demand Curves

Market Equilibrium and Efficiency:  If price and quantity take anything other than their equilibrium values, a transaction that will make at least some people better off without harming others can always be found.


Economic Surplus
    Consumer Surplus - The cumulative difference between what you were willing to pay and what you had to pay.
    Producer Surplus - The cumulative difference between what you were willing to accept and what you actually recieved for goods sold.
    Deadweight loss - The loss in economic surplus resulting from interference with the market. 
         Price floors, price ceilings, taxes

To use some of these ideas let's work a few problems.

1. In 1965 Andy Warhol spent $5 per week on two goods, Campbell tomato soup and Brillo soap pads.  The price of a can of soup in that year was $0.25 and the price of a soap pad was $0.10.  During the second week in January he purchased 16 cans of soup and 10 pads.  At the end of the week his utilometer read as follows: MU16th can of soup = 120 and MU10th soap pad = 60. Did Warhol buy soup and pads in the correct quantities? Explain.


2. Suppose the weekly demand for soft pretzels in Philadelphia is given by the equation P = 12 - 0.25Q, and the weekly supply of soft pretzels is given by the equation P = 6 + 0.75Q, where P is the dollar price of one dozen pretzels and Q is dozens of pretzels.
a. What is the equilibrium price?
b. What is the equilibrium quantity?
c. What is consumer surplus?
d. What is producer surplus?
e. The local government is persuaded to impose a price ceiling of $7.50.  What shortage of pretzels will result from this policy?
f. What will be the total economic surplus lost due to the price ceiling policy?
g. The local government abandons the price ceiling and a week later imposes a tax of $0.50 per dozen pretzels on sellers.  What will be the total price per dozen paid by consumers?
h. What will be the net price received by sellers?
i. How much tax revenue is collected by the local government?
j. What will be the deadweight loss attributable to the imposition of the tax?


Try this problem set on trade, tarifs and quotas in the TV market from Econ 1102 to see if you can work with the ideas presented here.