Supply and Demand | ECON 101H

Individual Demands

Emma's Weekly Demand For Cups Of Coffee

Emma's weekly demand for cups of coffee depends on its price:

When the price is above $\$9$, Emma buys zero cups.
When the price is above $\$6$ and at most $\$9$, Emma buys 1 cup.
When the price is above $\$3$ and at most $\$6$, Emma buys 2 cups.
When the price is above $\$0$ and at most $\$3$, Emma buys 3 cups.
When the price is $\$0$, Emma buys 4 cups.

Individual Demands

Harriet's Weekly Demand For Cups Of Coffee

Harriet's weekly demand for cups of coffee depends on its price:

When the price is above $\$4$, Harriet buys zero cups.
When the price is above $\$3$ and at most $\$4$, Harriet buys 2 cups.
When the price is above $\$2$ and at most $\$3$, Harriet buys 4 cups.
When the price is above $\$1$ and at most $\$2$, Harriet buys 6 cups.
When the price is at most $\$1$, Harriet buys 8 cups.

"Market" Demand

Emma and Harriet's Combined (i.e. "Market") Demand

Demand Curve

Determinants of (Market) Demand

Consumer Surplus

Emma's Surplus

At price $P$, Emma buys $Q(P)$ cups of coffee.
The willingness to pay (WTP) is the maximum amount Emma would pay for $Q(P)$ cups. For a step demand, this is the sum of the values she places on each cup.
The expenditure is what Emma actually pays: $P \times Q(P)$.
The consumer surplus (CS) is the difference: $CS = WTP - Expenditure$.
Example: At $P = 4$, Emma buys 2 cups. She values the 1st cup at $\$9$ and the 2nd at $\$6$, so $WTP = 15$. Her expenditure is $4 \times 2 = 8$. Her consumer surplus is $15 - 8 = 7$.

Consumer Surplus

Emma's Surplus

As price falls:

The quantity demanded increases (weakly).
Willingness to pay increases (weakly).
Expenditure may increase or decrease.
Consumer surplus increases.
$P=9$, $Q=1$ $P=8$, $Q=1$ $P=7$, $Q=1$ $P=6$, $Q=2$ $P=5$, $Q=2$ $P=4$, $Q=2$ $P=3$, $Q=3$ $P=2$, $Q=3$ $P=1$, $Q=3$ $P=0$, $Q=4$
$WTP=9$, $Expenditure=9$ $WTP=9$, $Expenditure=8$ $WTP=9$, $Expenditure=7$ $WTP=15$, $Expenditure=12$ $WTP=15$, $Expenditure=10$ $WTP=15$, $Expenditure=8$ $WTP=21$, $Expenditure=9$ $WTP=21$, $Expenditure=6$ $WTP=21$, $Expenditure=3$ $WTP=27$, $Expenditure=0$
$CS=0$ $CS=1$ $CS=2$ $CS=3$ $CS=5$ $CS=7$ $CS=12$ $CS=15$ $CS=18$ $CS=27$

Consumer Surplus

Formal Definition

At price $p_X$, the consumer demands $x(p_X)$ units of good X (we are assuming income and other prices are constant so we do not refer to these variables when writing the demand for good X).
The area under an individual demand (for good X) curve (from 0 to $x(p_X)$) is a measure of how much the consumer is willing to pay for consuming $x(p_X)$ units. (Why? Try to see by writing a discrete/step demand as we did in class.)
At price $p_X$ the consumer pays the quantity demanded times the price, $x(p_X)\cdot p_X$ (expenditure on good X), to the producer/seller.
The difference between: (1) how much the consumer is willing to pay to consume $x(p_X)$ and (2): the payment $x(p_X)\cdot p_X$, is the consumer surplus.
See the next slide for a graphic depiction of the CS.

Consumer Surplus

Graphical Representation

Decomposing Total Cost

Fixed Cost and Marginal Costs

$TC(0)=20$ (fixed cost)
$Q=0$ $Q=1$ $Q=2$ $Q=3$ $Q=4$ $Q=5$ $Q=6$ $Q=7$ $Q=8$ $Q=9$
$TC(0)=20$ $TC(1)=28$ $TC(2)=32$ $TC(3)=36$ $TC(4)=44$ $TC(5)=58$ $TC(6)=80$ $TC(7)=114$ $TC(8)=164$ $TC(9)=232$
$MC(0)=8$ $MC(1)=4$ $MC(2)=4$ $MC(3)=8$ $MC(4)=14$ $MC(5)=22$ $MC(6)=34$ $MC(7)=50$ $MC(8)=68$ $MC(9)=88$
$VC(0)=0$ $VC(1)=8$ $VC(2)=12$ $VC(3)=16$ $VC(4)=24$ $VC(5)=38$ $VC(6)=60$ $VC(7)=94$ $VC(8)=144$ $VC(9)=212$

Producer Surplus

Profit and Variable Costs

$P=0,\; Q=0$. Revenue$=0$, $VC=0$, $PS=0$ $P=4,\; Q=0$. Revenue$=0$, $VC=0$, $PS=0$ $P=8,\; Q=4$. Revenue$=32$, $VC=24$, $PS=8$ $P=14,\; Q=5$. Revenue$=70$, $VC=38$, $PS=32$ $P=22,\; Q=6$. Revenue$=132$, $VC=60$, $PS=72$ $P=34,\; Q=7$. Revenue$=238$, $VC=94$, $PS=144$ $P=50,\; Q=8$. Revenue$=400$, $VC=144$, $PS=256$ $P=68,\; Q=9$. Revenue$=612$, $VC=212$, $PS=400$ $P=88,\; Q=10$. Revenue$=880$, $VC=300$, $PS=580$ $P=90,\; Q=10$. Revenue$=900$, $VC=300$, $PS=600$

Supply Curve

Determinants of (Market) Supply

Producer Surplus

Definition and Interpretation

The individual supply curve corresponds to the producer marginal cost curve (provided the marginal cost is increasing).

The producer surplus is the revenue (payments by the consumers) minus the area under the supply curve.

You should think of the producer surplus as the profits (plus any fixed costs the producer incurs).

Or equivalently the producer surplus is the revenue minus the variable cost (i.e. the area under the supply curve).