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Chapter 2: Demand and Consumer Choice (Vocabulary)

The Foundational Principles from Chapter 1

  • Cost-Benefit Principle: Make a decision if the benefits outweigh the costs. (e.g., A business invests if revenue from new tech > cost of tech).
  • Opportunity Cost Principle: The true cost of a choice is the value of the next best thing you give up. (e.g., College means forgoing job income).
  • Marginal Principle: Decisions are made one unit at a time. Focus on the extra (marginal) benefit vs. extra (marginal) cost of each additional unit. (e.g., A company produces one more unit if its marginal revenue > marginal cost).
  • Interdependence Principle: Everything is connected. Choices impact other outcomes and vice versa. (e.g., Oil price changes affect transportation and consumer goods).
  • Core Idea: These principles help understand how individuals, businesses, and governments make rational decisions by evaluating trade-offs.

Chapter 2: Demand and Consumer Choice (Overview)

This chapter explains how consumers behave in markets.

Key Topics:

  1. Individual Demand: What one person wants to buy at different prices.
  2. Your Decisions and Your Demand Curve: How individual choices form a demand curve.
  3. Market Demand: What all consumers together want to buy.
  4. What Shifts Demand Curves?: Non-price factors that change overall willingness to buy.
  5. Shifts versus Movements Along Demand Curves: Distinguishing price-driven changes from non-price changes.

Understanding an Individual’s Demand Curve

  • Key Concept: Ceteris Paribus: Latin for "holding all other things constant." This lets us study how price alone affects quantity demanded.
  • The Law of Demand: As price falls, people buy more; as price rises, people buy less. This is an inverse relationship.
  • Implication: An individual demand curve slopes downward.
  • Note: If a non-price factor changes (like income or preferences), the whole demand curve shifts. Ceteris paribus helps us isolating price effects first.

Individual Demand Curve: Definition and Example

  • Definition: A graph showing how much of an item an individual plans to buy at each possible price.
  • Responsiveness: If your favorite cookie's price drops, you'll plan to buy more, because it's cheaper relative to other snacks.
  • Distinctions:
    • Individual vs. Market: Individual is one person; Market is the sum of many individuals.
    • Demand vs. Buying Decisions: Demand is a plan (how much you'd buy at various prices); a buying decision is the actual quantity bought at one specific market price.

Creating Darren’s Demand Curve (Example Data)

This shows Darren's planned gasoline purchases per week:

  • Price P = 5 \Rightarrow Q_d = 1 gallon

  • Price P = 4 \Rightarrow Q_d = 2 gallons

  • Price P = 3 \Rightarrow Q_d = 3 gallons

  • Price P = 2 \Rightarrow Q_d = 5 gallons

  • Price P = 1 \Rightarrow Q_d = 7 gallons

  • Interpretation: As the price of gasoline falls, Darren plans to buy more. This follows the Law of Demand.

  • Visualization: Plot these points on a graph (price on vertical axis, quantity on horizontal) and connect them to form Darren's downward-sloping demand curve.

Ceteris Paribus and Demand Shifts

  • Ceteris Paribus: Essential for isolating the effect of price changes. Without it, it's hard to know why quantity bought changed.
  • Why Demand Shifts: If non-price factors change, the entire demand curve moves (shifts left or right). These factors include:
    • Income: (e.g., more income means more demand for normal goods).
    • Tastes and Preferences: (e.g., new trends increase demand).
    • Prices of Related Goods:
      • Substitutes: If a substitute's price rises, demand for the original good rises.
      • Complements: If a complement's price rises, demand for the original good falls.
    • Expectations: (e.g., expecting a price rise soon can increase current demand).
    • Number of Buyers: More buyers mean higher market demand.
  • Crucial Difference:
    • A movement along the curve happens only because of a price change of the good itself.
    • A shift of the curve happens because of a change in a non-price factor.

The Law of Demand

  • Intuition: People buy more when prices are low. This is because lower prices increase buying power (income effect) and make the good more attractive than alternatives (substitution effect).
  • Formal Statement: Quantity demanded is higher when price is lower (and vice versa), assuming all other factors are constant.
  • Graphical Implication: Demand curves always slope downward.
  • Mnemonic: "Demand, down to the ground."
  • Mathematical Note (ceteris paribus): \frac{\text{d}Q_d}{\text{d}P} < 0 (Meaning, as price increases, quantity demanded decreases).

Key Take-Aways: Individual Demand

  • The individual demand curve shows how much a person plans to buy at each price, while holding other factors constant (ceteris paribus).
  • Other factors (income, tastes, etc.) cause the entire demand curve to shift, not just move along it.
  • The Law of Demand: Lower prices mean higher quantity demanded; higher prices mean lower quantity demanded.

Chapter 2 Outline and the Rational Rule for Buyers

  • Chapter 2 topics: Individual Demand, Decisions & Demand Curve, Market Demand, Shifting Demand Curves, Shifts vs. Movements.
  • The Rational Rule for Buyers: Buy an additional unit if its marginal benefit (MB) is greater than or equal to its price (P). Essentially, your demand for a good reflects its marginal benefit to you.
  • Core Idea: Consumers make optimal choices by buying units as long as their additional value (MB) meets or exceeds the additional cost (price).

Revisiting Darren’s Gasoline Demand (Marginal Benefit Data)

This data shows the additional benefit Darren gets from each extra gallon of gasoline, in priority order:

  • 1st gallon: MB_1 = 5.00

  • 2nd gallon: MB_2 = 4.00

  • 3rd gallon: MB_3 = 3.00

  • 4th gallon: MB_4 = 2.50

  • 5th gallon: MB_5 = 2.00

  • 6th gallon: MB_6 = 1.50

  • 7th gallon: MB_7 = 1.00

  • Observations: The benefit from each additional gallon decreases. This is diminishing marginal utility.

  • How it Works: Darren will buy gallons as long as the marginal benefit for that gallon is at least equal to its price. For example, if gas is 3 per gallon, he buys 3 gallons (since MB3 = 3.00 but MB4 = 2.50$$).

Real-World Relevance and Implications

  • Uses of Demand Curves:
    • Pricing Strategies: Businesses use them to set prices based on how sensitive customers are to cost changes.
    • Taxation: Governments predict how taxes affect buying habits and tax revenue.
    • Welfare Analysis: Economists measure consumer happiness (consumer surplus) in markets.
  • Ceteris Paribus: Reminds us that real-world demand is complex. Factors like income, trends, or global events also shift demand, not just price.
  • Marginal Benefits: This concept applies to daily decisions – we weigh the extra benefit vs. extra cost for almost everything we consume.
  • Ethical/Practical Implications: Government policies (like subsidies or taxes) change prices, which then affect people's marginal benefits and how