No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Three: Demand 72 A few observations are worth noting about the market demand curve. First, while there is no individual “Mr. Market” (since the market demand curve is simply the summation of individual demand curves), it must reflect diminishing marginal utility and therefore slope downward just as if there actually were a Mr. or Ms. Market. Each additional unit provides a smaller increase in utility than the preceding unit and therefore a smaller amount of money will be offered for it. Second, our example is for a very small market. As you increase to the millions of people that actually buy AirPod Pros, the demand curve will slope downward but in a smooth fashion (as in Figure 3.1 ) rather than having the stair step shape shown in Figure 3.4 . Individual demand curves will always have a stair step shape. No one wants 2.47 AirPod Pros; they want either two or three, but as you add the millions of members to the market curve the stair steps will be so small they will approach a smooth curve. For an excellent additional way to think about Demand, watch this video from Professor Tabarrok: CONSUMER SURPLUS In chapter 2 we identified differences in productive ability as the rationale to explain the possibilities of gains from trade. That explanation showed simply that everyone has a comparative advantage at something , due to differences in opportunity costs. This showed that beneficial trade can increase the total output of both parties, and they both can increase consumption. In a similar fashion, our initial review of demand shows the benefits of trade from market transactions with a slightly different perspective: gains in utility. As seen in Figure 3.5 , the area above the market (or equilibrium) price but below the demand curve is a gain to the consumer, and is known as the consumer surplus . At each quantity below the equilibrium quantity (Q e ), individuals would be willing to pay much more than the market price as they use the good or service in its most urgent application. Yet, those items can also be purchased at the market price, not just the unit Q e . The Demand Curve consumer surplus: the gain to consumers due to the difference in the maximum price they would be willing to pay (a.k.a. their reservation price) and what they actually have to pay P ($) Q (#) Q e P e D CS Figure 3.5, Consumer Surplus. At any market equilibrium price and quantity, consumers would have been willing to pay higher prices for the most urgent uses of that good or service, as illustrated by the demand curve. Yet they will only have to pay the market price. The area below the demand curve, but above the dashed line of the equilibrium price reflects what is called the consumer’s surplus (shaded in orange).