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

Chapter Three: Demand 73 Consider Figure 3.6 . A helpful way to think of the relationship of utility to demand is to think of anywhere above the demand curve as having negative utility to a potential consumer: the price you pay (and its associated opportunity cost of what other good/service you must sacrifice) is greater than the utility you would gain from that item. So if a soda is worth a dollar to you, but the price is greater (say $1.50), then to purchase it would be a subtraction to your overall well-being or utility. The demand curve is therefore a line representing the marginal decision —the price is just low enough at the demand curve to prompt a purchase. This is true for both an individual and a market demand curve. Any price greater will subtract from overall utility and therefore the purchase is not made; any price less adds to utility and therefore the purchase is made. To put the consumer surplus in context, imagine a hot August day where you just finished a long hike. You forgot to bring any water on the hike and you are hot, sweaty and very thirsty. On the drive home, you stop at the first convenience store and purchase a large cool bottle of mineral water for $1.49. The reality is that if you had no other choice, you would perhaps have been willing to pay $10 for that first bottle of water—you value the water at $10. But the market equilibrium price is much less at $1.49. You obtained a utility gain from what you would have been willing to pay (the value to you) and what you actually had to pay (the market price). Other consumers would also have been willing to pay more, but they also got a benefit of the market price. This works out in the overall demand curve as the area labeled CS in Figure 3.5 and reflects the difference between how the goods are valued by the individual purchaser and the price they actually had to pay. We will see in the next chapter on supply that there is an analogous producer’s surplus, and we will then be able to see how the equilibrium or market price is determined. ELASTICITY Let’s now talk about a new concept that will be quite helpful in thinking about the market process. Imagine you are a producer of designer t-shirts. Now, you may have a vision of serving the world, and perhaps t-shirts that are both cool and honoring of Christ is a way to do that; however, wouldn’t you be able to serve Christ better if you made a bit more money? After all, with more money, you could expand your product line to serve both God and your customers even better! So you might begin to think, as all entrepreneurs must, about how you can increase your profit. I will say more about P ($) Q (#) D Positive Utility Negative Utility Margin of Choice Figure 3.6, Demand Curve is the Margin of Decision. The demand curve is therefore a line representing the marginal decision