MARKET DEMAND

1. MARKET DEMAND Overview • Constructing market demand from individual demands • Measurement of consumer surplus • Complications caused by positive and negative externalities

2. MARKET DEMAND The “market” (or “aggregate”) demand function measures the demand of all consumers for a specific product. Market demand is obtained by adding the quantities demanded by all individuals (or “segments” of consumers) at each price and plotting this total quantity for all possible prices. Assumptions: • All consumers face the same price for the good in question, as well as the same prices of all other goods. Consumer income will vary in general but are invariant with respect to prices. • Individual demand for the good is independent of its consumption by all other individuals. In particular, there are no consumption externalities.

3. HORIZONTAL SUMMATION • Sum the quantity demanded by all consumers at each possible price of the good (pX), given their income (Ih) and all other prices (pY): h Dh(pX ; pY, Ih) where consumers/households indexed by h=1,…,N

4. HORIZONTAL SUMMATION

5. Consumer Surplus • Consumers buy goods because it makes them better off • Consumer Surplus measures how much better off they are • Consumer Surplus • The difference between the maximum amount a consumer is willing to pay for a good and the amount actually paid • Can calculate consumer surplus from the demand curve

6. Consumer Surplus - Example • Student wants to buy concert tickets • Demand curve tells us willingness to pay for each concert ticket • 1st ticket worth $20 but price is $14 so student generates $6 worth of surplus • Can measure this for each ticket • Total surplus is addition of surplus for each ticket purchased

7. Consumer Surplus - Example

8. Consumer Surplus • The stepladder demand curve can be converted into a straight-line demand curve by making the units of the good smaller • Consumer surplus is the area under the demand curve and above the price

9. Consumer Surplus

10. Applying Consumer Surplus • Combining consumer surplus with the aggregate profits that producers obtain, we can evaluate: • Costs and benefits of different market structures • Public policies that alter the behavior of consumers and firms

11. NETWORK EXTERNALITIES Definition: A consumer's demand for a good changes with the number of other consumers who buy the good, there are network externalities. Types: • “Bandwagon” = positive • “Snob effects” = negative Examples: • physical: telephone, email, IM networks • virtual: software (e.g., word processors), language (e.g., English v. Esperanto) • technical standards (e.g., QWERTY keyboard) • negative/congestion: highway traffic, cable modem service

12. MARKET DEMAND WITH NETWORK EFFECTS Demand dependence: • The utility of a good derived by a consumer depends on how many other consumers buy/use the good • Consequently individual and market demand depends on aggregate number of purchasers: h Dh(pX ; nX) where nX gives the number of consumers who purchase X. Note: • We suppressed other prices and income. • Could also depend on who consumes the good. Circularity: • Market demand is sum of individual demands which in turn depend on market demand. • Key role of expectations: expected popularity of a “network good” critical in ensuring its popularity. • “Chicken and egg” problem: how to sell the first unit when it has little/no value until others buy it?

13. HORIZONAL SUMMATION WITH“BANDWAGON EFFECTS”

14. HORIZONAL SUMMATION WITH“SNOB EFFECTS”