EBF 200
Introduction to Energy and Earth Sciences Economics

 

Some Marginal Analysis

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You are looking to buy pizza. Your “pizza happiness” in $ is described in the table below. Pizzas cost $2 each. How many should you buy?

Table 2.4 Pizza Happiness in $
# of Pizzas 0 1 2 3 4 5
Pizza Happiness ($) 0 10 17 22 25 26

Method 1: Brute Force

Simply figure out your happiness for each number. Happiness=Pizza Happiness-Total Cost (remember pizzas cost $2 each). Inelegant, low score on exam, but it will work. Fill in the table below and choose the spot that maximizes your happiness (what we will soon call consumer surplus).

Table 2.5 Pizza Happiness in $ (fill in)
# of Pizzas 0 1 2 3 4 5
Pizza Happiness ($) 0 10 17 22 25 26
Total Cost ($) 0 2 4
Happiness ($) 0 8 13

Method 2: The Elegant Economic Way of Thinking (This gets you all the credit!)

Let Marginal Happiness(X)=Pizza Happiness(X)-Pizza Happiness(X-1). Keep buying pizza as long as marginal happiness>cost of pizza (here $2).

Remember, decisions are made on the margin!

Table 2.6 The Elegant Economic Way of Thinking
# of Pizzas 0 1 2 3 4 5
Pizza Happiness ($) 0 10 17 22 25 26
Marginal Happiness ($) - 10 7
Total Cost ($) 0 2 4
Total Happiness (Consumer Surplus) 0 8 13

Fill in the blanks, and pick your bliss point!

A Problem for You

Delicious cuy (a delicacy in Peru) costs $10 a serving. Your cuy happiness is given in the table below. How many cuy will you buy, and what will be your total happiness?

Table 2.7 Cuy Happiness ($)
# of Cuy 1 2 3 4 5
Cuy Happiness ($) 20 36 47 52 54

Some people talk about something called a Giffen Good. This is a mythical good with an upward sloping demand curve, meaning that more sell if the price is higher. Sir Robert Giffen hypothesized that an inferior staple good, such as bread, might actually see an increase in demand as its price rises. The idea being that as the price of bread increases, poor consumers would have less money to spend on other goods (meat, for example), and would actually need to purchase more bread. You can probably see, however, that there would have to be a lot of constraints on this hypothetical world- no other types of inferior staple goods available as substitutes, and no corresponding wage inflation to provide additional income to buy bread, to name a few. In order to come up with a scenario where we have an actual, upward-sloping demand curve, we need to do a lot of semantical gymnastics and make a lot of special-case assumptions. Life is much simpler if we just believe that the First Law of demand holds. Which it does, of course, because it is the law, and not merely just a good idea. I like to think of it as the economic law of gravity. In a few special, rare and carefully constructed circumstances, you can appear to circumvent it, but for almost all of us almost every day, it holds true. (Or, I should say, is not falsified.)

Definitions

Demand Curve

relationship between price and quantity that people want to buy. Demand is not a number or a constant: it is a function, with different values at different places.

Marginal

This is an adjective (a descriptive word) that refers to the effect of doing a little bit more of something. So, the Marginal Utility from consuming pizza refers to the extra amount of utility you will get from eating one more slice of pizza. We often say “what will change at the margin,” which means “What will be the effect of a small change in one of the inputs?”

Main points about the demand curve:

  • Demand curves always slope downwards (have a negative slope).
  • This is called the “First Law of Demand.”
  • They slope downwards because of Declining Marginal Utility: the amount of utility we get from consuming an extra unit of something is less than the amount we got from consuming the previous unit of that thing.
  • Market demand curves are the sum of all individual demand curves.