Microeconomics for

Managers
Biresh Sahoo,

Ph.D

Professor, XIM, Bhubaneswar

MEM Lecture 7

Application: Welfare effects of

changes in housing prices
Consider the following two scenarios:
1. A builder has purchased a house for
Rs.20,00000. The very next day, the prices
of all houses, including the one the builder
just bought, double.
2. The builder has purchased a house for
Rs.20,00000. The very next day, the prices
of all houses, including the one the builder
just bought, fall by half.

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In each case, how does the price change

affect the builders welfare? (Can the
2
builder be better off before the price

Other goods (y)

Scenario I

60,00000

40,00000
O2

20,00000

u1
B1

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H2

B2

1.5

u0
2

Qty. of housing (x)

3

Scenario II

Other goods (y)

u0
40,00000

B1

30,00000

u1

B2
A

20,00000

O3

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H3

3
Qty. of housing (x)
4

Application of demand analysis

While at a discount shoe store, a customer asked a

clerk, I see that your shoes are buy one, get one freelimit one free pair per customer. Will you sell me one
pair for half-price? The clerk answered, I cant do
that. When the customer started to leave the store,
the clerk hastily offered, However, I am authorized to
give you a 40 percent discount on any pair in the
store.
Assuming the consumer has $200 to spend on shoes
(X) or all other goods (Y), and that shoes cost $100 per
pair, answer the following questions:
a) Illustrate the consumers opportunity set under the
buy one, get one free deal and under a 40
percent discount.
b) Why was the 40 percent discount offered only after
the consumer rejected the buy one, get one free
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deal and started to leave the store?

Income on other
goods (y)

200

F
N
100

IC

D
G

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J
1

H
3

K
4

Pairs of
shoes (x)
6

Application of demand analysis

A common marketing tactic among many liquor

stores is to offer their clientele quantity (or volume)

discounts. For instance, the second-leading brand of
wine exported from Chile sells in the US for $8 per
bottle if the consumer purchases up to eight bottles.
The price of each additional bottle is only $4. If a
consumer has $100 to divide between purchasing
this brand of wine and other goods, graphically
illustrate how this marketing tactic affects the
consumers budget set if the price of other goods
$1. Will a consumer ever purchase exactly eight
bottles of wine? Explain.
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Other
Goods
100
90
80
70
60
50
36 40
30
20
10
0

12
12.5

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Bottles of
Wine

16
17

Other
Goods
100
90
80
70
60
50
36 40
30
20
10
0

u1
uo

12
12.5

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Bottles of
Wine

16
17

Other
Goods
100
90
80
70
60
50
36 40
30
20
10
0

uo

u1

12
12.5

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Bottles of
Wine

16
17

10

Market demand: How to arrive at?

Summing individual demand curves to derive market
demand for sandwiches

Price

(a) You

(b) Brian

(c) Chris

(d) Market demand

for sandwiches

dY
0

2 4

dB
0

2 4

dY+dB+dC=D

dC
0

12

Sandwiches per month

Market demand curve is the horizontal sum of individual demand curves

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11

Determinants of demand
Income
Prices of substitutes
Prices of

complements
Advertising
Population
Consumer
expectations

Change in quantity demanded

Price of pizza (p)
A to B: Increase in quantity demanded (x)
A

10

D0
0

Pizzas (x)

Change in demand
Price of pizza (p)
D0 to D1: Increase in demand (x)

D1

D0
0

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12

Pizzas (x)

14

Application: Consumer surplus (CS)

The value consumers get from a good but do not have to pay for it.
That is, the amount a buyer is willing to pay for a good minus the amount the same buyer

actually pays for it.

An illustrative example:
Imagine that you have a digital camera, and because now you badly
need money, you decide to sell it. One way to do so is to hold
an auction. Assume that four persons show up for your auction.
Buyer

Willingness to Pay

John
Paul
George
Peter

Rs.1000
Rs. 800
Rs. 700
Rs. 500

To sell your camera, you begin bidding at a low price, say Rs.100.
Because all four buyers are willing to pay much more, the price
rises quickly. The bidding stops when John bids Rs.800 (or
slightly more). Note that camera will go to that buyer who values
it most highly.
Johns CS = Rs.1000 Rs.800 = Rs.200
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Example continued
Now consider a somewhat different example. Suppose
that you have two identical cameras to sell. Again, you
auction them off to the four possible buyers.
To keep things simple, we assume that both cameras are
to be sold for the same price and that no buyer is
interested in buying more than one camera.
Therefore, price rises until two buyers are left. In this case,
John and Paul bid Rs.700 (or slightly higher). At this price,
both John and Paul each receive CS of Rs.300 and Rs.100.

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Using DD curve to measure CS

1000
800
1000
700
800
500
700

Buyers
<p
<p<
<p<
<p<
p<

CS: Discrete
500
demand curve

None
John
John, Paul
John, Paul, George
John, Paul, George,
Johns CS = 500
Peter
1000
Price

Price

Quantit
y
0
1
2
3
4

Pauls CS = 300
Georges CS = 200

800
700

Peters CS = 0

500

Demand
curve

Total CS = 1000

0
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Camera
18

CS: Continuous DD
curve
Total willingness to pay for 4
units = Rs.24
CS = 16

Price (p)

10
8
6
Actual amount paid for 4
units = Rs.8

4
2

D
0
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Quantity (x)
19

Learning and applying CS

Why do some tennis clubs have an annual membership
charge in addition to their hourly court fees?
Assume that Johns dd. curve for court time is: p = 50 - (1/4)x,
where x is measured in hours per year. What is the maximum
annual membership fees John would be willing to pay for the
right to buy court time for Rs.25/hr?
Price
(Rs./hr)

CS = (1/2)*100*25
= Rs.1250

50 A

25 C
0
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100

200

Court time (hr/yr)

20

Thank you
for your patience

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21