Daniel l. Rubinfeld

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122 Part 2 Producers, Consumers, and Competitive Markets At all prices above point C, however, there is no export demand, so ~hat world demand and domestic demand are identical. As a result, for all pnces above C / world demand is 0..1 o-iven bv line seo-ment b AE. (If we were to add QOE for prices above C, we would be incorrectly adding a negative. export demand to a positive domestic demand.) As the figure shows, the resul:Ulg total de~and for wheat, given by AEF, is kinked. The kink occurs at pomt E, the pnce level above which there is no export demand. Wb w "'2JQ Several years ago, the U.s. Department of .rr0usin~ a~d Urban Develpment beo-an an experimental program of housmg SubsIdIes, a pro~ram mmed at easino-°the housino- burdens of the poor. The subsidies typically mvolved supplem~nts based solely on income but could alternatively ~ave been designed as a percentao-e of housino- expenditures. In order to determme the effects of such a programO on various °demographic groups, we need information about the price and income elasticities of demand for housing. A family's demm1d for housing depends on the age and status of the ho~sehold makino- the purchasino- decision. One approach to housing demand IS to relate the ;umber of roo~ls per house for each household (the quantity demanded) both to an estimate of the price of an additional room in a house and to the household's family income.~ (Prices of rooms vary because of differences in construction costs.) Table 4.4 lists some of the price and income elasticities for different demographic groups. In o-eneral, the elasticities show that the size of houses that consumers dem~d (as measured by the number of rooms) is relatively insensitive to differences in either income or price. However, differences do appear among subgroups of the population. For example, families with young household hea.ds have a price elasticity of 0.22, which is substantially greater than those wIth GROUP PRICE ELASTICITY INCOME ELASTICITY Single individuals -0.14 0.19 Married, head of household age less -0.22 0,07 than 30, 1 child Married, head age 30-39, 2 or more 0 0.11 children Married, head age 50 or older, -0.08 0.18 1 child 4 See Mahlon Strazheim, An Econometric Analysis oj the Llrban HOl/sing IVlarket (New York: National Bureau of Economic Research, 1975), ch.-1. older household heads. Presmnably, families buying houses are more price sensitive when parents and their children are yotmger and parents may be plm1- lUng for more children. Among married households, the income elasticity of demand for rooms also increases with age-a fact which tells us that older households buy larger houses than younger households. Price and income elasticities of demand for housing also depend on where people live. s Demand in central cities is much more price elastic than in suburbs. Income elasticities, ho'wever, increase as one moves farther from the central city. Thus poorer (on average) central-city residents (who live where the price of land is relatively high) are more price sensitive in their housing choices than their wealthier suburban counterparts. as 4.4 Consumers buy goods because the purchase makes them better off. Consumer surplus measures how mllch better off individuals are, in the aggregate, because they can buy goods in the market. Because different consumers place different values on the consumption of particular goods, the maximum amount they are willing to pay for those goods also differs. Consllmer surpllls is the difference between the maximllm amollnt that a conSllmer is willing to pay for a good and the amollnt that the conSllmer actllally pays. Suppose, for example, that a student would have been willing to pay $13 for a rock concert ticket even though she had to pay only $12. The $1 difference is her consumer surplus. 6 When we add the consumer surpluses of all consumers who buy a good, we obtain a measure of the aggregate consumer surplus. Consumer Surplus and Demand Consumer surplus can be calculated easily if we know the demand curve. To see the relationship behveen demand and consumer surplus, let's examine the individual demand curve for concert tickets shown in Figure 4.13. (Although the following discussion applies to an individual demand curve, a similar argument also applies to a market demand curve.) Drawing the demand curve as a staircase rather than a straight line shows us how to measure the value that our con Sllmer obtains from buying different numbers of tickets_ When deciding how many tickets to buy, our student might reason as follows: The first ticket costs $14 but is \vorth $20. This $20 valuation is obtained by using the demand curve to find the maximum amount that she will pay for each additiollal ticket ($20 being the maximum that she will pay for the first ticket). The first ticket is worth purchasing because it generates $6 of surplus value above and beyond its cost. The second ticket is also worth buying because it generates a surplus of $5 ($19 - $14). The third ticket generates a surplus of $4. The 5 See Allen C Goodman and Masahiro Kawai, "Functional Form, Sample Selection, and Housing ~emand," JOlll'/lal of Llrban Economics 20 (September 1986): 155-67. " Measuring consumer surplus in dollars involves an implicit assumption about the shape of Consumers' indifference curves: namely, that the marginal utility associated with increases in a consumer's income remains constant within the range of income in question. In many cases, this is a reasonable assumption. It may be suspect, however, when large changes in income are ulvolved. Chapter 4 Individual and Market Demand 23 (individual) consumer surplus Difference behveen what a consumer is willing to pay for a good and the amount actually paid.
124 Part 2 Producers, Consumers, and Competitive Markets AA Price (dollars per 20 ticket) 19 £§q+¥§ & Q¥%S@4 w .. 20 Price (dollars per 19 ticket) Chapter 4 Individual and Market Demand 125 18 18 17 17 16 15 Consumer Surplus 16 Consumer Surplus 15 14~-----------------------L----------------- 13 14 13 Actual Expenditure Demand Curve Rock Concert Tickets Consumer surplus is the total benefit from the consumption of a product, net of the total cost of it. Here, the consumer associated with six concert tickets the area. fourth, however, generates a surplus of only $3, the fifth a surplus of $2, and the sixth a surplus of just $L Our student is indifferent about purchasing the seventh ticket (which generates zero surplus) and prefers not to buy any more than that because the value of each additional ticket is less than its cost. In Figure 4.13, consumer surplus is fowld by nddillg the excess unilles or surpilises fOI nllllilits pll/, chnsed. In this case, then, consumer surplus equals $6 + $5 + $4 + $3 + $2 + $1 = $21 To calculate the aggregate consumer surplus in a market, we simply find the area below the mnrket demand curve and above the price line. For our rock concert example, this principle is illush'ated in Figure 4.14. Now, because the nwnber of tickets sold is measured in thousands and individual demand curves differ, the market demand curve appears as a straight line. Note that the actual expenditure on tickets is 6500 X $14 = $91,000. Consumer surplus, shown as the shaded triangle, is 1/2 X ($20 - $14) X 6500 = $19,500 This figure is the total benefit to consumers, less what they paid for the tickets. Of course market demand curves are not ahvays straight lines. Nonetheless, we can always measure consumer surplus by finding the area below demand curve and above the price line. Surplus Consumer surplus has important tions in economics. When added over many individuals, it measures the o 2 3 5 6 7 Rock Concert Tickets (Thousands) For the market as a whole, consumer surplus is measured by the area under the demand curve and above the line representing the purchase price of the good. Here, the consumer surplus is given by the shaded triangle and is equal to 1/2 X ($20 - $14) X 6500 = $19,500. *' gate benefit that consumers obtain from buying goods in a market. When we combine consurner surplus "'lith the aggregate profits that producers obtain, we can evaluate both the costs and benefits not only of alternative market structures, but of public policies that alter the behavior of consumers and firms in those markets .. Ail" is. free in t~~e sense that \'\'e .don't pay to. breatl:le i.t. But the. ~bsence of a market for an may help explaill why the aIr quality ill some CIties has been d:terior~ting for decades. To encourage cleaner air~ Congress passed the Clean AlI· Act ill 1963 and has since amended it a number of times. In 1970, for example, automobile emissions controls were tightened. Were these controls worth :t Were the benefits of cleaning up the air sufficient to outweigh the costs imposed directly on car producers and indirectly on car buyers To answer this question, Congress asked the National Academy of Sciences to.evaluate emissions conti'ols in a cost-benefit study. Using empirically determmed ~stimates of the demand for clean air, the benefits portion of the Shldy detenmned how much people value clean air. Although there is no actual market for clean air, people do pay more for houses where the air is clean than for
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PART 1 Introduction: Marl
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Daniel l. Rubinfeld

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