How can the Demand Curve be derived from the Utility Maximum Principle?

Table of Contents

Executive Summary

List of Abbreviations

List of Figures

1 Introduction

2 Problem Definition

3 Objectives

4 Methodology

5 Theoretical Background: Definitions and Explanations
5.1 Supply, Demand and how Markets Establish: A short Introduction
5.2 The Demand on Economical Markets and its Influencing Factors
5.3 Utility Maximum Principle
5.3.1 Utilitarianism and the Welfare
5.3.2 Utility Function
5.3.3 Economical Principle

6 How the Demand Curve can be derived fromb Utility Maximum Principle

7 Results and Conclusion

Bibliography

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

List of Figures

Figure 1: Regular Demand Curve

Figure 2: Shift of the Demand Curve

Figure 3: Elasticity of Demands

Figure 4: Indifference Curve

Figure 5: The optimal demanded Unit of a Bundle

Figure 6: New Optimum after a Price Decrease

Figure 7: The derived Demand Curve

1 Introduction

Economics try to explain the behavior of marketers by developing models. These models only work if some assumptions have been made before. First of all it has to be a perfect market with all its factors to make good assumptions for the behavior of marketers. With the so called ceteris paribus some of these factors can be changed to see which effects this change has on the whole model. The ceteris paribus allows changing one factor, at which the other factors stay the same. Another assumption is that all marketers act upon the economical principle, which means that they are rational and they compare the opportunity costs of every trade. Scientists talk here about the homo oeconomicus. This subject is the perfect marketer in a perfect market. Every act he is doing is an increase in his benefits and so an increase in welfare for the whole system. The demands occurring out of the trades are charted in a demand curve and every demand on a given price is a utility maximization of the demanding consumer. Now, it is interesting to find out how the demand curve can be derived by the utility maximum principle as noticed before the demand curve has to develop out of a utility increase.

2 Problem Definition

The problem here is to find out how the demand curve can be derived from the utility maximum principle. Some theories and contents of the utility maximum principle have to be found which can exactly define the market demand.

3 Objectives

The objective of this assignment is to discover a way to derive the demand curve from the utility maximum principle. Herefore it is very important to define what the demand curve actually is and to find out what the utility maximum principle stands for.

4 Methodology

The methodology of this paper can be described as followed. The first chapter occupies with the theoretical background of the contents of the topic. Some definitions about how market establish will be given. In the next step the demand in economical markets and its influencing factors will be shown. The question here will be which factors can influence the demand curve. After this, the utility maximum principle will be described. Definitions about utilitarianism, utility functions and the economical principle will be given. The next chapter will show how the demand curve can be derived by the utility maximum principle, followed by a short conclusion.

5 Theoretical Background: Definitions and Explanations

This chapter will occupy with some definitions and explanations which bother the topic of this assignment. The issues of supply and demand, of the demand curve itself and of the utility maximum principle will be covered, to get a theoretical overview of these sophisticated themes. Initially, a short overview of economical markets will be given to get the basics which are important for this assignment issue.

5.1 Supply, Demand and how Markets Establish: A short Introduction

A market consists of buyers and suppliers, which stand for the demand and the supply of a good^[1].^[2] Today, time and place of a market is irrelevant, because a trade can be made nearly everywhere and at anytime. Even on the moon Neal Armstrong could have closed an insurance contract via mobile communication technology, to securitize his family if something had happened on the way back to earth. Globalization and innovative technology are responsible for these market opportunities. In sciences academics use the so called completely competitive market (perfect market) to describe economic theories. These perfect markets have to have several assumptions applied, to define them as perfect markets:

-Indefinitely number of suppliers and buyers
-Homogeneity of goods
-No local preferences
-No temporal preferences
-No personal preferences
-Complete transparency

An indefinitely number of suppliers and buyers enable that a trade is always possible and that not market participant can influence the market with his decision. The second assumption (homogeneity of goods) means that every offered good is completely equal. It is important that there are no objective differences and also the characteristics of the goods have to be the same. The third assumption assumes that there exist no local advantages or disadvantages for the market participants; in fact the distance to a market is always the same. Temporal preferences establish if goods are not always at every place available (e.g. seasonal available fruits) and exactly this situation should be eliminated by that assumption. Personal preferences arise from discounts given because of long costumer relationships. This advantages turn into disadvantages for other market participants. The complete transparency as last assumption applies to the objective, areal and temporal information of the market participants. Here the information status has to be equal to all marketers, to finally get a perfect market. In reality perfect markets do not exist, even if some markets like the stock exchange are very close to that. These markets are not perfect markets.^[3] To describe impacts on markets, scientists often use the ceteris paribus (cet. par.), which means that the named assumptions are not considered, but all others stay the same.^[4] Beside the differentiation between perfect and non perfect markets, markets can also be differed into open and closed markets. Open markets have no inhibitions or barriers which affects on the market entry or exit. On the contrary closed markets can have economical or political barriers, which complicate the market entry or exit for the marketers. Economical reasons could be high investing cots to enter the market or to exit the market. Political reasons occur through requirements or laws which impacts the decisions of marketers.^[5] For example, nuclear power plants are impossible to install in Germany, because the government wants to exit from this type of electricity production. Another form to divide markets is to have a look on the number of market participants. A polypoly exists if a market has many buyers and sellers and the action of one marketer does not affect on the total market. Buyers and suppliers are price taker, because they cannot influence the market. In this matter a polypoly is not a perfect market, because the called assumptions do not apply here. We do not have homogeneous products, any preferences, etc. In memoriam, a perfect market does not exist in reality. The second type is the monopoly; here only one supplier offers the needed good and he dictates the market circumstances. An oligopoly is a market with many demanders and just a few suppliers. In this case the supplying side can work with price strategies and influence the market.^[6] This sub-chapter should give a short overview about the meaning of supply and demand and how markets establish. The following text goes deeper into detail and occupies with the demand side of the market.

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^[1] A good can be an item or a service.

^[2] Mankiw & Taylor (2012), p. 77.

^[3] Paschke (2011), pp. 98 – 99.

^[4] Fischbach & Wollenberg (2007), p. 53.

^[5] Paschke (2011), pp. 100 – 101.

^[6] Mankiw & Taylor (2012), pp. 78 – 79.