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182 CHAPTER 5 THE THEORY OF DEMAND

U.S. cities, Hausman and Leibtag estimate the compen- food expenditures. To put these amounts in perspective,
sating variation due to low food prices induced by the in Hausman and Leibtag’s sample of households, the
entry of a new Wal-Mart supercenter in a local retail average food expenditure was about $150 per
market. They also estimate the compensating varia- month, or $1,800 a year. The combined compensating
tion due to the increased product variety provided by variations from low prices and enhanced product
the presence of the new Wal-Mart. variety thus amounted to 25 percent of this amount,
Hausman and Leibtag estimate that the compen- or $450 per year. This represents the maximum
sating variation due to low food prices is equal to amount of income a typical U.S. household would
an amount that is approximately 5 percent of house- have been willing to forgo in the late 1990s in ex-
hold food expenditures. The compensating variation change for the lower prices and greater product variety
resulting from increased variety is even larger, engendered by the entry of a Wal-Mart supercenter.
amounting to about 20 percent of total household

5.4 In the previous sections of this chapter, we showed how to use consumer theory to

MARKET derive the demand curve of an individual consumer. But business firms and policy
DEMAND makers are often more concerned with the demand curve for an entire market of con-
sumers. Since markets might consist of thousands, or even millions, of individual con-
sumers, where do market demand curves come from?
In this section, we illustrate an important principle: The market demand curve is the
horizontal sum of the demands of the individual consumers. This principle holds whether
two consumers, three consumers, or a million consumers are in the market.
Let’s work through an example of how to derive a market demand from individ-
ual consumer demands. To keep it simple, suppose only two consumers are in the mar-
ket for orange juice. The first is “health conscious” and likes orange juice because of
its nutritional value and its taste. In Table 5.1, the second column tells us how many
liters of orange juice he would buy each month at the prices listed in the first column.
The second user (a “casual consumer” of orange juice) also likes its taste, but is less
concerned about its nutritional value. The third column of Table 5.1 tell us how many
liters of orange juice she would buy each month at the prices listed in the first column.
To find the total amount consumed in the market at any price, we simply add the
quantities that each consumer would purchase at that price. For example, if the mar-
ket price is $5 per liter, neither consumer will buy orange juice. If the price is $3 or
$4, only the health-conscious consumer will buy it. Thus, if the price is $4 per liter,
he will buy 3 liters, and the market demand will also be 3 liters; if the price is $3 per
liter, the market demand will be 6 liters. Finally, if the market price is below $3, both
consumers will purchase orange juice. Thus, if the price is $2 per liter, the market de-
mand will be 11 liters; if the price is $1 the market demand will be 16 liters.

TABLE 5.1 Market Demand for Orange Juice
Price Health Conscious Casual Market Demand
($/Liter) (Liters/Month) (Liters/Month) (Liters/Month)
5 0 0 0
4 3 0 3
3 6 0 6
2 9 2 11
1 12 4 16