Consumer Equilibrium Microeconomics Midterm - PowerPoint

Document Sample
Consumer Equilibrium Microeconomics Midterm - PowerPoint Powered By Docstoc
					   Chapter 1
    What is
Economics About
Definition of Economics

SCIENCE of how individuals and
 societies deal with the fact that
wants are greater than resources
 available to satisfy those wants
               Scarcity
• Wants are greater than the resources
  available to fill those wants
• What do you have scarcity of???
  – Money
  – Time
• What do firms have scarcity of???
  – Labor
  – Land
  – Capital
       Thus….
   Economics is the
SCIENCE of SCARCITY
 Normative vs. Positive Economics
• Normative
  – What “ought” to be


• Positive
  – What is
 Examples: Positive or Normative?
• The government fought inflation during the early
  1980s because it felt the inflation was damaging
  potential long-term economic growth.
• The government should cut taxes in order to stimulate
  consumption.
• Increases in consumer spending improved the
  Japanese economy last year.
• Balancing the federal budget would be good for the
  economy.
               Micro vs. Macro
• Microeconomics
  – Study of human behavior and choices
  – Looks at SMALL units (individual, market, single
    firm)
• Macroeconomics
  – Study of human behavior and choices
  – Looks at LARGE units (aggregated markets, whole
    economy)
Economic Way of Thinking

             • Watch
– “An economist is someone that sees
   something working in practice and
    asks if it would would in principle”
              • Think
             • Identify
        Why Study Economics?
• Social Problems
  – Discrimination
  – Crime
• Understand why things happen
  – Coupons
  – Minimum Wage
• Understand the Political Process
   Homework
due Friday April 4th
      • Chapter 1
    – Questions 1 and 2
Beginning to Think Like an
       Economist
    …is this a good thing?
            Defining Economic Goods
• Utility
   – Satisfaction you receive from consuming a product
   – Good vs. Bad
• Tangibility
   – Can the good be touched or is it a service?
• Resources or factors of production used
   – Land: natural resources
   – Labor: Physical and mental talents of people
   – Capital: produced goods that can be used as inputs for
     further production
   – Entrepreneurship: talent of organizing resources, seeking
     new opportunities, and developing new ways of doing things
    Remember Scarcity Runs the
           Show…
• What was scarcity??
• So…how do we make sure that only those who
  REALLY need the good get it??
• Prices
  – System of rationing of the good
  – Cause people to compete for the item
          Opportunity Cost
• Value of the next best alternative
  foregone
• Pizza vs CD
  – Pizza for $1.00 per slice; CD for $15.00
• Revolutionary War
  – The British and their red coats
• Big Macs
  – Big Macs in Japan cost $8.25
• Highway System
  – Paid for with taxes
Summary Statement of Scarcity
    and Related Concepts
    Costs and Benefits at the
            Margin
• What is the margin??
  – The “last” or “additional”
• Marginal Cost
  – The cost of the “last” unit employed
• Marginal Benefits
  – The benefit of the “last” unit employed
• Unintended effects
  – Minimum wage
  – Gun bounties
  – Seat belts
                   Efficiency
• What is the “right amount” of time to study?
  – Right amount = optimal or efficient amount
  – Marginal Costs = Marginal Benefits
         Economic way of thinking
               includes…
•   Analyzing scarcity
•   Look at opportunity cost of decisions
•   Measure costs and benefits
•   Look at marginal effects
•   Examine unintended effects
       Economic Thinking Errors
• Association vs. Causation
  – You hit red lights because you are running late
  – Don’t study for a test so you fail
• Fallacy of Composition
  – What is good for the individual is good for the group
• Forgetting Ceteris Paribus
  – All else remains constant
What is this?
                      Model
• Simplified version of reality
  – Includes only the “important” aspects
• Why is a model necessary??
         Parts of a Theory
                • Variables
         – Magnitudes that can change
              • Assumptions
– Ideas about event that will not allow to change
               • Hypothesis
               – Educated guess
               • Predictions
   – Based on hypothesis and assumptions
             Scientific Approach
•   What do you want to predict/explain?
•   What variables are important?
•   State assumptions
•   State hypothesis
•   Test
•   If results are good…Yeah You!!
•   If results are bad…amend or reject theory
                    Building and Testing a Theory
                                                                                       Evidence supports the
                                                                                     theory. No further action is
                                                                                     necessary, although it is a
                                                                                      good idea to continue to
                                                                                     examine the theory closely.




Decide on what          Identify the      State the               State the    Test the theory        Either
it is you want to     variables that   assumptions of            hypothesis.   by comparing
    explain or       you believe are     the theory.                           its predictions
     predict.          important to                                             against real-
                     what you want                                             world events.
                      to explain or
                                                                                                      Or
                          predict.




                                                                                    Evidence rejects the theory, so
                                                        Return                      either formulate a new theory,
                                                                                   or amend the old theory in terms
                                                                                     of its variables, assumptions,
                                                                                            and hypotheses.
      How do we judge theories?
• Look at how well they predict
• NOT by the assumptions
• Example: Firms try to maximize profits
  – Do they thing about this every second?
  – Probably not
  – Over the course of the year…make decisions to
    maximize profits
   Appendix A

Working with Diagrams
  Types of Relationships between
            variables
• Direct
  – Positive
• Inverse
  – Negative
• No Relationship
  – Variables are independent
Two-Variable Diagram Representing an
         Inverse Relationship

                               The variables price
        Price of CDs ($)       and quantity
                               demanded are
                    A
          20                   inversely related.
                           B
          18
                               C
          16
                                    D
          14
                                         E
          12            Demand for CDs
            0
                  100 120 140 160 180
                Quantity Demanded of CDs
Two-Variable Diagram Representing a
         Direct Relationship
     Consumption ($)

         360
                                         F
         300
                                     E
         240
                               D         The variables
         180                             income and
                         C               consumption are
         120
                    B                    directly related.
          60   A
           0
                   100 200 300 400 500
                        Income ($)
               Two Diagrams Representing
               Independence between Two
                       Variables
             Variables X and Y are                     Variables X and Y
     Y                                        Y        are independent.
         independent (neither variable
            is related to the other).
40                                           40                 D


30                                           30                 C

          A       B      C       D
20                                           20                 B


10                                           10                  A


0                                        X    0                                      X
          10     20      30     40                10       20        30         40

                  (a)                                                     (b)
                    Slope
• Used to see how a variable changes in
  response to another variable changing


               Y   vertical
       Slope     
               X horizontal
            To calculate slope
• Find two points on any straight line



           Y2  Y1     Y1  Y2
                    or
           X 2  X1    X1  X 2
 What sign do you expect the slope
             to have?
• Direct relationship
  – Positive
• Inverse relationship
  – Negative
• No Relationship
  – 0 or infinity
                         Calculating Slopes
     Y                                                   Y
                           Y     –10                                 Y +10
                                                             Slope =       =    = +2
                   Slope=  =         = –1                            X     +5
                             X     10
                      (negative slope)                            (positive


               A
40                                                  40                     D
         Y
                         B                          30
30                                                                     C
                   X
                                   C
20                                                  20            B

                                            D
10                                                  10       A


 0                                              X    0                                 X
              10        20    30       40                        10 15 20
                       Calculating Slopes
                                                Slope =
                                                             Y
                                                             X
                                                                  =
                                                                    +10
                                                                      0
                                                                        =` 
     Y                                      Y
                                                         (infinite slope)

40                                     40            D

         A        B     C     D
30                                     30            C


20                     Y              20            B
                               0
              Slope =       =    =0
                       X     10
                    (zero slope)
10                                     10            A


 0                                 X    0                                       X
         10      20     30    40                10       20     30         40

                 (c)                                                 (d)
              The 45 Line
                          45 Line
     Y




20                    A




         45
 0                                  X
                 20
        Appendix B

Should you major in Economics??
  Five myths about economics and an
           economics major
• Economics is all mathematics and statistics
• Economics is only about inflation, interest rates,
  unemployment, and other such things
• People become economists only if they want to “make
  money”
• Economics wasn’t very interesting in high school, so it
  isn’t going to be interesting now
• Economics is a lot like business, but business is more
  marketable
  Chapter 2
  Economic
  Activities:
Producing and
   Trading
                  Efficiency
• Efficiency of Production is goal
• If a firm is producing the max possible given
  available resources and technology
    Production Possibility Frontier
               (PPF)
• Shows all possible combinations of goods for a
  particular economy at a particular point in time,
  given its resources and technology constraints
    Production Possibilities Frontier
              for Grades
HOURS S PENT                HOURS S PENT
  S TUDYING     GRADE IN      S TUDYING     GRADE IN   POINT IN
 S OCIOLOGY    S OCIOLOGY    ECONOMICS     ECONOMICS   PART (b)

     6             90            0            60          A
     5             85            1            65          B
     4             80            2            70          C
     3             75            3            75          D
     2             70            4            80          E
     1             65            5            85          F
     0             60            6            90          G

                               (a)
Production Possibilities Frontier for Grades
         Grade in S o c io lo g y
                                                      Part (b)
                 A         (S o c . 90, Ec o n. 60)
           90

           85              B        (S o c . 85, Ec o n. 65)

                                  C               H
           80
                                                         Pro duc tio n
                                          D              Po s s ibilitie s
           75
                                                        Fro ntie r (PPF)
                                                  E
           70

                                                          F
           65
                                                                 G
           60
                60    65        70    75     80      85        90
                               Grade in Ec o no mic s
      Where are we on the PPF?
• Can we be on the PPF?
  – Yes!
  – efficient
• Can we be under the PPF?
  – Yes!
  – Inefficient
• Can we be over the PPF?
  – NO
Two types of Production Possibility
            Frontiers
Constant Opportunity Costs
• STRAIGHT LINE
• DOWNWARD SLOPED (inverse relationship)
• 1 to 1 relationship (slope constant)
     Production Possibilities Frontier
      (Constant Opportunity Costs)


              COMPUTERS AND           TELEVIS ION S ETS   POINT IN
COMBINATION         (numbe r o f units pe r ye ar)        PANEL (b)

    A               50,000   and           0                 A
    B               40,000   and      10,000                 B

    C               30,000   and      20,000                 C
    D               20,000   and      30,000                 D

     E              10,000   and      40,000                 E
     F                   0   and      50,000                 F


                                Part (a)
Production Possibilities Frontier
 (Constant Opportunity Costs)
Co mpute rs (th o us a nds p e r ye ar)            Pa rt (b)

                A
           50
                                         A s traig ht-line PPF
                                         illu s trate s c o n s tan t
                          B
           40                            o pp o rtun ity c o s ts .

                                   C
           30

                                             D
           20

                                                       E
           10
                                                               F

            0           10        20        30     40       50
                    Te le vis io n S e ts (tho us and s pe r ye a r)
          Second Type of PPF
Changing Opportunity Costs
• BOWED OUT PPF
• Real world PPF
• Changing slope with every point
   Production Possibilities Frontier
    (Changing Opportunity Costs)
                             Pa rt (a)


              COMPUTERS      AND TELEVIS ION S ETS      POINT IN
COMBINATION         (nu mbe r o f un its pe r ye a r)   PANEL (b)

    A               50,000      and           0            A

    B               40,000      and      20,000            B
    C               25,000      and      40,000            C

    D                    0      and      60,000            D
     Co mpute rs (tho us ands pe r ye ar)
                                                          Production
       A
50
                                    Part (b)
                                                          Possibilities
                            B                              Frontier
40
                                                          (Changing
30                                                        Opportunity
                                                    C
25
           A bo we d o utward
                                                            Costs)
20
           (co ncave ) PPF illus trate s
           inc re as ing o ppo rtunity
10         c o s ts .

                                                                      D

 0           10           20        30         40         50         60

                    Te le vis io n S e ts (tho us ands pe r ye ar)
    Law of Increasing Opportunity
                Costs
• Goes along with CHANGING OPPORTUNITY
  COSTS
• As more of a good is produced the opportunity
  cost to produce that good increases.
 Go o d X
                                    A Summary Statement
                                        about Increasing
                     A
100      }5              B          Opportunity Costs and
 95
                                          a Production
                                     Possibilities Frontier
                                         That Is Bowed
                                      Outward (Concave
                                      C
 50                                       Downward)
              20

30                                              D


                    10                   10


     0             60 70           110        120
                       Ho us e s
    Economic Concepts illustrated by
                PPF
•   Scarcity
•   Choice
•   Opportunity Costs
•   Law of Increasing Opportunity Costs
   Examples of Law of Increasing
       Opportunity Costs
• Armed Services
  – WWI, WWII and Korean War draft was irrelevant of
    job or education level; Civil War education and job
    level mattered
• Home Improvements
  – Swedish men make more improvements
    themselves compared to US men
            Economic Growth
• Increase in resources
• Increase in technology
• Shift of PPF outward
  How would each of the following
       affect the US PPF?
• A rise in the unemployment rate
• The invention of the computer
• An increase in the number of birth in the United
  States
• An increase in the number of births in Russia
Economic Growth within
  a PPF Framework
 Military Go o ds

                     Ec o nomic g ro wth s hifts
                     the PPF o utward.



                                  PPF
                                     2

              PPF
                 1




 0
               Civilian Go o ds
    Production Possibilities Frontier
              for Grades
HOURS S PENT                HOURS S PENT
  S TUDYING     GRADE IN      S TUDYING     GRADE IN   POINT IN
 S OCIOLOGY    S OCIOLOGY    ECONOMICS     ECONOMICS   PART (b)

     6             90            0            60          A
     5             85            1            65          B
     4             80            2            70          C
     3             75            3            75          D
     2             70            4            80          E
     1             65            5            85          F
     0             60            6            90          G

                               (a)
Production Possibilities Frontier for Grades
         Grade in S o c io lo g y
                                                      Part (b)
                 A         (S o c . 90, Ec o n. 60)
           90

           85              B        (S o c . 85, Ec o n. 65)

                                  C               H
           80
                                                         Pro duc tio n
                                          D              Po s s ibilitie s
           75
                                                        Fro ntie r (PPF)
                                                  E
           70

                                                          F
           65
                                                                 G
           60
                60    65        70    75     80      85        90
                               Grade in Ec o no mic s
More Hours of Study Shifts the
Production Possibilities Frontier
     Grade in S o c io lo g y

      95

      90

      85

      80                        X (S o c . 80, Ec o n. 75)
     77.5                         Y (S o c . 77.5, Ec o n. 77.5)
      75                             Z (S o c . 75, Ec o n. 80)
                          D
      70
                             PPF1                   PPF2
      65                   (6 ho urs )            (7 ho urs )
      60
            60 65    70  75 80 85 90 95
                          77.5
                    Grade in Ec o no mic s
           Efficiency…Again
• Produce max amount possible given resources
  and technology
• ON PPF – EFFICIENT
• UNDER PPF – INEFFICIENT
• OVER PPF – NOT POSSIBLE
             Unemployment
• Economy is not producing the maximum output
  given the resources and technology available
• Efficient?
• On, over, or under PPF?
           Efficiency Criterion
• Will alternate arrangements of resources or
  goods make at least one person better off
  without hurting someone else?
• Yes? Inefficient
• No? Efficient
Efficiency, Inefficiency, and Unemployment Resources,
   Te le vis io n S e ts
                         within a PPF Framework
           A
  55
                B
  50


                                          Effic ie nt po ints lie o n
                                          the pro duc tio n po s s ibilitie s
                              C
  35                                      fro ntie r; ine ffic ie nt po ints
                                          lie be lo w the fro ntie r.
                                      D
  28


                                                 E
  15
                          F




   0   5       15          35       45        52
                    Cars (tho us ands )
            Trade or exchange
• Process of giving up one thing for something
  else
• Why would you trade?
  – Make yourself better off
  – Give up something that you value less for
    something you value more
• Example: a leather jacket is $100…what does
  this show??
  – Value the $100 less than you value the jacket
          Periods relevant to trade
• Before the trade takes place
   – Ex ante
   – Decision takes place  $2000 of other goods or the $2000
     television set?
   – Which makes me better off?
• At the point of the trade
   – The $2000 changing hands
• After the trade
   – Ex post
   – No guarantee that trade will meet expectations
   – Buyers remorse
              Benefits of Trade
• Compare the consumer’s and producers point
  of views
  – Consumer Surplus
    • Maximum buying price – price paid
    • Satisfaction gained by not having to pay as much
  – Producer Surplus
    • Price received – minimum selling price
    • Satisfaction gained by getting more than anticipated for
      the good
     Which makes you better off?
• Increases in Consumer or Producer Surplus?
  – Consumer
• Why?
  – Price that you pay will be lower
                Terms of Trade
• Trade is where things are given up to get
  something else
  – What things?
     • Money, goods, services…
• Terms of trade is how much is given up
• Which part does buyers remorse fit into?
  – terms of trade
  – Where the money usually comes in
                  Costs of Trade
• Transaction costs
  – Time and effort needed to search out, negotiate,
    and consummate a trade
  – May cause trades to not take place
     • Don’t know about the good
     • Shipping costs are too high
     • Don’t like to work with salesperson
• Third-party effects
  – Impacts of trade on parties not immediately involved
     • Second hand smoke (negative externality)
          Producing and trading
• Two people: Elizabeth       Elizabeth      Elizabeth
  and Brian                    Apples         Bread
                                  20             0
• Each produce two
  goods: Bread and               10             10
  Apples                          0             20
• Elizabeth  10 loaves of   Brian Apples   Brian Bread
  bread and 10 apples
                                  0             10
• Brian  5 loaves of
                                 15             5
  bread and 15 apples
                                 30             0
        Comparative Advantage
• Should both produce apples and bread or
  should they specialize?
• What does specialize mean?
  – Produce the good that you do best
  – Produce at a lower costs than other person(s) can
  – Called comparative advantage
  – Looks at opportunity cost
    • What was that?
    • What you have to give up
    • Give up less?? Have the comparative advantage
   What are the opportunity costs?
• Elizabeth                          Elizabeth   Elizabeth
   – If give up 10 apples how much    Apples      Bread
     more bread can she produce?
       • 10 units
   – If give up 10 loaves of bread
                                        20          0
     how many more apples can
     she produce?
       • 10 units
                                        10          10
• Opportunity Costs
   – 10 Bread = 10 Apples
   – 1 Bread = 1 Apple                  0           20
   What are the opportunity costs?
• Brian                               Brian   Brian
   – If give up 15 apples how much   Apples   Bread
     more bread can he produce?
      • 5 units
   – If give up 5 loaves of bread
                                       0       10
     how many more apples can he
     produce?
      • 15 units
                                      15       5
• Opportunity Costs
   – 5 Bread = 15 Apples
   – 1 Bread = 3 Apples               30       0
   – 1/3 Bread = 1 Apple
            Should we specialize?
• Elizabeth
   1 Bread = 1 Apple
• Brian
   1 Bread = 3 Apples
   1/3 Bread = 1 Apple
• Who produces apples cheaper?
  • What does cheaper mean?
     • Lower opportunity cost (give up less)
  • Brian!!! Give up only 1/3 loaves of bread
• Who produces bread cheaper?
  • Elizabeth!!! Give up only 1 apple
                   Here is the deal
•   Elizabeth produces only bread (20 loaves)
•   Brian produces only apples (30 apples)
•   Trade 8 loaves of bread for 12 apples
•   Breakdown of end result
    – Elizabeth Bread?
       • 12 loaves (20 - 8 traded)
    – Elizabeth Apples?
       • 12 apples (0 + 12 traded)
• Brian Bread
  – 8 loaves (0 + 8 traded)
• Brian Apples
  – 18 apples (30 -12 traded)
• Are they better off??
            Are they better off??
                 No        Specialization Gains from
            Specialization  and Trade       trade
              or Trade
Elizabeth
 Bread
Elizabeth
 Apples
  Brian
 Bread
  Brian
 Apples
            Are they better off??
                 No        Specialization Gains from
            Specialization  and Trade       trade
              or Trade
Elizabeth        10
 Bread
Elizabeth        10
 Apples
  Brian          5
 Bread
  Brian          15
 Apples
            Are they better off??
                 No        Specialization Gains from
            Specialization  and Trade       trade
              or Trade
Elizabeth        10             12
 Bread
Elizabeth        10             12
 Apples
  Brian          5              8
 Bread
  Brian          15             18
 Apples
            Are they better off??
                 No        Specialization Gains from
            Specialization  and Trade       trade
              or Trade
Elizabeth        10             12            +2
 Bread
Elizabeth        10             12           +2
 Apples
  Brian          5              8            +3
 Bread
  Brian          15             18           +3
 Apples
            Are they better off??
                 No        Specialization Gains from
            Specialization  and Trade       trade
              or Trade
Elizabeth
 Bread
Elizabeth
 Apples
  Brian
 Bread
  Brian
 Apples
Both are Better off!!
            Economic System
• The way in which a society decides to answer
  key economic questions
  – What goods will be produced?
  – How will the goods be produced?
  – For whom will the goods be produced?
  – Where on the PPF will the economy operate?
  – What is the nature of trade?
  – What function do prices serve?
    Two major economic systems
• Capitalism
  – An economic system based on private ownership of
    capital
  – Market economy
• Socialism
  – An economic system based on state ownership of
    capital
• Most use pieces of each  mixed capitalism
             How do they differ
• PPF
  – Capitalist: Buying behavior of consumers signal for
    producers to produce more/less
  – Socialist: Government sets up how much to
    produce
• What good to produce?
  – Capitalist: Consumers and producers decide
  – Socialist: Government decides
• How goods will be produced?
  – Capitalist: producers decide
  – Socialist: government decides
• For whom to produce?
  – Capitalist: Consumers decide if they are able and
    willing to purchase the good
  – Socialist: Government may redistribute funds to get
    certain people certain items
• Trade
  – Capitalist view: Trade benefits both sides
  – Socialist view: Trade benefits one side at the
    expense of the other
• Prices
  – Capitalism views
    • Rations goods and services
    • Conveys information
    • Serves as an incentive to respond to information
  – Socialism views
    • Price is set by greedy businesses with much economic
      power
    • Price controls (can’t charge more or less than a certain
      price)
   Now we want to
 use these questions
 for the next chapter
    as we look at:
What a market is and how is it
        established.
   Chapter 3
Supply, Demand:
    Theory
                Market
• Market is an arrangement by which people
  exchange goods and services including money
• Two sides
  – Buyer
  – Seller
  Starting with the Buyer Side
• Quantity demanded
  – Amount of a good people are willing and able to buy
    at a particular price at a particular point in time
     Important parts of definition
•   Willing
•   Able
•   Particular Price
•   Particular point in time
                Demand
Quantity demanded over all prices during a
  specific point in time
• Important parts:
• Quantity demanded
• All prices
• Specific point in time
       So….
So….
Who does what in the Market?
• Consumers
  – Buy goods
  – Sell Labor
• Firms
  – Sell goods
  – Buy Labor
           Circular Flow
• Depiction of how the market works in the
  economy
• Includes both buyers and sellers
• Shows the flow of goods and services between
  consumers and firms
   Law of Demand



• As price of a good (decreases) increases
    the Quantity demanded of that good
            (increases) decreases
     Demand Schedule
• Numerical table of quantity demanded at
  different prices
           Price          Quantity
             4              10
             3              20
             2              30
             1              40
         Demand Curve
• Graphical representation of the demand
  schedule
• Used to represent the relationship between
  price and quantity
• Why type of relationship do you expect price
  and quantity to have?
          Demand Schedule and Demand
                    Curve
DEMAND S CHEDULE FOR GOOD X            Pric e (do llars )
   PRICE        QUANTITY   POINT IN                   A
  (do llars )   DEMANDED   PANEL (b)    4
                                                                  De mand Curve
                                                             B
      4            10         A         3


      3            20         B                                       C
                                        2

                                                                            D
      2            30         C         1

      1            40         D
                                        0          10       20      30     40
                                             Quantity De mande d o f Go o dX
                   (a)                                      (b)
         Market Demand
                Curves
• Previous demand curve was for an individual
  – Single buyer
• How can we get the market curve from
  individual demand curves?
  – All buyers
• Sum the individual Demand curves…
Therefore….
        Deriving a Market Demand
            Schedule & Curve
                   Part (a)

                  QUANTITY DEMANDED

PRICE     JONES   S MITH      OTHER BUYERS ALL BUYERS

$15         1       2              20           23

 14         2       3              45           50

 13         3       4              70           77

 12         4       5             100          109

 11         5       6             130          141

 10         6       7             160          173
                              Part (b)
    Pric e ($)
                 De mand Curve
                                       Pric e ($)
                                                    De mand Curve
                                                                        Deriving a
      12          A1
                     (Jo ne s )
                                        12
                                                        (S mith)
                                                       A2
                                                                         Market
      11              B1
                               +        11                B2
                                                                         Demand
                                                                        Schedule
       0       4 5
           Quantity Demande d
                                         0         5 6
                                             Quantity De mande d         & Curve
     Pric e ($)                         Pric e ($)
                  De mand Curve                       Marke t De mand
                  (o the r buye rs )                      Curve
        12          A3                    12           A4
                        B3                               B4
+       11
                                  =       11




         0    100 130                    0     109 141
        Quantity De manded         4 + 5 + 100
                                              Quantity De mande d
                                   5 + 6 + 130
  Determinants of Demand
• Income
  – Normal good
  – Inferior good
• Preferences
• Prices of Related Goods
  – Substitutes
  – Compliments
   Determinants Continued…
• Number of Buyers
• Expectations of Future
   Change in Demand vs.
Change in Quantity Demanded
• Change in Demand
  – SHIFT OF CURVE
    • Due to any non-price determinate
• Change in Quantity demanded
  – MOVEMENT ON ORIGINAL CURVE
    • Due only to a change in price
          Change in Demand versus
Pric e
         Change in Quantity Demanded
                      Pric e
                   A c hang e in de mand                    A c hang e in
                       (a s hift in the                quantity demande d
                      de mand c urve )                  (a mo ve me nt alo ng
                                                      the de mand c urve , D )

                                                B



                                                     A



                            D
                    D                                     D
0        Quantity De mande d               0   Quantity De mande d
                   (a)                                   (b)
    Change in Demand
• SHIFT OF CURVE
• SHIFT LEFT??
  – DECREASE IN DEMAND
• SHIFT RIGHT??
  – INCREASE IN DEMAND
Shifts in the Demand Curve
                             Part (a)
  Pric e (do llars )
                                     Rig htward s hift
                                    in de mand c urve
                                 (inc re as e in de mand)




                         A           B
    30




                                          D
                             D

      0                500        700

              Quantity De mande d o f Blue Je ans
Shifts in the Demand Curve
                           Part (b)
  Pric e (do llars )
                                 Le ftward s hift
                              in de mand c urve
                            (de c re as e in de mand)




                       B          A
      30




                                        D
                           D

        0         450          650
            Quantity Demande d of Blue Je ans
      Change in price of related
•   Substitutes goods
    – Something used in replace of another good
    – Price of Coke increases...
• Compliments
    – Something used with another good
    – Price of Tennis Rackets increase
           Substitutes and Complements
                                        Part (a)
                                     S UBS TITUTES
Pric e                                       Pric e

                   If Co c a-Co la and
                   Pe ps i-Co la are
                   s ubs titute s , a
             B     hig he r pric e fo r
P2                 Co c a-Co la le ads to . . .

P1                  A

                                    . . . a rig htward
                                    s hift in the de mand
                                    c urve fo r Pe ps i-Co la.                        DPC 2

                                     DCC                                         DPC 1

0         Qd 2   Qd1                              0
     Quantity De manded o f Co c a-Cola               Quantity De mande d o f Pe ps i-Cola
          Substitutes and Complements
                                        Part (b)
                                     COMPLEMENTS
 Pric e      If te nnis rac ke ts and
                                             Pric e
             te nnis balls are
             c o mple me nts , a hig he r
             pric e fo r te nnis
             rac ke ts le ads to . . .
              B
P2

 P1                   A
                                   . . . a le ftward
                                   s hift in the de mand
                                   c urve fo r te nnis balls .
                                                                                     DTB 1

                                      DTR                                      DTB 2

 0          Qd 2 Qd1                          0
Quantity De mande d o f Te nnis Rac ke ts          Quantity De mande d o f Te nnis Balls
             SELF TEST-Do we
•   Substitutes understand??
    – Coke vs. Pepsi --- what happens if the price of
      Coke increases?
    – Qd of Pepsi?
      • NOTHING
    – Qd of Coke?
      • DECREASES
    – Demand for Coke?
      • NOTHING
    – Demand for Pepsi?
      • INCREASES
• Compliments
  – Tennis Balls and Tennis Rackets --- what happens
    if the price of Tennis Rackets increase?
  – Qd of Tennis Balls?
    • NOTHING
  – Qd of Tennis Rackets?
    • DECREASES
  – Demand for Tennis Balls?
    • DECREASES
  – Demand for Tennis Rackets?
    • NOTHING
               Examples
• The housing market: Consumer’s income
  increases
• The sugar market: Saccharine is found to lead to
  cancer
• The jelly market: The price of peanut butter
  increases
• The beer market: The price of beer decreases
    Does the Law of Demand
             Hold?
• The price of eating out increases from $10 to
  $15 and the quantity demanded of restaurants
  increases from 10 to 14 meals.
 Pric e ($)
                  B
                                                          The Law
 15
 10
              A           The s e two
                          po ints ,
                          A and B,
                                                             of
                          are o bs e rve d.
                                                          Demand
     0       10 14
           Quantity De mande d                             Holds
     o f Re s taurant Me als (millio ns )
                    (a)
          WRONG                          RIGHT

Pric e ($)                     Pric e ($)
                      D
                                                  B
15                B            15
                                              A
10            A                10


 0         10 14                0         10 14
Quantity De mande d             Quantity De mande d
o f Re s taurant Me als         o f Re s taurant Me als
       (millio ns )                    (millio ns )
           (b)                             (c )
    The other side…supply
• Quantity supplied
  – Amount of a good that producers are willing and
    able to sell at a particular point in time at a
    particular price
            Important Parts
•   Able
•   Willing
•   Particular price
•   Particular point in time
                  Supply
• Quantity Supplied at all prices during a specific
  time period
• Thus…
          Law of Supply


• As the price of a good increases (decreases)
  the quantity supplied of that good increases
  (decreases)
        Supply Schedule
• Numerical table of quantity supplied at different
  prices

              Price           Quantity
                4               40
                3               30
                2               20
                1               10
            Supply Curve
• Supply Curve
  – Graphical representation of the relationship
    between price and quantity supplied
• What type of relationship do we have between
  price and quantity supplied?
       Supply Curve
                     Exhibit 7
Pric e (do llars )

                           S upply Curve

        4                                  D


       3                         C


        2                  B


        1            A



       0     10      20      30      40
            Quantity S upplie d of Go o dX
   Stuff continued…
• Change in supply
   – SHIFT OF SUPPLY CURVE
• Change in quantity supplied
   – MOVEMENT ALONG ORIGINAL SUPPLY
     CURVE
• Increase in supply --- shift right
• Decrease in supply --- shift left
          Change in Supply versus
         Change in Quantity Supplied
Pric e                                  Pric e

                      S         S                               S




                                                        B



                                                   A            A c hang e in
                    A c hang e in s upply                     quantity
                       (a s hift in the
                                                             (a mo ve me nt alo ng
                       s upply c urve )                     the s upply c urve ,S )

0        Quantity S upplie d                0    Quantity S upplie d
                (a)                                     (b)
Shifts in the Supply Curve
                            Part (a)
  Pric e (do llars )
                                        S
                Rig htward s hift
                in s upply c urve                 S
             (inc re as e in s upply)



                                   A        B
       5




       0                       200      300
               Quantity S upplie d o f Go o d X
Shifts in the Supply Curve
                             Pa rt (b)
  Pric e (do llars )
                        S2               S1




                  B           A
        5


                                    Le ftward s hift
                                   in s upply c urv e
                                (de c re as e in s upply)


        0      50        150
               Qu antity S upp lie d o f Go o d X
             Question???
• Can the supply curve ever be vertical?
• First…what does a vertical curve indicate about
  the relationship between price and quantity
  supplied?
         Supply Curves When There Is No
         Time to Produce More or No More
Pric e
                 Can Be Produced
                         Pric e



                    S upply Curve o f                     S upply Curve o f
                    The ate r S e ats                     S tradivarius Vio lins
                    fo r To nig ht’s
                    Pe rfo rmanc e




0             500                        0            X
         Numbe r o f The ate r S e ats       Numbe r o f S tradivarius Vio lins
                    (a)                                  (b)
       Determinants of Supply
•   Price of inputs
•   Technology
•   Number of sellers
•   Price expectations
•   Taxes and subsidies
                Examples
• The computer market: The price of computer chips
  decreases
• The fast food market: McDonalds opens three new
  stores in Bakersfield
• The pencil market: The price of pencils increases
• The gasoline market: A tax is imposed on gas station
  owners for each gallon of gas pumped out of their
  station
   Market Supply Curves
• Previous supply curve was for an individual
  – Single seller
• How can we get the market curve from
  individual supply curves?
  – All sellers
• Sum the individual supply curves…
Therefore….
        Deriving a Market Supply
           Schedule & Curve
                     Part (a)

                     QUANTITY S UPPLIED
PRICE    BROWN   ALBERTS   OTHER S UPPLIERS ALL S UPPLIERS

 $10      1          2             96              99

  11      2          3             98             103

  12      3          4            102             109

  13      4          5            106             115

  14      5          6            108             119

  15      6          7            110             123
           S upply
                        Part (b)                                Deriving
Pric e ($) Curve               Pric e ($) S upply
                                          Curve
          (Bro wn)                       (Albe rts )            a Market
   12                              12
   11        A1
                  B1
                           +       11          A2
                                                    B2
                                                                 Supply
                                                                Schedule
     0    2 3
     Quantity S upplie d
                                   0         3 4
                                       Quantity S upplie d      & Curve
             S upply Curve                  Marke t
Pric e ($)        (o the r       Pric e ($) S upply
               s upplie rs )
                                            Curve
    12             B3              12            B4
+   11        A3           =       11         A4


     0     98 102                   0     103 109
    Quantity S upplie d        2 + 3 + 98 Quantity S upplie d
                               3 + 4 + 102
     Next Step….


Putting Supply and Demand
         Together
                 Auction
                 Model
            Can think of supply and
            demand as an auction
      where buyers bid the price
down and sellers bid the
price up until Qs and Qd
are equal at the same price
                   But…
• There is only one price where Qs=Qd
• This is called the equilibrium price
• The market is always working towards this price
       Scissors and economics?
• Alfred Marshall compared Supply and demand
  to a pair of scissors
  – “It is impossible to say which blade is actually doing
    the cutting just like it is impossible to say whether
    demand or supply is responsible for the price
     What determines the price?
• The interaction of supply and demand
              Equilibrium
• Also called the market clearing price
  – When Qs=Qd
• Disequilibrium
  – When Qs=Qd
      At Disequilibrium can have…
• Shortage (excess demand)
   – Qd > Qs
   – Price too low
   – Price must increase to rid shortage
• Surplus (excess supply)
   – Qd < Qs
   – Price too high
   – Price must decrease to rid surplus
                      Moving to Equilibrium
Pric e (do llars )

                                                 S

     15
                           S urplus
                                               PRICE     Qs    Qd    CONDITION

                                               $15       150    50     S urplus
     10                            E
                                                10       100   100   Equilibrium

                                                 5        50   150    S ho rtag e
                           S ho rtag e
       5


                                                     D


       0             50      100         150
                          Quantity
         Moving to Equilibrium
• If we have a surplus, price must _______ to get
  to equilibrium.
• Decrease
• If we have a shortage, price must _______ to
  get to equilibrium.
• Increase
 Do Shortage and Scarcity refer to
       the same thing???
• NO!!
• Shortage is only when price is less than the
  equilibrium price
• Scarcity is always present (at all prices)
Applications of Supply and Demand
• Romanee-Conti Wine
  – Dated back to 1990 and sells for $800 a bottle or $8 a
    sip…why?
• Ticket scalping
  – Why would people pay higher prices to see an event?
  – Prices must have been below equilibrium.
• Freeway
  – Why would people be willing to pay a toll to use a road?
            Remember..
• Equilibrium price and quantity are determined
  by the INTERACTION of supply and demand
• A change in supply, demand, or both will
  change the equilibrium price
• Exception: If supply and demand move in
  same direction and magnitude so changes are
  offset
Change in Supply and Demand but no change in
              equilibrium price
         What Happens???
•   Increase D and S constant?
•   Decrease D and S constant?
•   D constant and increase S?
•   D constant and decrease S?
•   D increase and S decreases by equal amounts?
•   D decrease and S increases by equal amounts?
•   D increases more than S decreases?
•   D increases less than S decreases?
           A Summary Exhibit of a Market
                                        MARKET



           DEMAND                        PRICE,                         S UPPLY
                                        QUANTITY



   Prefe renc e s                                               Numbe r           Taxe s
                       Numbe r
                      o f Buyers                                    of             and
                                                 Pric e s o f
                                                                S e lle rs      S us idie s
                                                 Re le vant
Inc o me                    Expe c tatio ns      Re s ouc e s
                           o f Future Pric e                                    Go ve rnme nt
               Pric e s o f                                                     Re s tric tio ns
           Re late d Go o ds                          Te c hno lo g y
            (S ubs titute s                                             Expe ctatio ns
                  and                                                        of
           Co mple me nts )                                             Future Pric e
                    Price Controls
• Produces a barrier to which the economy can
  no longer operate freely
  – Can’t get to equilibrium price
• Two types
  – Price ceiling
  – Price Floor
             Price Ceiling

• Government mandated maximum price
  above which legal trades cannot be
  made
• Price ceiling is below equilibrium price.
            Pric e
           (do llars                                    S       Price
                  18                                             Ceiling

Eq uilibrium                                         A pric e c e iling
                  12
Pric e                                            c re ate s a s ho rtag e


    Pric e
                   8
    Ce iling
                             S h o rtag e




                                                            D

                   0   100      150         190        Qu antity o f Go o d X


                             Eq uilibrium
                              Qu antity
         Impacts of Price Ceilings
• Shortage sustained
• Fewer exchanges
• Non-price rationing schemes
  – First come first served
• Buying & selling at prohibited prices
  – Black markets
• Tie in Sales
  – Pay certain amount for rent of the house and an amount for
    renting the refrigerator
• Distort normal economic information and incentives
  – Lower prices is supposed to mean greater availability
               Price Floor
• Government mandated minimum price below
  which legal trades cannot be made
• Price floor is above equilibrium price
          Pric e
        (do llars )                            S
                                                            Price
                           S urplus
                                                            Floor
   Pric e
                20
   Flo o r

Equilibrium
Pric e          15                              A pric e flo o r
                                            c re ate s a s urplus




                                                   D


                 0    90     130      180   Quantity o f Go o d X


                           Equilibrium
                            Quantity
       Impacts of Price Floors
• Sustained surpluses
• Fewer exchanges
• Example: Minimum wage
              Minimum Wage
• In California the minimum wage is $6.75 per
  hour
  – Increased from $6.26 on January 1, 2002
• Government mandated minimum wage is $5.15
  – Last increase was on September 1, 1997
        Impacts of Minimum Wage
•   Surplus of unskilled
•   Fewer workers overall employed
•   Supply and Demand would determine wage
•   Minimum wage doesn’t guarantee better
    standards of living for low wage employees
       Wag e Rate                                               S
         (do llars )                    S urplus
 Minimum
       4.25
 Wag e 5.75



                                                                 Effects of
Equilibrium
                                                               the Minimum
         3.25
Wag e 4.25
                                                                    Wage




                                                               D Numbe r o f
                                                              Uns kille d Wo rke rs
           0               N               N              N3
                              2              1
          Numbe r o f Wo rke rs   Numbe r o f Wo rke rs   Numbe r o f Wo rke rs
             Emplo ye d at            Emplo ye d          Who Want to Wo rk at
           Minimum Wag e          atEquilibrium Wag e        Minimum Wag e
                      Chapter 5
                       Elasticity

You are responsible for reading Chapter 4!!!
         What have we done?
• Chapter 3 gave us downward sloping demand
  curves
  – Law of demand
• Now want to see how Qd changes when price
  changes
                    Elasticity
• Response of one variable to a change in
  another variable
• Price elasticity of demand
  – Measure of the responsiveness of Qd of a product to
    a change in the price of that product
     %Q
Ed 
     %P

     Qd
      Q
Ed 
     P
      P
                    So…
• What if Ed = 3?
  – If price was increased from the prevailing
    point the % change in Qd would be 3 times
    the change in price
• Shouldn’t it be negative?
  – So price increases and Qd decreases?
• Yes!!
  – For ease we look at the absolute value, but
    know that the law of demand holds
             Point elasticity
• Measures the change between two observed
  points.

             Qd   Qb  Qa
              Q      Qa
        Ed      
             P    Pb  Pa
              P       Pa
                      example
                                 50  100
•   P1 = 10                        100  2.5
                          A  1;
•   P2 = 12                       12  10
•   Q1 = 100
                                    10
•   Q2 = 50
•   Elasticity??                 100  50
•                                   50
    Which is Point A???
                          A  2;          6
•   Big Problem!!!                10  12
                                    12
                 Problem
• Answers vary depending on where you start
• Becomes more important the larger the change
                Arc Elasticity
• To avoid the endpoint problem take elasticity at the
  midpoint (average) of the two points

            Qd            Qd 1  Qd 2
        Qd 1  Qd 2     Qd 1  Qd 2 
                                    
  Ed        2              2      
             P              P  P2
                              1
          P  P2          P  P2 
           1
                            1
                                     
          2               2 
                  Differences
• With arc elasticity it is clear which points are
  used
• P1 is the first price
• P2 is the second price
• Qd and Qd are the first and second quantity
    1        2


  demanded respectively
Price elasticity of demand can yield
           5 basic results
•   Numerator > Denominator
•   Numerator < Denominator
•   Numerator = Denominator
•   Numerator = 0
•   Denominator = 0
•   Each has a specific name and result
             Elastic Demand
• Ed > 1
• % change in quantity demanded > % change in
  price
• FLATTER CURVE
• What are some examples of an elastic good???
            Inelastic Demand
• Ed<1
• % change in the price > percent change in
  quantity demanded
• STEEPER CURVE
• What are some examples of an inelastic good?
     Price Elasticity of Demand
Price     Part (a)              Price    Part (b)

                                              Ed < 1
           Ed > 1                             Inelastic
           Elastic

P2                              P2
        10%                             10%
P1                              P1
                            D
                     20%                         4%
                                                            D

0              Q2     Q1        0             Q2 Q1
        Quantity Demanded               Quantity Demanded
          Unit Elastic Demand
• Ed=1
• % change in price = % change in quantity
  demanded
• Change in price brings a proportionate change
  in quantity demanded
• CURVE
Price Elasticity of Demand
     Price         Part (c)


                     Ed = 1
                     Unit Elastic

     P2
             10%
     P1

                                    D
                      10%



      0            Q2 Q1
             Quantity Demanded
   Perfectly Elastic Demand
• Ed =          (denominator = 0)
• % change in quantity demanded is A LOT in
  response to a change in price
• Price increases and quantity demanded goes
  to 0
• Totally flat --- horizontal
• Extreme
• Examples???
  Perfectly inelastic demand
• Ed = 0
• % change in quantity demanded
  DOESN’T CHANGE in response to a
  change in price
• Totally steep --- vertical
• Extreme
• Examples???
          Price Elasticity of Demand
Price        Part (d)                Price      Part (e)
                                                   D


                                                       Ed = 0
             Ed =                                     Perfectly Inelastic
             Perfectly Elastic       P2
P2                                           10%
P1   1%                              P1
                                 D




0                Q1                  0              Q1
          Quantity Demanded                  Quantity Demanded
   Aren’t demand curve downward
              sloping?
• Because the extremes (perfectly inelastic and
  perfectly elastic) are not.
• Use as points of reference only
  How does a change in price affect Total
          Revenue of a Firm?
• Revenue depends on elasticity
• Michael Jordan and Nike shoes
  – No substitutes -- inelastic demand
    • What happens to Qd if price increases?
  – Substitutes – elastic demand
    • What happens to Qd if price increases?
        What is total revenue??
• Total revenue = price*quantity

• Firm uses to decide if to produce more or less
             examples
• Elastic demand
   – Price increase
   – Price decrease
• Inelastic demand
   – Price increase
   – Price decrease
• Unit elastic demand
   – Price increase
   – Price decrease
                      Elasticities,
         P   TR 
Ed > 1
                         Price
         P   TR    Changes, and
                         Total
         P   TR 
Ed < 1                 Revenue
         P   TR 



         P   TR
Ed = 1
         P   TR
   Important to look at because…
• Elasticity of the demand determines if with a
  price increase…
  – Total revenue increases
  – Total revenue decreases
  – Total revenue remains the same
   Price elasticity of demand and a
              straight line
• Demand is downward sloping
• Along the line elasticity varies from highly
  elastic to highly inelastic
• But…remember SLOPE is constant
Point   P   Qd
 A      8   3
 B      7   4
 C      6   5
 D      5   6
 E      4   7
 F      3   8
 G      2   9
     Price Elasticity of Demand along
             a Demand Curve
                             Price (dollars)
               (3)                                        Elastic
                             8
 (1)   (2)  QUANTITY (4)                  A               Range
POINT PRICE DEMANDED Ed      7
                                                  B                   Unit Elastic
 A     $8         3          6                                        Range
                      2.14                                C
 B      7         4          5
                      1.44                                                       Inelastic
                                                                  D
 C      6         5          4                                                   Range
                      1.00                                              E
 D      5         6          3
                      0.69                                                   F
 E      4         7
                      0.47   2
 F      3         8                                                                G     D
                      0.29   1
 G      2         9
                                 1    2       3       4       5     6    7   8       9
                                              Quantity Demanded
            (a)                                               (b)
               Summary
• Upper end of Demand Curve
  – Qd is low and price is high
  – One unit change in demand is much larger
    in terms of percent than change in price
• Lower end of Demand Curve
  – Qd is high and price is low
  – One unit change in demand is much
    smaller in terms of percent than change in
    price
                     So…
• As move down the demand curve from higher
  prices to lower the price elasticity of demand
  goes from elastic to inelastic
 Determinants of price elasticity of
            demand
• Number of substitutes available
  – Increase substitutes increases elasticity
  – More narrowly defined goods have more substitutes
    (compared to broadly defined)
     • Example: Fords vs all cars
            More Determinants
• Percentage of one’s budget that is spent on the
  good
  – More expensive??? More elastic
  – More affected by price (even small changes)
            Final Determinants
• Amount of time that passed since price change
  – Increase time passed gives more opportunity to
    change behavior or react to price change
  – Overtime can look for substitutes
  – Increase time increases elasticity
  – More elastic in long term than short
     Cross Elasticity of Demand

• Measures the responsiveness of quantity
  demanded to a change in price of ANOTHER
  good
                          Qx 2  Qx1
                         Qx 2  Qx1 
                                    
                %Qdx         2     
           Ec        
                %Py      Py 2  Py1
                         Py 2  Py1 
                        
                                    
                                     
                              2     
When would you use Cross Price
         Elasticity?
 • To determine if goods are substitutes or compliments
 • Ec>0 – substitutes
    – % change in quantity demanded and price move
      in same direction
 • Ec<0 – compliments
    – % change in quantity demanded and price move
      in opposite directions
 • Ec=0 – goods unrelated
 Income elasticity of demand
• Measures the responsiveness of
  quantity demanded to the change in
  income
                    Qx 2  Qx1
                   Qx 2  Qx1 
                               
        %Qd            2      
  Ey           
       %income       Y2  Y1
                     Y2  Y1 
                             
                     2 
     Why use income elasticity of
             demand?
• Use to determine if a good is normal or inferior
• Ey>0 – normal good
  – As income increases Qd increases
• Ey<0 – inferior good
  – As income increases Qd decreases
                Can also say…
• If |Ey| > 1
   – % change in Qd > % change in Y
   – Income elastic
• If |Ey| < 1
   – % change in Qd < % change in Y
   – Income inelastic
• If |Ey| = 1
   – % change in Qd = % change in Y
   – Income unit elastic
Can we use income elasticity in the
          real world??
• If invest in the stock market do you want to
  invest in a normal or inferior good?
• Normal
• Why
• Increase income would increase quantity
  bought and increase stock prices
     Price Elasticity of Supply
• Measures the responsiveness of quantity supplied of
  a good to the change in the price of that good


                    Qs1  Qs 2
                   Qs1  Qs 2 
                              
            %Qs        2     
       Ed      
            %P       P  P2
                       1
                     P  P2 
                      1
                             
                     2 
      Classification is like demand
• Es > 1
  – Elastic
• Es < 1
  – Inelastic
• Es = 1
  – Unit elastic
• Each of these will result in a “normal” upward sloped
  supply curve
      Any extreme elasticities???
• Yes!!
• Es =
           
  – Perfectly elastic or horizontal
• Es = 0
  – Perfectly inelastic or vertical
        Price Elasticity of Supply
Price     Part (a)              Price     Part (b)


                                                            S
           Es > 1
           Elastic
                            S
                                                       Es < 1
P2                              P2                     Inelastic
        10%                             10%
P1                              P1


                     20%                       4%



 0             Q1      Q2        0            Q1 Q2
        Quantity Supplied               Quantity Supplied
Price Elasticity of Supply
    Price         Part (c)


                                  S


                             Es = 1
    P2                       Unit Elastic
            10%
    P1


                     10%



    0             Q1 Q2
            Quantity Supplied
         Price Elasticity of Supply
 Price       Part (d)                Price         Part (e)
                                                     S


                                                          Es = 0
                 
            Es = •
            Perfectly Elastic       P2
                                                          Perfectly
                                                          Inelastic
                                             10%
P1                              S   P1




 0              Q1                  0                Q1
         Quantity Supplied                   Quantity Supplied
Does time play a role in elasticity of
             supply?
• Yes!!
• Overtime producers are able to adjust their
  behavior and production patterns
• Supply becomes more elastic as time passes
           Elasticity and taxes
• If government levies a tax on a product who
  pays the tax??
• Producers?? Consumers?? Share??
• Depends on the elasticity of demand and
  supply
               How find??
• Find equilibrium price
• Supply shifts left in the amount of the tax
• Find new equilibrium
• Find point of second equilibrium on ORGINAL
  supply curve
   – Shows the actual price realized by firm or
     equilibrium price – tax = point in question
• Difference between points determines how much of
  tax you pay
                   Who Pays the Tax?
                    Price
                   (dollars)
                                                  S2 (after tax)
Part of tax paid
by consumers in                                    S1 (before tax)
terms of higher
   price paid.          9.00
                                 B
                        8.50                      $1 Tax
                                     A
                        8.00

                       7.50

Part of tax paid
by producers in
terms of lower
  price kept.                                          D1




                          0     Q2 Q1
                               Quantity of VCR Tapes
       Who pays more of the tax??
•   Perfectly inelastic demand
•   Perfectly elastic demand
•   Demand more elastic than supply
•   Supply more elastic than demand
       Different Elasticities and Who
            Part (a) Pays the Tax Part (b)
  Price (dollars)                                Price (dollars)
                    D1               S2
                                                        Producers pay          S2
                                          S1
                                                           full tax
                                                                                    S1
                    B              $1 Tax
9.00
                                                                              $1 Tax
                                                               B     A
8.00                    A                      8.00                            D1

                            Consumers pay
                               full tax


  0                Q1                            0            Q2      Q1
            Quantity of VCR Tapes                           Quantity of VCR Tapes
                 Summary
• Ed > Es producer bears most of the tax burden
• Ed < Es consumer bears most of the tax burden
• Ed = Es equally share the tax burden
     Chapter 6
 Consumer Choice:
Maximizing Utility and
Behavioral Economics
       Diamond-Water Paradox
• Why is water (necessary to life) so cheep while
  a diamond (not necessary to life) is so
  expensive?
     Two types of value for a good
• Value of Exchange
   – Price
• Utility
   – Satisfaction or wellbeing
     How do you measure utility?
• Construct an artificial measure called a UTIL
• Remember we assume people are rational
• What does it mean to be rational?
  – Will not consume a bad voluntarily
• All consumed goods have utility or you would
  not consume it.
                 Total Utility
• Amount of satisfaction or “use value” you
  receive from consuming a particular good
• Thus…
               Marginal Utility
• Additional utility gained from consuming an
  additional unit of a good
• Change in total utility brought about by the
  additional consumption
Thus…
Calculate the Marginal Utility

     Quantity   Pizza Slices
                Total Utility
        1           10

        2            16

        3            18

        4            19
 Law of Diminishing Marginal Utility

• The more units of a good we consume during a
  period of time the less additional satisfaction we
  get from the additional units
(1) UNITS OF    (2) TOTAL      (3) MARGINAL
   GOOD X      UTILITY (utils) UTILITY (utils)
     0                0                —
     1                10               10
     2                19               9
     3                27               8
     4                34               7
     5                40               6
          Total Utility (utils)                  Marginal Utility (utils)
                                       TU
         40                                      10
                                                  9
         34
                                                  8
         27                                       7
                                                  6
                                                                              MU
         19


         10



                                                  0
           0     1    2    3      4   5 Good X          1    2    3    4    5 Good X
     Does the “law” always hold?
• Some goods have increasing MU initially then
  decreasing later, but the law says satisfaction
  should begin to decrease with the second unit
• Tennis
  – As you get better you like it more, so the 10th game
    may be more enjoyable
               Soften the Law
• Principle of Diminishing Returns
  – For a given period of time the MU gained from
    consuming equal successive units of a good will
    eventually decline as the amount consumed
    increases.
              Examples…
• Car rides
• Fads
• eating
           Thus…the law says
• At some point successive units of a good
  consumed by the SAME individual will become
  less valuable to that individual
• What about to someone else or the
  interpersonal utility?
  – Can’t do because we don’t know with certainty
    another person’s preferences
                    Example
• Who would value a dollar more: a poor person
  or a millionaire?
• Money hungry millionaire?
  – Answer would be millionaire
• Dollar is not much of a million
  – Answer would be a poor person
• Don’t guess at utility
 Diamond-Water Paradox revisited
• Goods have Total and Marginal Utility values
• Water
  –   TU?
  –   High because need it to live
  –   MU?
  –   Low because it is plentiful and we consume it in large
      quantities
Diamond-Water Paradox continued
• Diamonds
  – TU??
  – Low because not really necessary to live
  – MU??
  – High because very limited supply and consume in
    small quantities
Solution to Diamond-Water Paradox
• Things with great value in use have little value
  in exchange
• Those with little use value have higher
  exchange value
• Prices (value of exchange) are most often
  determined by…
  – Marginal Utility
          Is gambling worth it?
• If only want to win??? NO!!
• If gain pleasure from the gambling process???
  YES!!
How do we compare MU of different
            units?
• Example: What is the MU of an apple vs. an
  orange?
• Relative Marginal Utility of the good
• MU per dollar of purchase price
       Decision Making Process
• If the MU of good A relative to its price is
  greater than the MU of good B relative to its
  price we should buy more of A and less of B
• Compare          of each good
               MU
                P
                   Example
•   MUorange = 30
•   MUapple = 20
•   Income = $20
•   Buy 10 oranges for $1 each and 10 apples for $1
    each
• Good??
                  MU o MU A
                      
                   Po   PA
                 Not Good…
• We could do better by buying more oranges
  because per dollar it brings more satisfaction
• Buy one more orange and one less apple
  increases TU
• What happens to the MU of oranges?
   – Decreases MU of oranges
   – Why?
   – Diminishing MU when buy more
• What happens to the MU of apples?
   – Increases MU of apples
   – Why?
   – Increasing MU when buy less
• When do we stop?
         Consumer Equilibrium
• The combination of goods where our income
  can’t be redirected to improve our situation
• Therefore:



                 MU o MU A
                     
                  Po   PA
         Example
P =$2; P =$1; Income=$60
 M               c




     # muffins       MUM   # cookies   MUc
        5            11       44        6

        6             8       46        5

        7             6       48        4

        8             3       50        3
      What if the price of a good
               changes?

• Must recalculate
                     MU
                      P
Pa=$1;Pb=$1? Pa=$0.50;Pb=$1?
         Income = $7.00
    #a     MUa    #b      MUB
    1       12    1       22
    2      11.5   2       20
    3       11    3       18
    4       10    4       16
    5       9     5       14
    6       8     6       12
    7       7     7       10
                          Consumer Equilibrium and a Fall in Price
                     GOOD A    Orig inal                                         Ne w
                               Purc has e                                      Purc has e
Units of Go od A
                                   1         2         3         4        5         6       7
  Marg inal Utility
                                   12       11.5       11        10       9         8       7


                                                              Ne w              Orig inal
                     GOOD B                                 Purc has e         Purc has e
Units o f Go o d B
                                   1         2         3         4        5        6        7
  Marg inal Utility
                                   22       20         18        16       14       12       10

                           Orig inal                      Ne w
                           Purc has e                  Purc has e
                     Go o d A    Go o d B          Go o d A    Go o d B

                     12 utils   12 utils            8 utils   16 utils
                              =                             =
                      $1.00      $1.00               $.50      $1.00
                    So…
• As price decreases relative MU increases so
  consumers buy more to gain consumer
  equilibrium again
• Shows a negative relationship between price
  and amount people buy
  – JUST LIKE THE DEMAND CURVE
      Do RATS understand the inverse
  relationship between price and quantity?

• Choice between two liquids
  – Root beer
  – Collins mix
• Given 300 pushes (each liquid had a different number
  of pushes to get it – price)
• Found rats switched to the “cheaper” liquid when the
  “price” changed
  Why isn’t education and medical
             care free?
• If cost = 0 when do we stop using it?
• When MU = 0
• Thus we will see a lot of frivolous use of
  programs. It costs you nothing so use it.
           Consumer Surplus
• The difference between the actual price buyers
  pay for a good and the maximum amount they
  are WILLING and ABLE to pay for it
• Dollar measure of benefit gained from a price
  decrease
        Consumer Surplus cont.

• Triangle under the demand curve and above
  the equilibrium price out to the equilibrium
  quantity
          Consumers' Surplus
                     Part (a)
 Pric e                                Windo w
           Co ns ume rs ’                    P
           S urplus              S                   CS
                                                          S

                                        $7

                                        $5
$5

                                                          D
                                                              Q
                                         0       50 100



                                 D
     0
              100
                            Quantity
Changes in Supply affect Consumer
             Surplus

•   Decrease in the number of sellers
•   Advance in technology
•   Increase in the price of relevant resources
•   A per-unit subsidy placed on
    producers/seller
          Consumers' Surplus
          Part (b)       S2
 Pric e                              Windo w
      A                                              A
                               S1


P2          B                        CS with S 1 :



                                               P1            C
P1                   C
                                                     A
                                     CS with S 2 :

                                                P2       B

                               D1

 0
                          Quantity
           Sales schemes
• Consumer is willing to buy
  – One pair of shorts for $40
  – Second pair of shorts for $30
• Store has a choice
  – Sell shorts for $30
  – Have sale where buy first for $40 get $10
    off second pair?
  – Which has more CS??? (hint only use the
    demand curve)
                        Consumers’ Surplus and
                         Two Pricing Schemes
 Pric e                                   Pric e                         Pric e
              Bo b’s demand                  A         Cas e whe n          A          Cas e whe n
               fo r pairs o f                             e ac h                            firs t
$40              tro us e rs                             pair o f ($40) C         B       pair o f
                                                        tro us e rs                      tro us e rs
$30                            ($30) F                 D is $30 ($30)F              D is $40 and
                                                                                  E   s e c o nd pair
                                                                                           is $30




                                      D                                 D                                  D
 0        1   2         Pairs o f         0        2          Pairs o f   0       1   2          Pairs o f
                        Tro us e rs                           Tro us e rs                        Tro us e rs
                  (a)                                   (b)                               (c )

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:222
posted:1/12/2011
language:English
pages:255
Description: Consumer Equilibrium Microeconomics Midterm document sample