Midterm Slides

8/17/2019 Midterm Slides

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Chapter 1

What isEconomics About


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Definition of Economics

SCIENCE of how individuals and

societies deal with the fact thatwants are greater than resourcesavailable to satisfy those wants


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#hus%&Economics is the

SCIENCE of SCA'CI#(


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Normative vs& )ositive Economics

• Normative

! What *ought+ to be

• )ositive

! What is


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E,amples- )ositive or Normative

• #he government fought inflation during the early1./0s because it felt the inflation was damagingpotential longterm economic growth&

• #he government should cut ta,es in order to stimulateconsumption&

• Increases in consumer spending improved the2apanese economy last year&

• 3alancing the federal budget would be good for theeconomy&


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"icro vs& "acro

• "icroeconomics

! Study of human behavior and choices

! $oo4s at S"A$$ units 5individual6 mar4et6 singlefirm7

• "acroeconomics

! Study of human behavior and choices

! $oo4s at $A'8E units 5aggregated mar4ets6 wholeeconomy7


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Economic Way of #hin4ing

• Watch

! *An economist is someone that seessomething wor4ing in practice andas4s if it would would in principle+

• #hin4

• Identify


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Why Study Economics

• Social )roblems ! 9iscrimination

! Crime

• :nderstand why things happen ! Coupons

! "inimum Wage

• :nderstand the )olitical )rocess


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;omewor4due uestions 1 and ?


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3eginning to #hin4 $i4e an

Economist%is this a good thing


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9efining Economic 8oods

• :tility ! Satisfaction you receive from consuming a product ! 8ood vs& 3ad

•#angibility ! Can the good be touched or is it a service

• 'esources or factors of production used ! $and- natural resources ! $abor- )hysical and mental talents of people

! Capital- produced goods that can be used as inputs forfurther production

! Entrepreneurship- talent of organi@ing resources6 see4ingnew opportunities6 and developing new ways of doing things


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'emember Scarcity 'uns theShow%

• What was scarcity

• So%how do we ma4e sure that only those who'EA$$( need the good get it

• )rices

! System of rationing of the good

!Cause people to compete for the item


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pportunity Cost

• Balue of the ne,t best alternative foregone• )i@@a vs C9

! )i@@a for 1&00 per sliceD C9 for 1&00

• 'evolutionary War ! #he 3ritish and their red coats

• 3ig "acs

! 3ig "acs in 2apan cost /&?• ;ighway System

! )aid for with ta,es


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Summary Statement of Scarcity

and Related Concepts

C t d 3 fit t th


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Costs and 3enefits at the"argin

• What is the margin ! #he *last+ or *additional+

• "arginal Cost ! #he cost of the *last+ unit employed

• "arginal 3enefits ! #he benefit of the *last+ unit employed

• :nintended effects ! "inimum wage

! 8un bounties ! Seat belts


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Efficiency

• What is the *right amount+ of time to study

! 'ight amount F optimal or efficient amount

! "arginal Costs F "arginal 3enefits


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Economic way of thin4ingincludes%

• Analy@ing scarcity

• $oo4 at opportunity cost of decisions

• "easure costs and benefits• $oo4 at marginal effects

• E,amine unintended effects


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What is this


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"odel

• Simplified version of reality

! Includes only the *important+ aspects

• Why is a model necessary


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)arts of a #heory

• Bariables ! "agnitudes that can change

• Assumptions ! Ideas about event that will not allow to change

• ;ypothesis ! Educated guess

• )redictions ! 3ased on hypothesis and assumptions


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Scientific Approach

• What do you want to predictHe,plain

• What variables are important

• State assumptions• State hypothesis

• #est

• If results are good%(eah (ou• If results are bad%amend or reJect theory


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3uilding and #esting a #heory

Evidence rejects the theory, soeither formulate a new theory,

or amend the old theory in terms

of its variables, assumptions,

and hypotheses.

Identify the

variables that

you believe areimportant to

what you want

to explain or

predict.

Decide on what

it is you want to

explain orpredict.

State the

assumptions of

the theory.

State the

hypothesis.

Test the theoryby comparing

its predictionsagainst real-world events.

Return

Either

Or

Evidence supports the

theory. No further action is

necessary, although it is agood idea to continue to

examine the theory closely.


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;ow do we Judge theories

• $oo4 at how well they predict

• N# by the assumptions

• E,ample-


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Appendi, A

Wor4ing with 9iagrams


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#ypes of 'elationships betweenvariables

• 9irect

! )ositive

• Inverse

! Negative

• No 'elationship

!Bariables are independent


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#woBariable 9iagram 'epresenting an Inverse 'elationship

20

18

16

14

12

0

Price of CDs ($)

Quantity Demanded of CDs100 120 140 160 180

The variables price

and quantity

demanded are

inversely related.

Demand for CDs

AB

C

D

E


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#woBariable 9iagram 'epresenting a9irect 'elationship

360

300

240

180

120

60

0

Consumption ($)

Income ($)

100 200 300 400 500

The variables

income and

consumption are

directly related.

A

B

C

D

E

F


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Slope

• :sed to see how a variable changes inresponse to another variable changing

horizontal

vertical

X

Y Slope

∆

∆=

∆

∆=


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#o calculate slope

•


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What sign do you e,pect the slopeto have

• 9irect relationship

! )ositive

• Inverse relationship

! Negative

• No 'elationship

! 0 or infinity


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Calculating Slopes

∆Y∆X=+10+5= +2Slope =Slope= ∆Y = = –1 –10

10

40

30

20

10

0 10 20 30 40

A

B

C

D

∆

∆

X

Y

Y

X

40

30

20

10

010 20

A

B

C

D

X

Y

15

(negative slope)∆X

(positive


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Calculating Slopes

0

10

+10

0Slope =

∆Y= = ̀∆X

(infinite slope)

A

B

C

D

Slope =∆Y= = 0∆X

(zero slope)

(d)(c)

40

30

20

10

010 20 30 40

AB C D

Y

X

40

30

20

10

010 20 30 40

Y

X

∞


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#he = $ine

20

20

Y

X

A

45

Line45

0


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Appendi, 3

Should you maJor in Economics


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Chapter ?

Economic Activities-

)roducing and

#rading


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Efficiency

• Efficiency of )roduction is goal

• If a firm is producing the ma, possible givenavailable resources and technology


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)roduction )ossibility


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)roduction )ossibilities


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Where are we on the ))


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#wo types of )roduction )ossibility


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Second #ype of ))<

Changing pportunity Costs

• 3WE9 :# ))<

•'eal world ))


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)roduction)ossibilities


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$aw of Increasing pportunityCosts

• 8oes along with C;AN8IN8 ))'#:NI#(CS#S

• As more of a good is produced the opportunitycost to produce that good increases&

G $ ;


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A Summary Statementabout Increasing

pportunity Costs anda )roduction)ossibilities


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Economic Concepts illustrated by))<

• Scarcity

• Choice

•pportunity Costs• $aw of Increasing pportunity Costs

E amples of $a of Increasing


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E,amples of $aw of Increasingpportunity Costs

• Armed Services

! WWI6 WWII and Korean War draft was irrelevant of Job or education levelD Civil War education and Job

level mattered• ;ome Improvements

! Swedish men ma4e more improvements

themselves compared to :S men


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Economic 8rowth

• Increase in resources

• Increase in technology

•Shift of ))< outward

;ow would each of the following


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;ow would each of the followingaffect the :S ))


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C&&*&a' G$.

M&*&a#, G$.

PPF2

PPF1

E'-& + # . &.

% PPF /a#$

0

Economic 8rowth withina ))<


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"ore ;ours of Study Shifts the)roduction )ossibilities


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Efficiency%Again

• )roduce ma, amount possible given resourcesand technology

• N ))< ! E


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:nemployment

• Economy is not producing the ma,imum outputgiven the resources and technology available

• Efficient

• n6 over6 or under ))


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Efficiency Criterion

• Will alternate arrangements of resources orgoods ma4e at least one person better offwithout hurting someone else

• (es Inefficient

• No Efficient

Efficiency6 Inefficiency6 and :nemployment 'esources6& & S


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within a ))<


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#rade or e,change

• )rocess of giving up one thing for somethingelse

• Why would you trade

! "a4e yourself better off ! 8ive up something that you value less for

something you value more

• E,ample- a leather Jac4et is 100%what doesthis show ! Balue the 100 less than you value the Jac4et


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)eriods relevant to trade• 3efore the trade ta4es place

! E, ante

! 9ecision ta4es place ?000 of other goods or the ?000television set

! Which ma4es me better off

• At the point of the trade ! #he ?000 changing hands

• After the trade

! E, post ! No guarantee that trade will meet e,pectations

! 3uyers remorse


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3enefits of #rade

• Compare the consumerGs and producers pointof views

! Consumer Surplus

• "a,imum buying price ! price paid• Satisfaction gained by not having to pay as much

! )roducer Surplus

• )rice received ! minimum selling price• Satisfaction gained by getting more than anticipated for

the good


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Which ma4es you better off

• Increases in Consumer or )roducer Surplus

! Consumer

• Why

! )rice that you pay will be lower


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Costs of #rade


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Costs of #rade

• #ransaction costs

! #ime and effort needed to search out6 negotiate6and consummate a trade

! "ay cause trades to not ta4e place

• 9onGt 4now about the good• Shipping costs are too high

• 9onGt li4e to wor4 with salesperson

• #hirdparty effects ! Impacts of trade on parties not immediately

involved• Second hand smo4e 5negative e,ternality7


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)roducing and trading

• #wo people- Eli@abethand 3rian

• Each produce two

goods- 3read and Apples

• Eli@abeth 10 loaves ofbread and 10 apples

• 3rian loaves ofbread and 1 apples

Eli@abeth Apples

Eli@abeth3read

?0 0

10 100 ?0

3rian Apples 3rian 3read

0 101

L0 0

Comparative Advantage


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Comparative Advantage

• Should both produce apples and bread or

should they speciali@e

• What does speciali@e mean

! )roduce the good that you do best

! )roduce at a lower costs than other person5s7 can

! Called comparative advantage

! $oo4s at opportunity cost

• What was that• What you have to give up

• 8ive up less ;ave the comparative advantage


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What are the opportunity costs

• Eli@abeth ! If give up 10 apples how much

more bread can she produce

• 10 units

! If give up 10 loaves of breadhow many more apples canshe produce

• 10 units

• pportunity Costs

! 10 3read F 10 Apples ! 1 3read F 1 Apple

Eli@abeth Apples

Eli@abeth3read

?0 0

10 10

0 ?0


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What are the opportunity costs

• 3rian ! If give up 1 apples how much

more bread can he produce

• units

! If give up loaves of breadhow many more apples can heproduce

• 1 units

• pportunity Costs

! 3read F 1 Apples ! 1 3read F L Apples

! 1HL 3read F 1 Apple

3rian Apples

3rian3read

0 10

1

L0 0


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Should we speciali@e

• Eli@abeth1 3read F 1 Apple

• 3rian1 3read F L Apples

1HL 3read F 1 Apple• Who produces apples cheaper

• What does cheaper mean• $ower opportunity cost 5give up less7

• 3rian 8ive up only 1HL loaves of bread• Who produces bread cheaper

• Eli@abeth 8ive up only 1 apple


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;ere is the deal

• Eli@abeth produces only bread 5?0 loaves7

• 3rian produces only apples 5L0 apples7

• #rade / loaves of bread for 1? apples

• 3rea4down of end result

! Eli@abeth 3read• 1? loaves 5?0 / traded7

! Eli@abeth Apples• 1? apples 50 M 1? traded7

• 3rian 3read


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• 3rian 3read

! / loaves 50 M / traded7

• 3rian Apples ! 1/ apples 5L0 1? traded7

• Are they better off


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Are they better offNo

Speciali@ationor #rade

Speciali@ationand #rade

8ains fromtrade

Eli@abeth

3readEli@abeth Apples

3rian3read

3rian Apples


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8ains fromtrade

Eli@abeth

3read

10

Eli@abeth Apples

10

3rian3read

3rian Apples

1

A h b ff


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8ains fromtrade

Eli@abeth

3read

10 1?

Eli@abeth Apples

10 1?

3rian3read /

3rian Apples

1 1/

A th b tt ff


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8ains fromtrade

Eli@abeth

3read

10 1? M?

Eli@abeth Apples

10 1? M?

3rian3read / ML

3rian Apples

1 1/ ML

A th b tt ff


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8ains fromtrade

Eli@abeth

3readEli@abeth Apples

3rian3read

3rian Apples


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3oth are 3etter off

E i S t


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Economic System

• #he way in which a society decides to answer4ey economic uestions

! What goods will be produced

! ;ow will the goods be produced !


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#wo maJor economic systems

• Capitalism ! An economic system based on private ownership of

capital

! "ar4et economy• Socialism

! An economic system based on state ownership of

capital• "ost use pieces of each mi,ed capitalism

; d th diff


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;ow do they differ

• ))< ! Capitalist- 3uying behavior of consumers signal for

producers to produce moreHless

! Socialist- 8overnment sets up how much toproduce

• What good to produce

! Capitalist- Consumers and producers decide ! Socialist- 8overnment decides

• ;ow goods will be produced


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g p

! Capitalist- producers decide

! Socialist- government decides

•


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)rices ! Capitalism views

• 'ations goods and services• Conveys information

• Serves as an incentive to respond to information

! Socialism views• )rice is set by greedy businesses with much economic

power

• )rice controls 5canGt charge more or less than a certainprice7


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Now we want touse these uestions

for the ne,t chapteras we loo4 at-

What a mar4et is and how is it

established&


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Chapter LSupply6 9emand-

#heory

"ar4et


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"ar4et• "ar4et is an arrangement by which people

e,change goods and services including money

• #wo sides

! 3uyer

! Seller

Starting with the 3uyer Side


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Starting with the 3uyer Side

• >uantity 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


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Important parts of definition

• Willing

• Able

• )articular )rice

• )articular point in time

9emand


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9emand>uantity demanded over all prices during a

specific point in time

• Important parts-

• >uantity demanded

• All prices

• Specific point in time

So


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So%&

So%&

Who does what in the "ar4et


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Who does what in the "ar4et

• Consumers ! 3uy goods

! Sell $abor

•


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Circular


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$aw of 9emand


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$aw of 9emand

• As price of a good 5decreases7 increasesthe >uantity demanded of that good

5increases7 decreases

9emand Schedule


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9emand Schedule

• Numerical table of uantity demanded atdifferent prices

401302

203

104QuantityPrice

9emand Curve


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9emand Curve

• 8raphical representation of the demandschedule

• :sed to represent the relationship between

price and uantity• Why type of relationship do you e,pect price

and uantity to have

9emand Schedule and 9emand


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CurveP#&% ($**a#. )

(a)

4

3

2

1

10

20

30

40

A

B

C

D

PRICE

($**a#. )

>ANTIT!

DEMANDED

POINT IN

PANE" (b)

DEMAND S CHED"E FOR GOOD ;

4

3

2

1

0 10 20 30 40

B

C

A

D

D%-a'$ C/#%

>/a'&, D%-a'$% $ G$;

(b)

"ar4et 9emand


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"ar4et 9emand

Curves• )revious demand curve was for an individual ! Single buyer • ;ow can we get the mar4et curve from

individual demand curves ! All buyers

• Sum the individual 9emand curves%

#herefore


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#herefore%&

9eriving a "ar4et 9emandS h d l O C


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Schedule O Curve

>ANTIT! DEMANDED

Pa# (a)

OTHER B!ERS

20

45

70

100

130

160

A"" B!ERS

23

50

77

109

141

173

SMITH

2

3

4

5

6

7

?ONES

1

2

3

4

5

6

PRICE

@15

14

13

12

11

10


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9eterminants of 9emand


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9eterminants of 9emand• Income

! Normal good

! Inferior good

• )references

• )rices of 'elated 8oods

! Substitutes

! Compliments

9eterminants Continued


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9eterminants Continued%

• Number of 3uyers• E,pectations of


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Change in 9emand vs&

Change in >uantity 9emanded• Change in 9emand ! S;I


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Change in >uantity 9emandedP#&%

0 >/a'&, D%-a'$%$

A a'+% &' $%-a'$

(a . & &' %

$%-a'$ /#%)

P#&%

0 >/a'&, D%-a'$% $

B

A

A a'+% &'

/a'&, $%-a'$%$

(a -%-%' a*'+

% $%-a'$ /#% D )

D

D

D

(b)(a)

Change in 9emand


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Change in 9emand

• S;I


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P#&% ($**a#. )

30

0 500 700

R&+9a#$ . &&' $% -a'$ /#%

(&'#%a. % &' $%-a'$)

>/a'&, D%-a'$%$ B*/% ?%a'.

Pa# (a)

DD

A B

Shifts in the 9emand Curve


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P#&% ($**a#. )

30

0 450 650

"%9a#$ . &&' $%-a'$ /#%

($% #%a. % &' $%-a'$)

>/a'&, D%-a'$%$ B*/% ?% a'.

Pa# (b)

DD

B A

Change in price of related


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Change in price of related

goods• Substitutes ! Something used in replace of another good

! )rice of Co4e increases&&&

• Compliments ! Something used with another good

! )rice of #ennis 'ac4ets increase

Substitutes and ComplementsP ( )


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Pa# (a)SBSTITTES

P#&%

>/a'&, D%-a'$%$ CaC*a

P#&%

>/a'&, D%-a'$%$ P%.&C*a

00

I CaC*a a'$

P%. &C*a a#%

. /b. &/%. a

&+% # #&% #

C aC*a *%a$.

DPC 1

DPC 2

>$1>$ 2

P1

P2

DCC

A

B

a #&+a#$

. & &' % $% -a'$

/#% # P%. &C*a

Substitutes and ComplementsP (b)


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COMP"EMENTSPa# (b)

P#&%

>/a'&, D%-a'$%$ T%''&. Ra%.

P#&%

>/a'&, D%-a'$%$ T%''&. Ba**.

00

I %''&. #a%. a'$

%''&. ba**. a#%

-*%-% '. a &+% #

#&% # %''&.

#a%. *%a$.

DTB 2

DTB1

DTR

>$1>$2

P1

P2

A

B

a *%a#$

. & &' % $% -a'$

/#% # %''&. ba**.

SE$< #ES#9o we


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understand• Substitutes ! Co4e vs& )epsi what happens if the price of

Co4e increases

! >d of )epsi• N#;IN8

! >d of Co4e• 9EC'EASES

! 9emand for Co4e

• N#;IN8

! 9emand for )epsi• INC'EASES

• Compliments ! #ennis 3alls and #ennis 'ac4ets what happens


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ppif the price of #ennis 'ac4ets increase

! >d of #ennis 3alls• N#;IN8

! >d of #ennis 'ac4ets• 9EC'EASES

! 9emand for #ennis 3alls• 9EC'EASES

! 9emand for #ennis 'ac4ets

• N#;IN8

E,amples


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E,amples

• #he housing mar4et- ConsumerGs incomeincreases

• #he sugar mar4et- Saccharine is found to lead to

cancer • #he Jelly mar4et- #he price of peanut butter

increases

• #he beer mar4et- #he price of beer decreases

9oes the $aw of 9emand


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;old• #he price of eating out increases from 10 to

1 and the uantity demanded of restaurants

increases from 10 to 1= meals&

#he $awof

P#&% (@)

15T%. %

B

A


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of

9emand;olds0 >/a'&, D%-a'$%$ R%. a/#a' M%a*. (-&**&'. )

(b)

(a)

10

10 14

P#&% (@)

0>/a'&, D%-a'$%$ R%. a/#a' M%a*.

(-&**&'. )

15

10

10 14

B

A

P#&% (@)

0>/a'&, D%-a'$%$ R%. a/#a' M%a*.

(-&**&'. )

15

10

10 14

A

B

D

()

RIGHTRONG

T%. % &'.A a'$ Ba#% b. %#%$

A

#he other side%supply


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pp y

• >uantity supplied ! Amount of a good that producers are willing and

able to sell at a particular point in time at a

particular price

Important )arts


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Important )arts

• Able• Willing

• )articular price

• )articular point in time

Supply


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Supply

• >uantity Supplied at all prices during a specifictime period

• #hus%

$aw of Supply


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• As the price of a good increases 5decreases7the uantity supplied of that good increases5decreases7

Supply Schedule


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Supply Schedule

• Numerical table of uantity supplied at differentprices

101202

303

404QuantityPrice

Supply Curve


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Supply Curve

• Supply Curve ! 8raphical representation of the relationship

between price and uantity supplied

• What type of relationship do we have betweenprice and uantity supplied

Supply CurveE,hibit P


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E,hibit PP#&% ($**a#. )

0

4

1

10 20 30 40

2

3

A

B

D

C

S/*, C/#%

>/a'&, S/*&%$ G$;

Stuff continued%


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Stuff continued%

• Change in supply

! S;I


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Change in >uantity SuppliedP#&%

0 >/a'&, S/*&%$

A a'+ % &' . /*,

(a . & &' %./*, /#%)

P#&%

(b)(a)

0 >/a'&, S/*&%$

A

B

SS S

A a'+% &'

/a'&,

(a -%-%' a*'+% . /*, /#%S )

Shifts in the Supply Curve Pa# (a)


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P#&% ($**a#. )

0

>/a'&, S/*&%$ G$ ;

R&+9a#$ . &

&' . /*, /#%

(&'#%a.% &' ./*,)

Pa# (a)

S

S

200 300

5A B

Shifts in the Supply Curve


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Pa# (b)

0

>/a'&, S /*&%$ G $ ;

P#&% ($ **a#. )

15050

S1S2

"%9a#$ . &

&' . /*, /#%

($% #%a. % &' . /*,)

5B A

>uestion


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>

• Can the supply curve ever be vertical•


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Can 3e )roduced

(b)

P#&%

;

S/*, C/#%

S#a$&a#&/. &*&'.

N/-b%# S#a$&a#&/. &*&'.

0

P#&%

500

S/*, C/#%

T%a%# S%a.

# T'&+.

P%##-a'%

N/-b%# T%a%# S%a.

(a)

0

9eterminants of Supply


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• )rice of inputs• #echnology

• Number of sellers

• )rice e,pectations

• #a,es and subsidies

E,amples


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E,amples• #he computer mar4et- #he price of computer chips

decreases

• #he fast food mar4et- "c9onalds opens three newstores in 3a4ersfield

• #he pencil mar4et- #he price of pencils increases

• #he gasoline mar4et- A ta, is imposed on gas stationowners for each gallon of gas pumped out of their

station

"ar4et Supply Curves


137/255

pp y

• )revious supply curve was for an individual ! Single seller

• ;ow can we get the mar4et curve from

individual supply curves ! All sellers

• Sum the individual supply curves%

#herefore%&


138/255

9eriving a "ar4et SupplySchedule O Curve


139/255

>ANTIT! SPP"IED

Pa# (a)

A"" SPP"IERS

99

103

109

115

119

123

OTHER SPP"IERS

96

98

102

106

108

110

A"BERTS

2

3

4

5

6

7

BRON

1

2

3

4

5

6

PRICE

@10

11

12

13

14

15

9erivinga "ar4et

P#&% (@)S/*,C/#%

(B#')

P#&% (@) S/*,C/#%

(A*b%#. )

Pa# (b)


140/255

a "ar4et

SupplyScheduleO Curve3

11

12

2

( ) ( )

12

11

3 4

P#&% (@)

12

11

98 102>/a'&, S/*&%$

>/a'&, S/*&%$>/a'&, S/*&%$

S/*, C/#%(%#./*&%#.)

P#&% (@)

12

11

>/a'&, S/*&%$

103 109

2 3 98

3 4 102

00

00

Ma#%S/*,

C/#%

A1

B1

A2

B2

A3

B3

A4

B4


141/255

Ne,t Step%&

)utting Supply and 9emand#ogether

Auction


142/255

Auction

"odelCan thin4 of supply anddemand as an auction

where buyers bid the pricedown and sellers bid theprice up until >s and >dare eual at the same price

3ut%


143/255

• #here is only one price where >sF>d• #his is called the euilibrium price

• #he mar4et is always wor4ing towards this

price

Scissors and economics


144/255

• Alfred "arshall compared Supply and demandto a pair of scissors

! *It is impossible to say which blade is actually doing

the cutting Just li4e it is impossible to say whetherdemand or supply is responsible for the price

What determines the price


145/255

• #he interaction of supply and demand

Euilibrium


146/255

• Also called the mar4et clearing price ! When >sF>d

• 9iseuilibrium

! When >sF>d

At 9iseuilibrium can have%


147/255

• Shortage 5e,cess demand7 ! >d Q >s

! )rice too low

! )rice must increase to rid shortage

• Surplus 5e,cess supply7

! >d R >s

! )rice too high

! )rice must decrease to rid surplus


148/255

"oving to Euilibrium


149/255

• If we have a surplus6 price must to getto euilibrium&

• 9ecrease

• If we have a shortage6 price must toget to euilibrium&

• Increase

9o Shortage and Scarcity refer tothe same thing


150/255

the same thing

• N• Shortage is only when price is less than the

euilibrium price

• Scarcity is always present 5at all prices7

Applications of Supply and 9emand


151/255

• 'omaneeConti Wine ! 9ated bac4 to 1..0 and sells for /00 a bottle or / a sip%

why

• #ic4et scalping ! Why would people pay higher prices to see an event

! )rices must have been below euilibrium&

•


152/255

• Euilibrium price and uantity are determinedby the IN#E'AC#IN of supply and demand

• A change in supply6 demand6 or both will

change the euilibrium price• E,ception- If supply and demand move insame direction and magnitude so changes areoffset

Change in Supply and 9emand but no change ineuilibrium price


153/255

p

What ;appens


154/255

pp• Increase 9 and S constant• 9ecrease 9 and S constant

• 9 constant and increase S

• 9 constant and decrease S

• 9 increase and S decreases by eual amounts

• 9 decrease and S increases by eual amounts

• 9 increases more than S decreases

• 9 increases less than S decreases

A Summary E,hibit of a "ar4et


155/255

SPP"!

G%#'-%'

R%. #&&'.

Ta%.

a'$

S/. &$&%.

N/-b%#

S%**%#.

E%a&'.

F//#% P#&%

T%'*+,

P#&% .

R%*%a'

R%./%.

PRICE

>ANTIT!DEMAND

MARET

I'-%

P#%%#%'%.N/-b%#

B/,%#.

P#&% .

R%*a%$ G $.

(S/b. &/%.

a'$

C-*%-%'.)

E%a&'.

F//#% P#&%

)rice Controls


156/255

• )roduces a barrier to which the economy canno longer operate freely

! CanGt get to euilibrium price

• #wo types ! )rice ceiling

! )rice


157/255

• 8overnment mandated ma,imum priceabove which legal trades cannot bemade

• )rice ceiling is below euilibrium price&

)riceCeiling18

SP#&%

($ **a#.


158/255

0 100 150 190

8

12A #&% % &*&'+

#% a%. a . #a+%

D

E/&*&b#&/-

P#&%

P#&%

C% &*&'+

E/&*&b#&/-

>/a'&,

>/a'&, G$ ;

S#a+%

Impacts of )rice Ceilings


159/255

• Shortage sustained

•


160/255

• 8overnment mandated minimum price belowwhich legal trades cannot be made

• )rice floor is above euilibrium price

)rice


161/255

0 90 130 180

15

20

A #&% *#

#%a%. a . /#*/.

D

E/&*&b#&/-

P#&%

P#&%

F*#

E/&*&b#&/-

>/a'&,

>/a'&, G$ ;

S/#*/.

Impacts of )rice


162/255

• Sustained surpluses•


163/255

• In California the minimum wage is T&P perhour

! Increased from T&?T on 2anuary 16 ?00?

• 8overnment mandated minimum wage is &1 ! $ast increase was on September 16 1..P

Impacts of "inimum Wage


164/255

• Surplus of uns4illed•


165/255

Effects ofthe "inimum

Wage

0

325

D

E/&*&b#&/-

a+%

N/-b%# '. &**%$ #%#.

N/-b%# #%#.

a' # a

M&'&-/- a+%

N/-b%# #%#.

E-*,%$

aE/&*&b#&/- a+ %

N/-b%# #%#.

E-*,% $ a

M&'&-/- a+%

N2

N1

N3

4.25


166/255

Chapter 5

Elasticity

You are responsible for reading Chapter 4!!!

What have we done


167/255

• Chapter L gave us downward sloping demandcurves

! $aw of demand

• Now want to see how >d changes when pricechanges

Elasticity


168/255

• 'esponse of one variable to a change inanother variable

• )rice elasticity of demand

! "easure of the responsiveness of >d of a product toa change in the price of that product

QEd

∆=%


169/255

P

E d

∆%

P

P

Q

Q

E

d

d ∆

∆

=

So%


170/255

• What if Ed F L ! If price was increased from the prevailing

point the U change in >d would be L times

the change in price• ShouldnGt it be negative

! So price increases and >d decreases

• (es !


171/255

• "easures the change between two observedpoints&

a

ab

a

abd

d

P

P P

Q

QQ

P

P

Q

Q

E −−

=∆∆

=

e,ample1000−


172/255

• )1 F 10• )? F 1?

• >1 F 100

• >? F 0• Elasticity

• Which is )oint A

•3ig )roblem

6

12

12100

0100

2

"2

10

1012100

1000

1

=

−

−

=

=−=

A

A

)roblem


173/255

• Answers vary depending on where you start• 3ecomes more important the larger the change

Arc Elasticity


174/255

• #o avoid the endpoint problem ta4e elasticity at the

midpoint 5average7 of the two points

+

−

+−

=

+

∆

+∆

=

2

2

2

2

21

21

21

21

21

21

P P

P P

QQ

QQ

P P

P

QQ

Q

E

d d

d d

d d

d

d

9ifferences


175/255

• With arc elasticity it is clear which points areused

• )1 is the first price

• )? is the second price• >d1 and >d? are the first and second uantity

demanded respectively

)rice elasticity of demand can yield basic results


176/255

• Numerator Q 9enominator • Numerator R 9enominator

• Numerator F 9enominator

• Numerator F 0

• 9enominator F 0

• Each has a specific name and result

Elastic 9emand


177/255

• Ed Q 1• U change in uantity demanded Q U change in

price

•


178/255

• EdR1• U change in the price Q percent change in

uantity demanded

• S#EE)E' C:'BE• What are some e,amples of an inelastic good

)rice Elasticity of 9emandPrice Part (a) Price Part (b)


179/255

0

Quantity Demanded

ce

D

10%

20%

Q1

()

Q2

P1

P2

Ed> 1

Elastic

0

Quantity Demanded

ce

D

10%

4%

Q1

()

Q2

P1

P2

Ed< 1Inelastic

:nit Elastic 9emand


180/255

• EdF1• U change in price F U change in uantity

demanded

• Change in price brings a proportionate changein uantity demanded

• C:'BE

)rice Elasticity of 9emandPrice Part (c)


181/255

0

Quantity Demanded

Price

D

10%

10%

Q1Q2

P1

P2

Ed= 1

Unit Elastic

)erfectly Elastic 9emand


182/255

• Ed F 5denominator F 07• U change in uantity demanded is A $# in

response to a change in price

• )rice increases and uantity demanded goesto 0

• #otally flat hori@ontal

• E,treme

• E,amples

∞

)erfectly inelastic demand


183/255

•E

d

F 0• U change in uantity demanded9ESNG# C;AN8E in response to achange in price

• #otally steep vertical

• E,treme

• E,amples

)rice Elasticity of 9emandPrice Part (d) Price Part (e)


184/255

0

Quantity Demanded

Price

D1%

Q1

P1

P2

Ed=∞Perfectly Elastic

0

Quantity Demanded

PriceD

10%

Q1

P1

P2

Ed= 0

Perfectly Inelastic

ArenGt demand curve downwardsloping


185/255

• 3ecause the e,tremes 5perfectly inelastic andperfectly elastic7 are not&

• :se as points of reference only

;ow does a change in price affect #otal'evenue of a


186/255

• 'evenue depends on elasticity• "ichael 2ordan and Ni4e shoes

! No substitutes inelastic demand

• What happens to >d if price increases ! Substitutes ! elastic demand

• What happens to >d if price increases

What is total revenue


187/255

• #otal revenue F priceVuantity

•


188/255

! )rice increase ! )rice decrease

• Inelastic demand


• :nit elastic demand


Elasticities6)rice

Ed > 1

P↑ TR↓


189/255

Changes6 and#otal'evenue

P↓ TR↑

Ed < 1

P↑ TR↑

P↓ TR↓

Ed = 1

P↑

P↓

TR

TR

Important to loo4 at because%


190/255

• Elasticity of the demand determines if with aprice increase%

! #otal revenue increases

! #otal revenue decreases ! #otal revenue remains the same

)rice elasticity of demand and astraight line


191/255

• 9emand is downward sloping

• Along the line elasticity varies from highlyelastic to highly inelastic

• 3ut%remember S$)E is constant

)oint ) >d

A / L

3 P =


192/255

3 P =

C T

9 T

E = P

< L /8 ? .

)rice Elasticity of 9emand alonga 9emand Curve

Price (dollars)


193/255

(1)

POINT

(2)

PRICE

(3)

QUANTITY

DEMANDED

A

B

C

D

E

F

G

(4)

Ed

$8

7

6

5

4

3

2

3

4

5

6

7

8

9

2.14

1.44

1.00

0.69

0.47

0.29

(a)

8

7

6

5

4

3

2

1

1 2 3 4 5 6 7 8 9

Quantity Demanded

A

B

C

D

E

F

GD

ElasticRange

Unit Elastic

Range

InelasticRange

(b)

Summary

: d f 9 d C


194/255

• :pper end of 9emand Curve

! >d is low and price is high

! ne unit change in demand is much largerin terms of percent than change in price

• $ower end of 9emand Curve

! >d is high and price is low

! ne unit change in demand is much

smaller in terms of percent than change inprice

So%


195/255

• As move down the demand curve from higherprices to lower the price elasticity of demandgoes from elastic to inelastic

9eterminants of price elasticity ofdemand


196/255

• Number of substitutes available ! Increase substitutes increases elasticity

! "ore narrowly defined goods have more substitutes5compared to broadly defined7

• E,ample-


197/255

• )ercentage of oneGs budget that is spent on thegood

! "ore e,pensive "ore elastic

! "ore affected by price 5even small changes7


198/255

• Amount of time that passed since price change ! Increase time passed gives more opportunity to

change behavior or react to price change

! vertime can loo4 for substitutes

! Increase time increases elasticity

! "ore elastic in long term than short

Cross Elasticity of 9emand


199/255

• "easures the responsiveness of uantitydemanded to a change in price of AN#;E'good

+

−

+

−

=∆∆

=

2

2

%

%

12

12

12

12

y y

y y

x x

x x

y

dxc

P P

P P

QQ

QQ

P

Q E

When would you use Cross )riceElasticity


200/255

•#o determine if goods are substitutes or compliments• EcQ0 ! substitutes

! U change in uantity demanded and price movein same direction

• EcR0 ! compliments ! U change in uantity demanded and price move

in opposite directions

• EcF0 ! goods unrelated

Income elasticity of demand

• "easures the responsiveness of


201/255

"easures the responsiveness ofuantity demanded to the change inincome

+

−

+

−

=

∆

∆=

2

2

%

%

12

12

12

12

Y Y

Y Y

QQ

QQ

income

Q E

x x

x x

d y

Why use income elasticity ofdemand


202/255

• :se to determine if a good is normal or inferior • EyQ0 ! normal good

! As income increases >d increases

• EyR0 ! inferior good ! As income increases >d decreases

Can also say%

• If Ey Q 1


203/255

If Ey 1

! U change in >d Q U change in (

! Income elastic

• If Ey R 1

!U change in >

d

R U change in ( ! Income inelastic

• If Ey F 1

! U change in >d F U change in (

! Income unit elastic

Can we use income elasticity in thereal world


204/255

• If invest in the stoc4 mar4et do you want toinvest in a normal or inferior good

• Normal

• Why• Increase income would increase uantity

bought and increase stoc4 prices

)rice Elasticity of Supply• "easures the responsiveness of uantity supplied of

a good to the change in the price of that good


205/255

g g p g

+

−

+

−

=∆∆=

2

2

%

%

21

21

21

21

P P

P P

QQ

QQ

P

Qs E

s s

s s

d

Classification is li4e demand


206/255

• Es Q 1 ! Elastic

• Es R 1 ! Inelastic

• Es F 1 ! :nit elastic

• Each of these will result in a *normal+ upward sloped

supply curve

Any e,treme elasticities


207/255

• (es• Es F

! )erfectly elastic or hori@ontal

• Es F 0 ! )erfectly inelastic or vertical

∞

)rice Elasticity of Supply

Price Part (a) Price Part (b)


208/255

0

Quantity Supplied

S

10%

20%

Q2Q1

P1

P2

Es> 1

Elastic

0

Quantity Supplied

S

10%

4%

Q2Q1

P1

P2

Es< 1

Inelastic


Price Part (c)


209/255

0

Quantity Supplied

S

10%

10%

Q2Q1

P1

P2

Es= 1

Unit Elastic


Price Part (d) PriceS

Part (e)


210/255

0

Quantity Supplied

S

Q1

P1

Es=

Perfectly Elastic

0

Quantity Supplied

S

10%

Q1

P1

P2

Es= 0

Perfectly

Inelastic∞

9oes time play a role in elasticity ofsupply


211/255

• (es• vertime producers are able to adJust their

behavior and production patterns

• Supply becomes more elastic as time passes

Elasticity and ta,es


212/255

• If government levies a ta, on a product whopays the ta,

• )roducers Consumers Share

• 9epends on the elasticity of demand andsupply

;ow find•


213/255

Supply shifts left in the amount of the ta,

•


214/255

0

8.00

7.50

8.50

9.00

Quantity of VCR Tapes

A

B

Q2

D1

$1 Tax

Q1

S1(before tax)by consumers interms of higher

price paid.

Part of tax paid

by producers in

terms of lower

price kept.

Who pays more of the ta,


215/255

• )erfectly inelastic demand• )erfectly elastic demand

• 9emand more elastic than supply

• Supply more elastic than demand

9ifferent Elasticities and Who)ays the #a,

D1 S2Price (dollars)

Part (a)

S

Price (dollars)

Part (b)


216/255

0

8.00

9.00


A

B

Q1

S1

Consumers pay

full tax

$1 Tax

0

8.00


AB

Q2

D1

$1 Tax

S2S1

Producers payfull tax

Q1

Summary


217/255

• Ed Q Es producer bears most of the ta, burden• Ed R Es consumer bears most of the ta, burden

• Ed F Es eually share the ta, burden

Chapter T


218/255

Chapter TConsumer Choice-

"a,imi@ing :tility and

3ehavioral Economics

9iamondWater )arado,


219/255

• Why is water 5necessary to life7 so cheep whilea diamond 5not necessary to life7 is soe,pensive

#wo types of value for a good


220/255

• Balue of E,change ! )rice

• :tility

! Satisfaction or wellbeing

;ow do you measure utility


221/255

• Construct an artificial measure called a :#I$• 'emember 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&

#otal :tility


222/255

• Amount of satisfaction or *use value+ youreceive from consuming a particular good

• #hus%

"arginal :tility


223/255

• Additional utility gained from consuming anadditional unit of a good

• Change in total utility brought about by the

additional consumption

#hus%


224/255

Calculate the "arginal :tility


225/255

>uantity )i@@a Slices#otal :tility

1 10

? 1T

L 1/

= 1.

$aw of 9iminishing "arginal :tility


226/255

• #he more units of a good we consume during aperiod of time the less additional satisfaction

we get from the additional units

(1) UNITS OF

GOOD X

(2) TOTAL

UTILITY (utils)

(3) MARGINAL

UTILITY (utils)

01234

010192734

—10987


227/255

Total Utility (utils)

Good X0 1

40TU

2 3 4 5

34

27

19

10

Marginal Utility (utils)

Good X01

10

MU

2 3 4 5

9

87

6

5 40 6

9oes the *law+ always hold


228/255

• Some goods have increasing ": initially thendecreasing later6 but the law says satisfactionshould begin to decrease with the second unit

• #ennis ! As you get better you li4e it more6 so the 10th gamemay be more enJoyable

Soften the $aw


229/255

• )rinciple of 9iminishing 'eturns !


230/255

• Car rides•


231/255

• At some point successive units of a goodconsumed by the SA"E individual will becomeless valuable to that individual

• What about to someone else or theinterpersonal utility

! CanGt do because we donGt 4now with certaintyanother personGs preferences

E,ample


232/255

• Who would value a dollar more- a poor personor a millionaire

• "oney hungry millionaire

! Answer would be millionaire• 9ollar is not much of a million

! Answer would be a poor person

• 9onGt guess at utility

9iamondWater )arado, revisited


233/255

• 8oods have #otal and "arginal :tility values• Water

! #:

!;igh because need it to live ! ":

! $ow because it is plentiful and we consume it in largeuantities

9iamondWater )arado, continued


234/255

• 9iamonds ! #: ! $ow because not really necessary to live

!": ! ;igh because very limited supply and consume insmall uantities

Solution to 9iamondWater )arado,


235/255

• #hings with great value in use have little valuein e,change

• #hose with little use value have higher

e,change value• )rices 5value of e,change7 are most oftendetermined by%

! "arginal :tility

Is gambling worth it


236/255

• If only want to win N• If gain pleasure from the gambling process

(ES

;ow do we compare ": of differentunits


237/255

• E,ample- What is the ": of an apple vs& anorange

• 'elative "arginal :tility of the good

• ": per dollar of purchase price

9ecision "a4ing )rocess


238/255

• If the ": of good A relative to its price isgreater than the ": of good 3 relative to itsprice we should buy more of A and less of 3

•Compare of each good

P

MU

E,ample


239/255

• ":orange F L0• ":apple F ?0

• Income F ?0

• 3uy 10 oranges for 1 each and 10 apples for 1

each

• 8ood

A

A

o

o

P

MU

P

MU

>

Not 8ood%• We could do better by buying more oranges

because per dollar it brings more satisfaction


240/255

• 3uy one more orange and one less appleincreases #:

• What happens to the ": of oranges ! 9ecreases ": of oranges

! Why ! 9iminishing ": when buy more

• What happens to the ": of apples ! Increases ": of apples

! Why ! Increasing ": when buy less

• When do we stop

Consumer Euilibrium


241/255

• #he combination of goods where our incomecanGt be redirected to improve our situation

• #herefore-

A

A

o

o

P

MU

P

MU

=

E,ample)"F?D )cF1D IncomeFT0


242/255

X muffins ":" X coo4ies ":c

11 == T

T / =T

P T =/ =

/ L 0 L

What if the price of a goodchanges


243/255

• "ust recalculate

P

MU

)aF1D)bF1 )aF0&0D)bF1Income F P&00

Xa ":a Xb ":3


244/255

1 1? 1 ??

? 11& ? ?0

L 11 L 1/

= 10 = 1T

. 1=

T / T 1?

P P P 10


245/255

So%


246/255

• As price decreases relative ": increases soconsumers buy more to gain consumereuilibrium again

•Shows a negative relationship between priceand amount people buy

! 2:S# $IKE #;E 9E"AN9 C:'BE

9o 'A#S understand the inverserelationship between price and uantity


247/255

• Choice between two liuids

! 'oot beer

! Collins mi,

• 8iven L00 pushes 5each liuid had a different numberof pushes to get it ! price7

•


248/255

• If cost F 0 when do we stop using it• When ": F 0

• #hus we will see a lot of frivolous use of

programs& It costs you nothing so use it&

Consumer Surplus

#h diff b h l i b


249/255

• #he difference between the actual price buyerspay for a good and the ma,imum amount theyare WI$$IN8 and A3$E to pay for it

•9ollar measure of benefit gained from a pricedecrease

Consumer Surplus cont&


250/255

• #riangle under the demand curve and abovethe euilibrium price out to the euilibriumuantity

ConsumersY Surplus

S

P#&%

C'./-%#.

S/#*/.

S

P

CS

&'$Pa# (a)


251/255

0

>/a'&,

D

@5

100

S

0

D

@5

100>

50

@7

CS

Changes in Supply affect ConsumerSurplus

9 i th b f ll


252/255

• 9ecrease in the number of sellers

• Advance in technology

• Increase in the price of relevant resources

• A perunit subsidy placed onproducersHseller

ConsumersY Surplus

S1

P#&%

A

&'$S2

A

Pa# (b)


253/255

S1

0>/a'&,

D1

C

P1

P2

C

B

P1

CS & S 1

A

BP2

CS & S 2

Sales schemes• Consumer is willing to buy

! ne pair of shorts for =0

S d i f h t f L0


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! Second pair of shorts for L0

• Store has a choice

! Sell shorts for L0

! ;ave sale where buy first for =0 get 10off second pair

! Which has more CS 5hint only use the

demand curve7


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Documents

Midterm Slides