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Chapter 1
What is Economics
About
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
Homeworkdue 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 Building and Testing a Theory
a
Evidence rejects the theory, soeither formulate a new theory,
or amend the old theory in termsof its variables, assumptions,
and hypotheses.
Identify thevariables that
you believe areimportant to
what you wantto explain or
predict.
Decide on whatit is you want to
explain orpredict.
State theassumptions of
the theory.
State thehypothesis.
Test the theoryby comparing
its predictionsagainst real-world events.
Return
Either
Or
Evidence supports thetheory. No further action isnecessary, although it is agood idea to continue to
examine the theory closely.
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
Two-Variable Diagram Representing an Inverse Relationship
a
20
18
16
14
12
0
Price of CDs ($)
Quantity Demanded of CDs100 120 140 160 180
The variables priceand quantitydemanded areinversely related.
Demand for CDs
A
B
C
D
E
Two-Variable Diagram Representing a Direct Relationship
Two-Variable Diagram Representing a Direct Relationship
a
360
300
240
180
120
60
0
Consumption ($)
Income ($)
100 200 300 400 500
The variablesincome andconsumption aredirectly related.
A
B
C
D
E
F
Two Diagrams Representing Independence between Two
Variables
Two Diagrams Representing Independence between Two
Variables
a
(b)(a)
40
30
20
10
010 20 30 40
A B C D
Y
X
Variables X and Y areindependent (neither variable
is related to the other).
40
30
20
10
010 20 30 40
A
B
C
D
Y
X
Variables X and Yare independent.
Slope
• Used to see how a variable changes in response to another variable changing
horizontal
vertical
X
YSlope
To calculate slope
• Find two points on any straight line
21
21
12
12
XX
YYor
XX
YY
What sign do you expect the slope to have?
• Direct relationship– Positive
• Inverse relationship– Negative
• No Relationship– 0 or infinity
Calculating Slopes Calculating Slopes
a
YX
= +10+5
= +2Slope =Slope=Y
= = –1–10
10
40
30
20
10
010 20 30 40
(a)
A
B
C
D
X
Y
Y
X
40
30
20
10
010 20
(b)
A
B
C
D
X
Y
15
(negative slope)X
(positive
Calculating SlopesCalculating Slopes
a
010
+100
Slope =Y
= = `X(infinite slope)
A
B
C
D
Slope =Y
= = 0X(zero slope)
(d)(c)
40
30
20
10
010 20 30 40
A B C D
Y
X
40
30
20
10
010 20 30 40
Y
X
The 45 Line The 45 Line
a
20
20
Y
X
A
45
Line45
0
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
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
Production Possibilities Frontier for Grades
a
(a)
A
B
C
D
E
F
G
POINT INPART (b)
60
65
70
75
80
85
90
GRADE INECONOMICS
0
1
2
3
4
5
6
HOURS SPENTSTUDYING
ECONOMICS
90
85
80
75
70
65
60
GRADE INSOCIOLOGY
6
5
4
3
2
1
0
HOURS SPENTSTUDYING
SOCIOLOGY
Production Possibilities Frontier for Grades Production Possibilities Frontier for Grades
a
Grade in Soc io logy
90
85
80
75
70
65
6065 70 75 80 90
A
B
C
D
E
F
Grade in Economics
ProductionPos s ibilities
Frontier (PPF)
Part (b)
60 85
G
H
(Soc . 90, Econ. 60)
(Soc . 85, Econ. 65)
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)
Production Possibilities Frontier (Constant Opportunity Costs)
a
COMBINATIONCOMPUTERS AND TELEVISION SETS
(number of units per year)POINT INPANEL (b)
A
B
C
D
E
F
A
B
C
D
E
F
50,000
40,000
30,000
20,000
10,000
0
and
and
and
and
and
and
0
10,000
20,000
30,000
40,000
50,000
Part (a)
Production Possibilities Frontier (Constant Opportunity Costs)
Production Possibilities Frontier (Constant Opportunity Costs)
a
Co mpute rs (thous ands per ye ar)
50
40
30
20
10
0 10 20 30 40 50
A
B
C
D
E
F
Tele vis io n Sets (tho us ands pe r year)
A s traight-line PPFillus trate s cons tantopportunity c os ts .
Part (b)
Second Type of PPF
Changing Opportunity Costs
• BOWED OUT PPF
• Real world PPF
• Changing slope with every point
Production Possibilities Frontier (Changing Opportunity Costs)
Production Possibilities Frontier (Changing Opportunity Costs)
a
COMBINATIONCOMPUTERS AND TELEVISION SETS
(number of units pe r year)POINT IN
PANEL (b)
A
B
C
D
A
B
C
D
50,000
40,000
25,000
0
and
and
and
and
0
20,000
40,000
60,000
Part (a)
Production Possibilities
Frontier (Changing
Opportunity Costs)
Production Possibilities
Frontier (Changing
Opportunity Costs)
a
Computers (thous ands per year)
50
40
30
20
10
0 10 20 30 40 50
Televis ion Sets (thous ands per year)
Part (b)
60
B
C
A
D
25
A bowed outward
(concave) PPF illus trates
increas ing opportunity
cos ts .
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.
A Summary Statement about Increasing
Opportunity Costs and a Production
Possibilities Frontier That Is Bowed
Outward (Concave Downward)
A Summary Statement about Increasing
Opportunity Costs and a Production
Possibilities Frontier That Is Bowed
Outward (Concave Downward)
a
} 5
60 70 110 120
30
50
B
C
A
D
Hous es
Good X
20
10 10
0
95100
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
a
Civilian Goods
Military Goods
PPF2
PPF1
Economic growth s hiftsthe PPF outward.
0
Economic Growth within a PPF Framework
Economic Growth within a PPF Framework
Production Possibilities Frontier for Grades
Production Possibilities Frontier for Grades
a
(a)
A
B
C
D
E
F
G
POINT INPART (b)
60
65
70
75
80
85
90
GRADE INECONOMICS
0
1
2
3
4
5
6
HOURS SPENTSTUDYING
ECONOMICS
90
85
80
75
70
65
60
GRADE INSOCIOLOGY
6
5
4
3
2
1
0
HOURS SPENTSTUDYING
SOCIOLOGY
Production Possibilities Frontier for Grades Production Possibilities Frontier for Grades
a
Grade in Soc io logy
90
85
80
75
70
65
6065 70 75 80 90
A
B
C
D
E
F
Grade in Economics
ProductionPos s ibilities
Frontier (PPF)
Part (b)
60 85
G
H
(Soc . 90, Econ. 60)
(Soc . 85, Econ. 65)
More Hours of Study Shifts the Production Possibilities Frontier More Hours of Study Shifts the
Production Possibilities Frontier
aa
Grade in Soc io logy
65 70 75 80 90
X (Soc . 80, Econ. 75)
D
Grade in Economics
60 85
PPF2(7 hours )
9577.5
77.5 Y (Soc . 77.5, Econ. 77.5)Z (Soc . 75, Econ. 80)
PPF1(6 hours )
95
90
85
80
75
70
65
60
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,
within a PPF Framework Efficiency, Inefficiency, and Unemployment Resources,
within a PPF Framework
a
B
C
A
E
D
F
5 15 35 45 520
15
28
35
50
55
Cars (thous ands )
Televis ion Sets
Effic ient points lie onthe production pos s ibilitiesfrontier; ineffic ient pointslie be low the frontier.
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 and Brian
• Each produce two goods: Bread and Apples
• Elizabeth 10 loaves of bread and 10 apples
• Brian 5 loaves of bread and 15 apples
Elizabeth Apples
Elizabeth Bread
20 0
10 10
0 20
Brian Apples Brian Bread
0 10
15 5
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– If give up 10 apples how much
more bread can she produce?• 10 units
– If give up 10 loaves of bread how many more apples can she produce?
• 10 units
• Opportunity Costs– 10 Bread = 10 Apples– 1 Bread = 1 Apple
Elizabeth Apples
Elizabeth Bread
20 0
10 10
0 20
What are the opportunity costs?
• Brian– If give up 15 apples how much
more bread can he produce?• 5 units
– If give up 5 loaves of bread how many more apples can he produce?
• 15 units
• Opportunity Costs– 5 Bread = 15 Apples– 1 Bread = 3 Apples– 1/3 Bread = 1 Apple
Brian
Apples
Brian
Bread
0 10
15 5
30 0
Should we specialize?
• Elizabeth1 Bread = 1 Apple
• Brian1 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 or Trade
Specialization and Trade
Gains from trade
Elizabeth Bread
Elizabeth Apples
Brian Bread
Brian Apples
Are they better off??No
Specialization or Trade
Specialization and Trade
Gains from trade
Elizabeth Bread
10
Elizabeth Apples
10
Brian Bread
5
Brian Apples
15
Are they better off??No
Specialization or Trade
Specialization and Trade
Gains from trade
Elizabeth Bread
10 12
Elizabeth Apples
10 12
Brian Bread
5 8
Brian Apples
15 18
Are they better off??No
Specialization or Trade
Specialization and Trade
Gains from trade
Elizabeth Bread
10 12 +2
Elizabeth Apples
10 12 +2
Brian Bread
5 8 +3
Brian Apples
15 18 +3
Are they better off??No
Specialization or Trade
Specialization and Trade
Gains from 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:
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
Chapter 3
Supply, Demand: Theory
MarketMarket• Market is an arrangement by which people
exchange goods and services including money
• Two sides– Buyer– Seller
Starting with the Buyer SideStarting 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 definitionImportant parts of definition
• Willing
• Able
• Particular Price
• Particular point in time
DemandDemandQuantity demanded over all prices during a
specific point in time
• Important parts:
• Quantity demanded
• All prices
• Specific point in time
So….So…. So….
Who does what in the Market?Who does what in the Market?
• Consumers – Buy goods– Sell Labor
• Firms– Sell goods– Buy Labor
Circular FlowCircular 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 DemandLaw of Demand
• As price of a good (decreases) increases the Quantity demanded of that good
(increases) decreases
Demand ScheduleDemand Schedule• Numerical table of quantity demanded at
different prices
401
302
203
104
QuantityPrice
Demand CurveDemand 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 Schedule and Demand Curve
a
Price (dollars )
(a)
4
3
2
1
10
20
30
40
A
B
C
D
PRICE(dollars )
QUANTITYDEMANDED
POINT INPANEL (b)
DEMAND SCHEDULE FOR GOOD X
4
3
2
1
0 10 20 30 40
B
C
A
D
Demand Curve
Quantity Demanded of GoodX
(b)
Market Demand Curves
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….Therefore….
Deriving a Market Demand Schedule & Curve
Deriving a Market Demand Schedule & Curve
a
QUANTITY DEMANDED
Part (a)
OTHER BUYERS
20
45
70
100
130
160
ALL BUYERS
23
50
77
109
141
173
SMITH
2
3
4
5
6
7
JONES
1
2
3
4
5
6
PRICE
$15
14
13
12
11
10
Deriving a Market
Demand Schedule & Curve
Deriving a Market
Demand Schedule & Curve
a
Quantity Demanded
Part (b)
=
Price ($)
12
11
100 130Quantity Demanded
Demand Curve(other buyers )
Price ($)
1211
109 141
4 + 5 + 100
5 + 6 + 130
00
Market DemandCurve
A3B3
A4B4+
Price ($)
5
11
12
4
Demand Curve(Jones )
Price ($)Demand Curve
(Smith)
+1211
5 6Quantity DemandedQuantity Demanded
00
A1B1
A2B2
Determinants of DemandDeterminants of Demand• Income
– Normal good– Inferior good
• Preferences
• Prices of Related Goods– Substitutes– Compliments
Determinants Continued…Determinants Continued…• Number of Buyers
• Expectations of Future
Change in Demand vs. Change in Quantity Demanded
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 Change in Quantity Demanded
Change in Demand versus Change in Quantity Demanded
a
Price
0 Quantity Demanded
A change in demand(a s hift in the
demand curve)
Price
0 Quantity Demanded
B
A
A change inquantity demanded(a movement along
the demand curve , D )
DD
D
(b)(a)
Change in DemandChange in Demand• SHIFT OF CURVE
• SHIFT LEFT??– DECREASE IN DEMAND
• SHIFT RIGHT??– INCREASE IN DEMAND
Shifts in the Demand Curve Shifts in the Demand Curve
a
Price (dollars )
30
0 500 700
Rightward s hiftin demand curve
(increas e in demand)
Quantity Demanded of Blue Jeans
Part (a)
DD
A B
Shifts in the Demand Curve Shifts in the Demand Curve
a
Price (dollars )
30
0 450 650
Leftward s hiftin demand curve
(decreas e in demand)
Quantity Demanded of Blue Jeans
Part (b)
DD
B A
Change in price of related goods
Change in price of related goods• Substitutes
– 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 Substitutes and Complements
a
Part (a)SUBSTITUTES
Price
Quantity Demanded of Coca-Cola
Price
Quantity Demanded of Peps i-Cola
00
If Coca-Cola andPeps i-Cola ares ubs titutes , ahigher price forCoca-Cola leads to . . .
DPC1
DPC2
Qd1Qd 2
P1
P2
DCC
A
B
. . . a rightwards hift in the demandcurve for Peps i-Cola.
Substitutes and Complements Substitutes and Complements
a
COMPLEMENTSPart (b)
Price
Quantity Demanded of Tennis Rackets
Price
Quantity Demanded of Tennis Balls
00
If tennis rackets andtennis balls arecomplements , a higherprice for tennisrackets leads to . . .
DTB 2
DTB1
DTR
Qd1Qd2
P1
P2
A
B
. . . a le ftwards hift in the demandcurve for tennis balls .
SELF TEST-Do we understand??
SELF TEST-Do we understand??• Substitutes
– 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
ExamplesExamples• 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?
Does the Law of Demand Hold?
• The price of eating out increases from $10 to $15 and the quantity demanded of restaurants increases from 10 to 14 meals.
The Law of
Demand Holds
The Law of
Demand Holds
a
Price ($)
0Quantity Demanded
of Res taurant Meals (millions )
(b)
(a)
15
10
10 14
Price ($)
0Quantity Demandedof Res taurant Meals
(millions )
15
10
10 14
B
A
Price ($)
0Quantity Demandedof Res taurant Meals
(millions )
15
10
10 14
A
B
D
(c)
RIGHTWRONG
Thes e twopoints ,A and B,are obs erved.
B
A
The other side…supplyThe 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 PartsImportant Parts• Able
• Willing
• Particular price
• Particular point in time
SupplySupply• Quantity Supplied at all prices during a specific
time period
• Thus…
Law of SupplyLaw of Supply
• As the price of a good increases (decreases) the quantity supplied of that good increases (decreases)
Supply ScheduleSupply Schedule• Numerical table of quantity supplied at different
prices
101
202
303
404
QuantityPrice
Supply CurveSupply 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
Supply Curve Exhibit 7
a
Price (dollars )
0
4
1
10 20 30 40
2
3
A
B
D
C
Supply Curve
Quantity Supplied of GoodX
Stuff continued…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
Change in Supply versus Change in Quantity Supplied
a
Price
0 Quantity Supplied
A change in s upply(a s hift in thes upply curve)
Price
(b)(a)
0 Quantity Supplied
A
B
SS S
A change inquantity
(a movement alongthe s upply curve ,S )
Shifts in the Supply Curve Shifts in the Supply Curve
aa
Price (dollars )
0
Quantity Supplied of Good X
Rightward s hiftin s upply curve
(increas e in s upply)
Part (a)
S
S
200 300
5A B
Shifts in the Supply Curve Shifts in the Supply Curve
a
Part (b)
0
Quantity Supplied of Go od X
Price (do llars )
15050
S1S2
Leftward s hiftin s upply curve
(de creas e in s upply)
5B A
Question???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
Can Be Produced
Supply Curves When There Is No Time to Produce More or No More
Can Be Produced
a
(b)
Price
X
Supply Curve ofStradivarius Violins
Number of Stradivarius Vio lins0
Price
500
Supply Curve ofTheater Seatsfor Tonight’sPerformance
Number of Theater Seats
(a)
0
Determinants of SupplyDeterminants 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 CurvesMarket 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….Therefore….
Deriving a Market Supply Schedule & Curve
Deriving a Market Supply Schedule & Curve
a
QUANTITY SUPPLIED
Part (a)
ALL SUPPLIERS
99
103
109
115
119
123
OTHER SUPPLIERS
96
98
102
106
108
110
ALBERTS
2
3
4
5
6
7
BROWN
1
2
3
4
5
6
PRICE
$10
11
12
13
14
15
Deriving a Market Supply
Schedule & Curve
Deriving a Market Supply
Schedule & Curve
a
Price ($)
3
11
12
2
SupplyCurve
(Brown)Price ($) Supply
Curve(Alberts )
+
+ =
1211
3 4
Price ($)
1211
98 102Quantity Supplied
Quantity SuppliedQuantity Supplied
Supply Curve(other
s uppliers )Price ($)
1211
Quantity Supplied
103 1092 + 3 + 983 + 4 + 102
00
00
MarketSupplyCurve
Part (b)
A1
B1A2
B2
A3
B3A4
B4
Next Step….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 Moving to Equilibrium
aa
Price (dollars )
0
Quantity
S
D
5
15
50 150100
10 E
Surplus
Shortage
CONDITION
50
100
150
Surplus
Equilibrium
Shortage
QPRICE
$15
10
5
150
100
50
Qs d
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 A Summary Exhibit of a Market
a
SUPPLY
GovernmentRes tric tions
Taxesand
Sus idies
Numberof
Se llers
Expectationsof
Future Price
Technology
Prices ofRelevant
Res ouces
PRICE,QUANTITY
DEMAND
MARKET
Income
PreferencesNumber
of Buyers
Prices ofRelated Goods
(Subs titutesand
Complements )
Expectationsof Future Price
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.
Price Ceiling Price Ceiling
a
0 100 150 190
8
12
18
A price ce ilingcre ates a s ho rtage
D
SPrice
(do llars
EquilibriumPrice
PriceCe iling
EquilibriumQuantity
Quantity of Good X
Shortag e
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
Price Floor Price Floor
a
0 90 130 180
15
20
A price floorcreates a s urplus
D
SPrice
(dollars )
EquilibriumPrice
PriceFloor
EquilibriumQuantity
Quantity of Good X
Surplus
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
Effects of the Minimum
Wage
Effects of the Minimum
Wage
a
0
3.25
4.25
D
SWage Rate(dollars )
EquilibriumWage
MinimumWage
Number ofUns killed Workers
Surplus
Number of WorkersWho Want to Work at
Minimum Wage
Number of WorkersEmployed
atEquilibrium Wage
Number of WorkersEmployed at
Minimum Wage
N2
N1
N3
5.75
4.25
Chapter 5
Elasticity
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
P
QEd
%
%
PPQQ
E
d
d
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.
a
ab
a
abd
d
P
PPQ
PPQ
Q
E
example
• P1 = 10• P2 = 12• Q1 = 100• Q2 = 50• Elasticity??• Which is Point A??? • Big Problem!!!
6
121210
5050100
;2
5.2
101012
10010050
;1
A
A
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
2
2
2
2
21
21
21
21
21
21
PPPP
QQQQ
PPP
QQQ
E
dd
dd
dd
d
d
Differences
• With arc elasticity it is clear which points are used
• P1 is the first price
• P2 is the second price
• Qd1 and Qd2 are the first and second quantity 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 Elasticity of Demand
a
0
Quantity Demanded
Price
D
10%
20%
Q1
Part (a)
Q2
P1
P2
Ed > 1Elastic
0
Quantity Demanded
Price
D
10%
4%
Q1
Part (b)
Q2
P1
P2
Ed < 1Inelastic
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 Elasticity of Demand
a
0
Quantity Demanded
Price
D
10%
10%
Q1
Part (c)
Q2
P1
P2
Ed = 1Unit Elastic
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 Elasticity of Demand
a
0Quantity Demanded
Price
D1%
Part (d)
Q1
P1
P2
Ed = Perfectly Elastic
0Quantity Demanded
PriceD
10%
Part (e)
Q1
P1
P2
Ed = 0Perfectly Inelastic
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, Price
Changes, and Total
Revenue
Elasticities, Price
Changes, and Total
Revenue
a
Ed > 1
P TR
P TR
Ed < 1
P TR
P TR
Ed = 1
P
P
TR
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 Elasticity of Demand along a Demand Curve
a
(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)
Price (dollars)
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
G D
ElasticRange
Unit ElasticRange
InelasticRange
(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
2
2%
%
12
12
12
12
yy
yy
xx
xx
y
dxc
PP
PP
QQQQ
P
QE
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
2
2%
%
12
12
12
12
YYYY
QQQQ
income
QE
xx
xx
dy
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
2
2%
%
21
21
21
21
PPPP
QQQQ
P
QsE
ss
ss
d
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 Elasticity of Supply
a
0
Quantity Supplied
Price
S
10%
20%
Q2
Part (a)
Q1
P1
P2
Es > 1Elastic
0
Quantity Supplied
Price
S
10%
4%
Q2
Part (b)
Q1
P1
P2
Es < 1Inelastic
Price Elasticity of Supply Price Elasticity of Supply
a
0Quantity Supplied
Price
S
10%
10%
Q2
Part (c)
Q1
P1
P2Es = 1Unit Elastic
Price Elasticity of Supply Price Elasticity of Supply
a
0
Quantity Supplied
Price
S
Part (d)
Q1
P1
Es = Perfectly Elastic
0
Quantity Supplied
PriceS
10%
Part (e)
Q1
P1
P2
Es = 0PerfectlyInelastic
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? Who Pays the Tax?
a
0
8.00
7.50
8.50
9.00
Quantity of VCR Tapes
A
B
Q2
D1
$1 Tax
Q1
S2 (after tax)
S1 (before tax)
Price(dollars)
Part of tax paidby consumers interms of higher
price paid.
Part of tax paidby producers interms of lower
price kept.
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 Pays the Tax
Different Elasticities and Who Pays the Tax
a
0
8.00
9.00
Quantity of VCR Tapes
A
B
Q1
D1 S2
S1
Price (dollars)
Consumers payfull tax
Part (a)
$1 Tax
0
8.00
Quantity of VCR Tapes
AB
Q2
D1
$1 Tax
S2
S1
Price (dollars)
Producers payfull tax
Q1
Part (b)
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 6Consumer Choice:
Maximizing Utility and Behavioral Economics
Chapter 6Consumer 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
a
Total Utility (utils)
Good X0 1
40TU
2 3 4 5
34
27
19
10
(1) UNITS OFGOOD X
(2) TOTALUTILITY (utils)
(3) MARGINALUTILITY (utils)
Marginal Utility (utils)
Good X01
10
MU
2 3 4 5
9
8
7
6
012345
01019273440
—109876
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
P
MU
Example
• MUorange = 30• MUapple = 20• Income = $20• Buy 10 oranges for $1 each and 10 apples for $1
each
• Good??
A
A
o
o
P
MU
P
MU
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:
A
A
o
o
P
MU
P
MU
ExamplePM=$2; Pc=$1; Income=$60
# 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
P
MU
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 Consumer Equilibrium and a Fall in Price
a
GOOD B
Good A Good B
12 utils$1.00
12 utils$1.00
=
Good A Good B
8 utils$.50
16 utils$1.00
=
Units of Good A
Marginal Utility
Units o f Good B
Marginal Utility
GOOD A
1
12
2
11.5
6
8
3
11
4
10
5
9
7
7
1
22
2
20
6
12
3
18
5
14
7
10
4
16
Orig inalPurchas e
NewPurchas e
Orig inalPurchas e
Orig inalPurchas e
NewPurchas e
NewPurchas e
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 Consumers' Surplus
a
S
0
Quantity
Price
D
$5
100
Cons umers ’Surplus
S
0
D
$5
100Q
P
50
$7
CS
WindowPart (a)
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 Consumers' Surplus
a
S1
0Quantity
Price
D1
A
CP1
Window
P2
S2
C
B
A
P1
CS with S1:
A
BP2
CS with S2:
Part (b)
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
Consumers’ Surplus and Two Pricing Schemes
a
Price
($30)F
A
D
D
0 2 Pairs ofTrous ers
(b)
Cas e wheneach
pair oftrous ers
is $30C
Price
($30)F
A
D
D
0 2 Pairs ofTrous ers
($40)
1
B
(c)
Cas e whenfirs t
pair o ftrous ers
is $40 ands econd pair
is $30E
$40
Price
$30
D0 2 Pairs of
Trous ers1
(a)
Bob’s demandfor pairs of
trous ers