Class 1: Tues, Aug. 31 - - Determinants of Individual/Market Demand - Price - Income - Normal goods: Goods whose demand increases when income increases - Inferior goods: Goods whose demand decreases when income increases - Price of Related Goods - Substitutes: Demand goes up when the price of a substitute goes up - Complements: Demand goes down when the price of a complement goes up - Tastes and Preferences - Expectations - Number of Buyers An increase in quantity demanded is a movement down along the demand curve Class 2: Thurs, Sep. 2 - - - - Demand is the whole curve, quantity demanded is a point on the demand curve Increase in demand… one of the non-price determinants of D changes, causes the curve to shift to the right - Income increases for normal goods - Income decreases for inferior goods - Price of substitutes increases - Price of complements decreases - Changes in tastes or expectations - Number of buyers increases A decrease in quantity demanded is a movement up along the demand curve Decrease in demand… one of the non-price determinants of D changes, causing the curve to shift left - Income decreases for normal goods - Income increases for inferior goods - Price of substitutes decreases - Price of complements increases - Changes in tastes or expectations - Number of buyers decreases Determinants of a firm’s supply... - Price - Input prices - Technology - Expectations - Number of sellers When we draw an individual supply curve, everything but price is held constant - - - - - - - In the market supply curve, when we hold input prices, technology, expectations, and number of sellers constant, quantity supplied increases - When technology, expectations, and number of sellers are still held constant, input costs increase Supply refers to the entire curve If input costs increase, then the supply curve shifts to the left -- a decrease in supply An increase in in quantity supplied is a movement up along the supply curve INcrease in supply -- If one of the non-price determinants of S changes, the curve shifts to the right - Technology improves - Input prices decrease - Changes in expectations - Number of producers increase A decrease in quantity supplied is a movement down along the supply curve Decrease in supply -- one of the non-price determinants of S changes, causing the curve to shift left - Technology deteriorates - Input prices increase - Change in expectations - Number of producers decrease Equilibrium: putting supply and demand together - Defines price and market equilibrium quantity - Necessary and inevitably going to occur as market drives towards it - At this, quantity demanded equals quantity supplied Unless something disturbs the supply or demand curves, we will stay a equilibrium What happens when the price is too high? There is a surplus - Excess supply - There is a downward pressure on price, and price declines toward P* - As prices go down, quantity demanded increases and quantity supplied decreases - The process stops when equilibrium is reached and the surplus is eliminated What happens when the price is too low? There is a shortage - Excess demand - There is upward pressure on price, and price increases - As price increases, quantity demanded decreases and quantity supplied increases - This stops when equilibrium is reached and the shortage is eliminated P = 25 + 2Qs --- P =100 - 3Qd --- Q* = 15 --- P* = 55 Comparative Statics - Start at equilibrium - Change the value of one of the non-price determinants of supply or demand - - - - - - Compare the new equilibrium to the old one The three important questions of a comparative statics problem… 1. Which curve shifts? a. Is the thing that changes one of the b. Demand - since the price of a complement has changed and that is a determinant of of demand 2. Which way does it shift? a. To the right, since a fall in the price of a complement causes demand to increase 3. What happened to an equilibrium price and quantity after the shift? a. The increase in demand leads to an increase in equilibrium price and an increase in equilibrium quantity - The decrease in demand leads to a an increase in quantity supplied When demand changes, and the demand curve shifts, equilibrium and quantity change in the same direction The demand curve shifts right -- the increase in demand leads to an increase in equilibrium price and an increase in equilibrium quantity - The increase in demand leads to an increase in quantity supplied Supply decreases, leading to an increase in equilibrium price, and a decrease in equilibrium quantity - A decrease in supply led to a decrease in quantity demanded When supply increases, equilibrium price decreases and equilibrium quantity increases - An increase in supply led to an increase in quantity demanded When supply changes, and the supply curve shifts, equilibrium price and quantity change in opposite directions When supply increases, equilibrium price decreases and equilibrium quantity increases What’s more effective? - Drudge education will shift the demand curve to the left, lowering equilibrium price - However, more successful drug interdiction will shift the supply curve to the left, increasing the equilibrium price and decreasing the equilibrium quantity Class 3: Tues, Sep. 7 - Binding price floor: requires a price which is above the equilibrium price - Only circumstance that it will affect market Non-binding price floor: requires a price which is below the equilibrium price - Will have no impact on the market - Examples of Price Floors - Agricultural price supports -- government mandated minimum prices for agricultural products - Minimum wage -- government mandated minimum hourly wage that employers must pay their workers -- federal minimum wage is $7.25 rn - When state minimum wage is higher than federal, the state prevails - Effect on markets depends on if minimum wage is binding - Federal minimum wage rn is non-binding - If the minimum wage is binding, there will be a surplus of workers which means there will be unemployment - In order to be binding, a price ceiling has to be set below the equilibrium price - P^c is a binding price ceiling, which gets the price too low, and results in a shortage - Ex: rent control; wage and price controls - Price ceilings in post-war Germany and Poland in 1989 - Supplies in the cities basically disappeared because it wasn't in the interest of any suppliers/producers to make it available bc the price was so low -- no food, no common household items - You need to know the percentage changes involved to determine which is more sensitive to changes in price - Price elasticity of demand: a measure of how sensitive quantity demanded is to changes in price - = percentage change in quantity demanded / the percentage change in price - - Midpoint formula: Inelastic demand curve is more steep Elastic demand curve is more flat Slope indicates elasticity but is not equal to is Perfectly inelastic demand curve is vertical -- needed drugs like insulin, so no matter the price people will (be willing/have to) pay Perfectly elastic demand curve is horizontal -- means there is only one price that can prevail in the market If the absolute value of the price elasticity of demand is… - Greater than 1, demand is elastic - Less than 1, demand is inelastic - - = 1 demand is unit elastic For every quantity change is price, quantity demanded changes by 2% Every linear demand curve has an elastic part (the top) and an inelastic part (the bottom) Class 4: Tues, Sep. 14 - - Inelastic curve has a longer inelastic part - Elastic has a longer elastic one Rules of Thumb for Price Elasticity of Demand - Availability of Close Substitutes - Demand for a good with close substitutes is more elastic - Passage of Time - The longer the period of time, the more elastic is demand - Luxuries vs. Necessities - Demand for luxuries is more elastic than demand for necessities - Definition of the Market - The broader the definition of the good, the less elastic the demand - Share of a Good’s in a Consumer’s Budget - Demand for a good will be more elastic the larger the share of the good in the average consumer’s budget Other Elasticities - Cross-price elasticity of demand: measures the response of demand for one good to changes in the price of another good - - For substitutes, cross-price elasticity > 0 - ex. an increase in price of beef causes an increase in demand for chicken - For complements, cross-price elasticity < 0 - ex. an increase in price of computers causes decrease in demand for software - If the products are unrelated, then the cross-price elasticity of demand will be zero Income elasticity of demand: measures the response of quantity demanded to a change in consumer income - An increase in income causes an increase in demand for a normal good Hence, for normal goods, income elasticity > 0 - - For inferior goods, income elasticity < 0 Price elasticity of supply: measures the response of the quantity supplied a good to changes in the good’s price - - - Measures the ability and willingness of producers to alter the quantity they produce of a good in response to a change in the good’s price - Price elasticity of supply is typically higher the longer the period of tie involved The two factors in a consumption decision - Tastes and preferences - Utility = happiness, satisfaction or well-being - Marginal utility (MU) = the additional utility you get from one additional unit of a good or service - Diminishing marginal utility - When i don't have much of good X, MUx is high - When I am already consuming a lot of good X, MUx is low Some Basic Assumptions about Preferences - Completeness: preferences are assumed to be complete -- consumers can compare and rank all possible baskets - Thus, for any two markets A and B, a consumer will prefer A to B, will prefer B to A, or will be indifferent between the two. By indifferent we mean that a person will be equally satisfied with either basket - These preferences ignore costs - Transitivity: preferences are transitive, which means that if a consumer prefers basket A to basket B and basket B to basket C, then the consumer also prefers A to C; this is normally regarded as necessary for consumer consistency - More is better than less: goods are assumed to be desirable, ex. to be good. Consequently, consumers always prefer more of any good to less. In addition, consumers are never satisfies or satiated… more is always better, even if just a little better - Class 5: Thurs, Sep. 16 - Infinite number of indifference curves Principles of indifference curves - Higher indifference curves represent higher utility - - - Indifference curves can never cross/intersect Indifference curves usually slope downward - Slope up only if one the goods on the axis was a “bad” - Indifference curves are usually convex (concave up) -- bowed inward toward the origin Marginal Rate of Substitution (MRS): measures the amount of good Y you are willing to give up to get one more unit of X - It measures the marginal value of one more unit of X… that value being measured in units of Y - Diminishing marginal rate of substitution means that as you move down along an indifference curve, MRS decreases Budget Constraint - Budget depends on amount of money available to spend, the price of the good on the X-axis, and the price of the good on the Y-axis - - Slope of budget constraint: - Px = price of X -- Py = price of Y -- B = budget Consumer Optimum - - IMPORTANT: MUx/Px is the marginal utility per dollar spent on good X - MUy/Py is the marginal utility per dollar spent on good Y Conditions for a consumer optimum - Optimal consumption bundle (X*, Y*) is on the budget constraint - Slope of IC = Slope of BC, which is equivalent to MUx/Px = MUy/Py - Class 6: Tues, Sep 21 - Budget Constraint: General Form - Substitution effect: always opposites (doesn’t matter if goods are normal or inferior, all about relative prices) Income effect: these are always the same if both goods are normal Combined/Net effect: depends on which is stronger - Class 7: Thurs, Sep 23 - Deriving the Demand Curve: As Px goes down, optimum moves from O to O’ to O” Why does the demand curve slope down? - If the good is normal, the Substitution Effect and Income Effect work in the same direction - When Price decreases, substitution effect always make quantity increase - If the good is inferior, the SE and IE work in the same direction - If you have an inferior good and you become richer, you consume less - Combined Effect: If IE > SE, Pf decreases and quantity demanded goes down -this is a Giffen Good - Giffen Goods vs. Inferior Goods - All Giffen Goods are Inferior Goods BUT not all inferior goods and giffen goods - For a good to be giffen, it has to be an inferior good AND IE must outweigh SE Class 8: Tues, Sep 28 - - - - → Midterm #1 Review Topics [Consumer Theory Unit?]: - Demand, supply, and equilibrium - Comparative statics - Elasticity - Indifference curves, budget constraints, and equilibrium - Change in budget (income) - Change in prices - Income and substitution effects - Why does the demand curve slope down? Determinants of market demand - Price - Income - Normal goods: goods whose demand increases when income increases - Inferior goods: goods whose demand decreases when income increases - Price of related goods: - Substitutes: demand goes up when the price of a substitute goes up - Complements: demand goes down when the price of a complement goes up - Tastes and Preferences - Expectations - Number of Buyers -- how many in the market Increase in quantity demanded is a movement down along the demand curve - Only determinant that has changed is price Increase in demand -- one of the non-price determinants of D changes, causing the curve to shift right - Change in tastes and preferences in favor of the good - Price of substitute goes up - Number of buyers increased - Price of complement goes down - Income increases for normal good - Income decreases for inferior good Decrease in quantity demanded -- movement up along the demand curve Decrease in demand -- one of the non-price determinants of D changes, causing the curve to shift left - [number of] Buyers declined - - - - - Tastes and preferences changed NOT in favor of the good - Income decreases for normal goods - Income increases for inferior goods - Price of substitutes decreases - Price of complements increases - Number of buyers decreases Determinants of market supply - Price - Input prices - Technology - Expectations - Number of sellers Increase in quantity supplied is a movement up along the supply curve Increase in supply -- If one of the non-price determinants of S changes, the curve shifts to the right - Technology improves - Input prices decrease - Changes in expectations - Producers expect price to fall, then would want to sell more now before price falls - Number of producers/sellers increase A decrease in quantity supplied is a movement down along the supply curve Decrease in supply -- one of the non-price determinants of S changes, causing the curve to shift left - Technology deteriorates - Input prices increase - Change in expectations - Sellers - Number of producers decrease Equilibrium: - - - ON EXAM: Equation for demand curve -- not a demand function -- demand function has Qd as a function of Price - Function for demand curve you need to solve for P is terms of Q - Inverse demand and supply functions -- solved for P in terms of Q Three questions in any comparative statics problem… 1. Which curve shifts? b. Is the thing that changes one of the determinants of supply or demand 4. Which way does it shift? 5. What happened to an equilibrium price and quantity after the shift? a. Draw it out !!!!! - ON EXAM -- GO THRU THESE 3 QUESTIONS Drug education is more effective ?????? - Fall in price is what tells us education has been more effective If interdiction is more effective - Looking at horizontal distance of shift -- How far it shifts? Price Elasticity of Demand eD > 1 -- elastic eD = 1 -- unit elastic eD < 1 -- inelastic All demand curves have elastic and inelastic part -- top is elastic, point is unt, bottom is inelastic 10% increase in price -- price elasticity = 2.5 -- quantity demand would decrease by 25% Cross-price elasticity of demand: measures the response of demand for one good to changes in the price of another good - For substitutes, cross-price elasticity > 0 - ex. an increase in price of beef causes an increase in demand for chicken For complements, cross-price elasticity < 0 - ex. an increase in price of computers causes decrease in demand for software - - - - - - Income elasticity of demand: measures the response of quantity demanded to a change in consumer income - An increase in income causes an increase in demand for a normal good - Hence, for normal goods, income elasticity > 0 - For inferior goods, income elasticity < 0 Principles of indifference curves - Higher indifference curves represent higher utility - Indifference curves can never cross/intersect - Indifference curves usually slope downward - Slope up if one of the good is bad and it detracts from utility - Slope up only if one the goods on the axis was a “bad” - Indifference curves are usually convex (concave up) -- bowed inward toward the origin - Means diminishing marginal rate of substitution - Marginal rate of substitution is the amount of good Y that your willing to give up for an extra unit of good X -- and still remain as well off, same total utility Represent tastes and preferences with indifference curves Called indifference curves because anywhere along the indifference curve, any 2 points will give the consumer the same total utility - Consumer is indifferent between any 2 combinations of 2 goods that lie on a single indifference curve Marginal rate of substitution Budget constraint: general form Consumer optimum - At O: slope of IC = slope of BC - -MRS = -Px/Py - MUx/Px = MUy/Py - Marginal utility per dollar spent of good x equals marginal utility per dollar spent of good y Changes in the budget constraint - If only budget goes up (price stays the same), the slope stays the same and budget curve just shifts up to the right onto a new indifference curve - Budget constraint pivots when one price changes - New point of tangency Whenever a price changes (up or down)... income and substitution effect come into play - - Income effect is about consumer’s purchasing power when the price of one of the good’s they buy changes - Income effect -- these are always the same if both goods are normal -- BUT what if they aren’t both normal? - With a normal good, when your richer, you buy more of it Thought experiment to decompose both effects … ??? - Given the new prices, We gave the consumer enough money to increase their happiness to the old level, their old indifference curve - - As happy as they were before because on original indifference curve, but not at their old optimum -- new slope - O → O’’ is pure substitution effect - Gotten rid of the impact of the income effect by giving them enough money to be as happy as they were before Why does the demand curve go down? 1. The good is normal, so the SE and IE work in the same direction - Good went down, so cheaper so good is more, purchasing power goes up so you consume more when your richer so price went down - IE says more combined effect ….. ?? (time 1:16???) - Inferiority comes into play with IE - When your richer, you buy less of an inferior good - SE: when price decreases, SE always makes quantity increase - All Giffen Goods are inferior goods BUT not all inferior goods are giffen goods - For a good to be giffen: it must be an inferior good AND IE must outweigh SE - 2. The good is inferior, but the SE outweighs the IE
