Chapter 1
What is
Economics About
Definition of Economics
SCIENCE of how individuals and
societies deal with the fact that
wants are greater than resources
available to satisfy those wants
Scarcity
• Wants are greater than the resources
available to fill those wants
• What do you have scarcity of???
– Money
– Time
• What do firms have scarcity of???
– Labor
– Land
– Capital
Thus….
Economics is the
SCIENCE of SCARCITY
Normative vs. Positive Economics
• Normative
– What “ought” to be
• Positive
– What is
Examples: Positive or Normative?
• The government fought inflation during the early
1980s because it felt the inflation was damaging
potential long-term economic growth.
• The government should cut taxes in order to stimulate
consumption.
• Increases in consumer spending improved the
Japanese economy last year.
• Balancing the federal budget would be good for the
economy.
Micro vs. Macro
• Microeconomics
– Study of human behavior and choices
– Looks at SMALL units (individual, market, single
firm)
• Macroeconomics
– Study of human behavior and choices
– Looks at LARGE units (aggregated markets, whole
economy)
Economic Way of Thinking
• Watch
– “An economist is someone that sees
something working in practice and
asks if it would would in principle”
• Think
• Identify
Why Study Economics?
• Social Problems
– Discrimination
– Crime
• Understand why things happen
– Coupons
– Minimum Wage
• Understand the Political Process
Homework
due Friday April 4th
• Chapter 1
– Questions 1 and 2
Beginning to Think Like an
Economist
…is this a good thing?
Defining Economic Goods
• Utility
– Satisfaction you receive from consuming a product
– Good vs. Bad
• Tangibility
– Can the good be touched or is it a service?
• Resources or factors of production used
– Land: natural resources
– Labor: Physical and mental talents of people
– Capital: produced goods that can be used as inputs for
further production
– Entrepreneurship: talent of organizing resources, seeking
new opportunities, and developing new ways of doing things
Remember Scarcity Runs the
Show…
• What was scarcity??
• So…how do we make sure that only those who
REALLY need the good get it??
• Prices
– System of rationing of the good
– Cause people to compete for the item
Opportunity Cost
• Value of the next best alternative
foregone
• Pizza vs CD
– Pizza for $1.00 per slice; CD for $15.00
• Revolutionary War
– The British and their red coats
• Big Macs
– Big Macs in Japan cost $8.25
• Highway System
– Paid for with taxes
Summary Statement of Scarcity
and Related Concepts
Costs and Benefits at the
Margin
• What is the margin??
– The “last” or “additional”
• Marginal Cost
– The cost of the “last” unit employed
• Marginal Benefits
– The benefit of the “last” unit employed
• Unintended effects
– Minimum wage
– Gun bounties
– Seat belts
Efficiency
• What is the “right amount” of time to study?
– Right amount = optimal or efficient amount
– Marginal Costs = Marginal Benefits
Economic way of thinking
includes…
•
•
•
•
•
Analyzing scarcity
Look at opportunity cost of decisions
Measure costs and benefits
Look at marginal effects
Examine unintended effects
Economic Thinking Errors
• Association vs. Causation
– You hit red lights because you are running late
– Don’t study for a test so you fail
• Fallacy of Composition
– What is good for the individual is good for the group
• Forgetting Ceteris Paribus
– All else remains constant
What is this?
Model
• Simplified version of reality
– Includes only the “important” aspects
• Why is a model necessary??
Parts of a Theory
• Variables
– Magnitudes that can change
• Assumptions
– Ideas about event that will not allow to change
• Hypothesis
– Educated guess
• Predictions
– Based on hypothesis and assumptions
Scientific Approach
•
•
•
•
•
•
•
What do you want to predict/explain?
What variables are important?
State assumptions
State hypothesis
Test
If results are good…Yeah You!!
If results are bad…amend or reject theory
Building and Testing a Theory
Evidence supports the
theory. No further action is
necessary, although it is a
good idea to continue to
examine the theory closely.
Decide on what
it is you want to
explain or
predict.
Identify the
variables that
you believe are
important to
what you want
to explain or
predict.
State the
assumptions of
the theory.
State the
hypothesis.
Test the theory
by comparing
its predictions
against realworld events.
Either
Or
Return
Evidence rejects the theory, so
either formulate a new theory,
or amend the old theory in terms
of its variables, assumptions,
and hypotheses.
How do we judge theories?
• Look at how well they predict
• NOT by the assumptions
• Example: Firms try to maximize profits
– Do they thing about this every second?
– Probably not
– Over the course of the year…make decisions to
maximize profits
Appendix A
Working with Diagrams
Types of Relationships between
variables
• Direct
– Positive
• Inverse
– Negative
• No Relationship
– Variables are independent
Two-Variable Diagram Representing an
Inverse Relationship
The variables price
and quantity
demanded are
inversely related.
Price of CDs ($)
20
18
16
A
B
C
D
14
12
0
E
Demand for CDs
100 120 140 160 180
Quantity Demanded of CDs
Two-Variable Diagram Representing a
Direct Relationship
Consumption ($)
360
F
300
E
240
D
180
C
120
60
0
B
The variables
income and
consumption are
directly related.
A
100 200 300 400 500
Income ($)
Two Diagrams Representing
Independence between Two
Variables
Y
Variables X and Y are
independent (neither variable
is related to the other).
Variables X and Y
are independent.
Y
40
40
D
30
30
C
20
20
B
10
10
A
A
0
10
B
20
(a)
C
30
D
40
X
0
10
20
30
40
(b)
X
Slope
• Used to see how a variable changes in
response to another variable changing
Y
vertical
Slope 

X horizontal
To calculate slope
• Find two points on any straight line
Y2  Y1
Y1  Y2
or
X 2  X1
X1  X 2
What sign do you expect the slope
to have?
• Direct relationship
– Positive
• Inverse relationship
– Negative
• No Relationship
– 0 or infinity
Calculating Slopes
Y
Y
Y
–10
Slope=  =
= –1
X
10
(negative slope)
A
40
Y +10
=
= +2
X
+5
(positive
Slope =
D
40
Y
B
30
30
X
C
C
B
20
20
D
10
10
0
10
20
30
40
X
0
A
10 15 20
X
Calculating Slopes
Y
Y
40
A
B
C
20
Y
0
=
Slope =
=0
X
10
(zero slope)
10
0
10
20
(c)
30
40
D
30
C
20
B
10
A
D
30
40
X
0

Y
+10
=
=`
X
0
(infinite slope)
Slope =
X
10
20
30
40
(d)
The 45 Line
45 Line
Y
20
0
A
45
20
X
Appendix B
Should you major in Economics??
Five myths about economics and an
economics major
• Economics is all mathematics and statistics
• Economics is only about inflation, interest rates,
unemployment, and other such things
• People become economists only if they want to “make
money”
• Economics wasn’t very interesting in high school, so it
isn’t going to be interesting now
• Economics is a lot like business, but business is more
marketable
Chapter 2
Economic
Activities:
Producing and
Trading
Efficiency
• Efficiency of Production is goal
• If a firm is producing the max possible given
available resources and technology
Production Possibility Frontier
(PPF)
• Shows all possible combinations of goods for a
particular economy at a particular point in time,
given its resources and technology constraints
Production Possibilities Frontier
for Grades
GRADE IN
S OCIOLOGY
HOURS S PENT
S TUDYING
ECONOMICS
GRADE IN
ECONOMICS
POINT IN
PART (b)
6
90
0
60
A
5
85
1
65
B
4
80
2
70
C
3
75
3
75
D
2
70
4
80
E
1
65
5
85
F
0
60
6
90
G
HOURS S PENT
S TUDYING
S OCIOLOGY
(a)
Production Possibilities Frontier for Grades
Grade in S o c io lo g y
90
A
Part (b)
(S o c . 90, Ec o n. 60)
B
85
(S o c . 85, Ec o n. 65)
H
C
80
Pro duc tio n
Po s s ibilitie s
Fro ntie r (PPF)
D
75
E
70
F
65
G
60
60
65
75
80
70
85
Grade in Ec o no mic s
90
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)
COMBINATION
COMPUTERS AND
TELEVIS ION S ETS
(numbe r o f units pe r ye ar)
POINT IN
PANEL (b)
A
50,000
and
0
A
B
40,000
and
10,000
B
C
30,000
and
20,000
C
D
20,000
and
30,000
D
E
10,000
and
40,000
E
F
0
and
50,000
F
Part (a)
Production Possibilities Frontier
(Constant Opportunity Costs)
Pa rt (b)
Co mpute rs (th o us a nds p e r ye ar)
50
40
30
20
10
A
A s traig ht-line PPF
illu s trate s c o n s tan t
o pp o rtun ity c o s ts .
B
C
D
E
F
0
10
30
20
40
50
Te le vis io n S e ts (tho us and s pe r ye a r)
Second Type of PPF
Changing Opportunity Costs
• BOWED OUT PPF
• Real world PPF
• Changing slope with every point
Production Possibilities Frontier
(Changing Opportunity Costs)
Pa rt (a)
COMBINATION
COMPUTERS
AND TELEVIS ION S ETS
(nu mbe r o f un its pe r ye a r)
POINT IN
PANEL (b)
A
50,000
and
0
A
B
40,000
and
20,000
B
C
25,000
and
40,000
C
D
0
and
60,000
D
Co mpute rs (tho us ands pe r ye ar)
A
50
Part (b)
B
40
30
C
25
20
A bo we d o utward
Production
Possibilities
Frontier
(Changing
Opportunity
Costs)
(co ncave ) PPF illus trate s
inc re as ing o ppo rtunity
10
c o s ts .
D
0
10
20
30
40
50
Te le vis io n S e ts (tho us ands pe r ye ar)
60
Law of Increasing Opportunity
Costs
• Goes along with CHANGING OPPORTUNITY
COSTS
• As more of a good is produced the opportunity
cost to produce that good increases.
Go o d X
A
100
95
B
}5
50
A Summary Statement
about Increasing
Opportunity Costs and
a Production
Possibilities Frontier
That Is Bowed
Outward (Concave
C
Downward)
20
D
30
10
0
60 70
Ho us e s
10
110
120
Economic Concepts illustrated by
PPF
•
•
•
•
Scarcity
Choice
Opportunity Costs
Law of Increasing Opportunity Costs
Examples of Law of Increasing
Opportunity Costs
• Armed Services
– WWI, WWII and Korean War draft was irrelevant of
job or education level; Civil War education and job
level mattered
• Home Improvements
– Swedish men make more improvements
themselves compared to US men
Economic Growth
• Increase in resources
• Increase in technology
• Shift of PPF outward
How would each of the following
affect the US PPF?
• A rise in the unemployment rate
• The invention of the computer
• An increase in the number of birth in the United
States
• An increase in the number of births in Russia
Economic Growth within
a PPF Framework
Military Go o ds
Ec o nomic g ro wth s hifts
the PPF o utward.
PPF
2
PPF
1
0
Civilian Go o ds
Production Possibilities Frontier
for Grades
GRADE IN
S OCIOLOGY
HOURS S PENT
S TUDYING
ECONOMICS
GRADE IN
ECONOMICS
POINT IN
PART (b)
6
90
0
60
A
5
85
1
65
B
4
80
2
70
C
3
75
3
75
D
2
70
4
80
E
1
65
5
85
F
0
60
6
90
G
HOURS S PENT
S TUDYING
S OCIOLOGY
(a)
Production Possibilities Frontier for Grades
Grade in S o c io lo g y
90
A
Part (b)
(S o c . 90, Ec o n. 60)
B
85
(S o c . 85, Ec o n. 65)
H
C
80
Pro duc tio n
Po s s ibilitie s
Fro ntie r (PPF)
D
75
E
70
F
65
G
60
60
65
75
80
70
85
Grade in Ec o no mic s
90
More Hours of Study Shifts the
Production Possibilities Frontier
Grade in S o c io lo g y
95
90
85
80
77.5
75
D
X (S o c . 80, Ec o n. 75)
Y (S o c . 77.5, Ec o n. 77.5)
Z (S o c . 75, Ec o n. 80)
70
PPF1
(6 ho urs )
65
60
60 65
70
75 80 85 90
77.5
Grade in Ec o no mic s
PPF2
(7 ho urs )
95
Efficiency…Again
• Produce max amount possible given resources
and technology
• ON PPF – EFFICIENT
• UNDER PPF – INEFFICIENT
• OVER PPF – NOT POSSIBLE
Unemployment
• Economy is not producing the maximum output
given the resources and technology available
• Efficient?
• On, over, or under PPF?
Efficiency Criterion
• Will alternate arrangements of resources or
goods make at least one person better off
without hurting someone else?
• Yes? Inefficient
• No? Efficient
Efficiency, Inefficiency, and Unemployment Resources,
Te le vis io n S e ts
within a PPF Framework
A
55
B
50
Effic ie nt po ints lie o n
the pro duc tio n po s s ibilitie s
fro ntie r; ine ffic ie nt po ints
lie be lo w the fro ntie r.
C
35
D
28
E
15
F
0
5
15
35
45
Cars (tho us ands )
52
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
20
Elizabeth
Bread
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?
Elizabeth
Apples
Elizabeth
Bread
20
0
10
10
0
20
• 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
What are the opportunity costs?
• Brian
– If give up 15 apples how much
more bread can he produce?
Brian
Apples
Brian
Bread
0
10
15
5
30
0
• 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
Should we specialize?
• Elizabeth
 1 Bread = 1 Apple
• Brian
 1 Bread = 3 Apples
 1/3 Bread = 1 Apple
• Who produces apples cheaper?
• What does cheaper mean?
• Lower opportunity cost (give up less)
• Brian!!! Give up only 1/3 loaves of bread
• Who produces bread cheaper?
• Elizabeth!!! Give up only 1 apple
Here is the deal
•
•
•
•
Elizabeth produces only bread (20 loaves)
Brian produces only apples (30 apples)
Trade 8 loaves of bread for 12 apples
Breakdown of end result
– Elizabeth Bread?
• 12 loaves (20 - 8 traded)
– Elizabeth Apples?
• 12 apples (0 + 12 traded)
• Brian Bread
– 8 loaves (0 + 8 traded)
• Brian Apples
– 18 apples (30 -12 traded)
• Are they better off??
Are they better off??
No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples
Are they better off??
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples
No
Specialization Gains from
Specialization
and Trade
trade
or Trade
10
10
5
15
Are they better off??
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples
No
Specialization Gains from
Specialization
and Trade
trade
or Trade
10
12
10
12
5
8
15
18
Are they better off??
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples
No
Specialization Gains from
Specialization
and Trade
trade
or Trade
10
12
+2
10
12
+2
5
8
+3
15
18
+3
Are they better off??
No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples
Both are Better off!!
Economic System
• The way in which a society decides to answer
key economic questions
– What goods will be produced?
– How will the goods be produced?
– For whom will the goods be produced?
– Where on the PPF will the economy operate?
– What is the nature of trade?
– What function do prices serve?
Two major economic systems
• Capitalism
– An economic system based on private ownership of
capital
– Market economy
• Socialism
– An economic system based on state ownership of
capital
• Most use pieces of each  mixed capitalism
How do they differ
• PPF
– Capitalist: Buying behavior of consumers signal for
producers to produce more/less
– Socialist: Government sets up how much to
produce
• What good to produce?
– Capitalist: Consumers and producers decide
– Socialist: Government decides
• How goods will be produced?
– Capitalist: producers decide
– Socialist: government decides
• For whom to produce?
– Capitalist: Consumers decide if they are able and
willing to purchase the good
– Socialist: Government may redistribute funds to get
certain people certain items
• Trade
– Capitalist view: Trade benefits both sides
– Socialist view: Trade benefits one side at the
expense of the other
• Prices
– Capitalism views
• Rations goods and services
• Conveys information
• Serves as an incentive to respond to information
– Socialism views
• Price is set by greedy businesses with much economic
power
• Price controls (can’t charge more or less than a certain
price)
Now we want to
use these questions
for the next chapter
as we look at:
What a market is and how is it
established.
Chapter 3
Supply, Demand:
Theory
Market
• Market is an arrangement by which people
exchange goods and services including money
• Two sides
– Buyer
– Seller
Starting with the Buyer Side
• Quantity demanded
– Amount of a good people are willing and able to buy
at a particular price at a particular point in time
Important parts of definition
•
•
•
•
Willing
Able
Particular Price
Particular point in time
Demand
Quantity demanded over all prices during a
specific point in time
• Important parts:
• Quantity demanded
• All prices
• Specific point in time
So….
So….
Who does what in the Market?
• Consumers
– Buy goods
– Sell Labor
• Firms
– Sell goods
– Buy Labor
Circular Flow
• Depiction of how the market works in the
economy
• Includes both buyers and sellers
• Shows the flow of goods and services between
consumers and firms
Law of Demand
• As price of a good (decreases) increases
the Quantity demanded of that good
(increases) decreases
Demand Schedule
• Numerical table of quantity demanded at
different prices
Price
4
3
2
1
Quantity
10
20
30
40
Demand Curve
• Graphical representation of the demand
schedule
• Used to represent the relationship between
price and quantity
• Why type of relationship do you expect price
and quantity to have?
Demand Schedule and Demand
Curve
DEMAND S CHEDULE FOR GOOD X
Pric e (do llars )
PRICE
(do llars )
QUANTITY
DEMANDED
POINT IN
PANEL (b)
4
10
A
3
3
20
B
2
2
30
C
1
40
D
4
A
De mand Curve
B
C
D
1
0
10
20
30
40
Quantity De mande d o f Go o dX
(a)
(b)
Market Demand
Curves
• Previous demand
curve was for an individual
– Single buyer
• How can we get the market curve from
individual demand curves?
– All buyers
• Sum the individual Demand curves…
Therefore….
Deriving a Market Demand
Schedule & Curve
Part (a)
QUANTITY DEMANDED
PRICE
JONES
S MITH
OTHER BUYERS ALL BUYERS
$15
1
2
20
23
14
2
3
45
50
13
3
4
70
77
12
4
5
100
109
11
5
6
130
141
10
6
7
160
173
Part (b)
Pric e ($)
12
11
0
De mand Curve
(Jo ne s )
A1
B1
12
11
+
4 5
Quantity Demande d
Pric e ($)
+
Pric e ($)
12
11
0
De mand Curve
(o the r buye rs )
A3
B3
0
100 130
Quantity De manded
=
De mand Curve
(S mith)
A2
B2
5 6
Quantity De mande d
Pric e ($)
12
11
Deriving a
Market
Demand
Schedule
& Curve
Marke t De mand
Curve
A4
B4
0
109 141
4 + 5 + 100
Quantity De mande d
5 + 6 + 130
Determinants of Demand
• Income
– Normal good
– Inferior good
• Preferences
• Prices of Related Goods
– Substitutes
– Compliments
Determinants Continued…
• Number of Buyers
• Expectations of Future
Change in Demand vs.
Change in Quantity Demanded
• Change in Demand
– SHIFT OF CURVE
• Due to any non-price determinate
• Change in Quantity demanded
– MOVEMENT ON ORIGINAL CURVE
• Due only to a change in price
Pric e
Change in Demand versus
Change in Quantity
Demanded
Pric e
A c hang e in
quantity demande d
(a mo ve me nt alo ng
the de mand c urve , D )
A c hang e in de mand
(a s hift in the
de mand c urve )
B
A
D
D
0
Quantity De mande d
(a)
D
0
Quantity De mande d
(b)
Change in Demand
• SHIFT OF CURVE
• SHIFT LEFT??
– DECREASE IN DEMAND
• SHIFT RIGHT??
– INCREASE IN DEMAND
Shifts in the Demand Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in de mand c urve
(inc re as e in de mand)
30
A
B
D
D
0
500
700
Quantity De mande d o f Blue Je ans
Shifts in the Demand Curve
Part (b)
Pric e (do llars )
Le ftward s hift
in de mand c urve
(de c re as e in de mand)
30
B
A
D
D
0
450
650
Quantity Demande d of Blue Je ans
•
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
Part (a)
S UBS TITUTES
Pric e
Pric e
P2
P1
B
If Co c a-Co la and
Pe ps i-Co la are
s ubs titute s , a
hig he r pric e fo r
Co c a-Co la le ads to . . .
A
. . . a rig htward
s hift in the de mand
c urve fo r Pe ps i-Co la.
DCC
0
Qd 2 Qd1
Quantity De manded o f Co c a-Cola
DPC 2
DPC 1
0
Quantity De mande d o f Pe ps i-Cola
Substitutes and Complements
Part (b)
COMPLEMENTS
Pric e
P2
If te nnis rac ke ts and
te nnis balls are
c o mple me nts , a hig he r
pric e fo r te nnis
rac ke ts le ads to . . .
Pric e
B
A
P1
. . . a le ftward
s hift in the de mand
c urve fo r te nnis balls .
DTB 1
DTR
0
Qd 2
Qd1
Quantity De mande d o f Te nnis Rac ke ts
DTB 2
0
Quantity De mande d o f Te nnis Balls
•
SELF TEST-Do we
Substitutes understand??
– Coke vs. Pepsi --- what happens if the price of
Coke increases?
– Qd of Pepsi?
• NOTHING
– Qd of Coke?
• DECREASES
– Demand for Coke?
• NOTHING
– Demand for Pepsi?
• INCREASES
• Compliments
– Tennis Balls and Tennis Rackets --- what happens
if the price of Tennis Rackets increase?
– Qd of Tennis Balls?
• NOTHING
– Qd of Tennis Rackets?
• DECREASES
– Demand for Tennis Balls?
• DECREASES
– Demand for Tennis Rackets?
• NOTHING
Examples
• The housing market: Consumer’s income
increases
• The sugar market: Saccharine is found to lead to
cancer
• The jelly market: The price of peanut butter
increases
• The beer market: The price of beer decreases
Does the Law of Demand
Hold?
• The price of eating out increases from $10 to
$15 and the quantity demanded of restaurants
increases from 10 to 14 meals.
Pric e ($)
The Law
of
Demand
Holds
B
15
The s e two
po ints ,
A and B,
are o bs e rve d.
A
10
0
10 14
Quantity De mande d
o f Re s taurant Me als (millio ns )
(a)
WRONG
RIGHT
Pric e ($)
Pric e ($)
D
15
10
B
A
0
10 14
Quantity De mande d
o f Re s taurant Me als
(millio ns )
(b)
15
10
B
A
0
10 14
Quantity De mande d
o f Re s taurant Me als
(millio ns )
(c )
The other side…supply
• Quantity supplied
– Amount of a good that producers are willing and
able to sell at a particular point in time at a
particular price
Important Parts
•
•
•
•
Able
Willing
Particular price
Particular point in time
Supply
• Quantity Supplied at all prices during a specific
time period
• Thus…
Law of Supply
• As the price of a good increases (decreases)
the quantity supplied of that good increases
(decreases)
Supply Schedule
• Numerical table of quantity supplied at different
prices
Price
4
3
2
1
Quantity
40
30
20
10
Supply Curve
• Supply Curve
– Graphical representation of the relationship
between price and quantity supplied
• What type of relationship do we have between
price and quantity supplied?
Supply Curve
Exhibit 7
Pric e (do llars )
S upply Curve
4
D
3
C
2
1
0
B
A
20
40
10
30
Quantity S upplie d of Go o dX
Stuff continued…
• Change in supply
– SHIFT OF SUPPLY CURVE
• Change in quantity supplied
– MOVEMENT ALONG ORIGINAL SUPPLY
CURVE
• Increase in supply --- shift right
• Decrease in supply --- shift left
Change in Supply versus
Change in Quantity Supplied
Pric e
Pric e
S
S
S
B
A
A c hang e in s upply
(a s hift in the
s upply c urve )
0
Quantity S upplie d
(a)
0
A c hang e in
quantity
(a mo ve me nt alo ng
the s upply c urve ,S )
Quantity S upplie d
(b)
Shifts in the Supply Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in s upply c urve
(inc re as e in s upply)
5
0
A
200
S
S
B
300
Quantity S upplie d o f Go o d X
Shifts in the Supply Curve
Pa rt (b)
Pric e (do llars )
S2
5
B
S1
A
Le ftward s hift
in s upply c urv e
(de c re as e in s upply)
0
50
150
Qu antity S upp lie d o f Go o d X
Question???
• Can the supply curve ever be vertical?
• First…what does a vertical curve indicate about
the relationship between price and quantity
supplied?
Pric e
Supply Curves When There Is No
Time to Produce More or No More
Can Be Produced
Pric e
S upply Curve o f
The ate r S e ats
fo r To nig ht’s
Pe rfo rmanc e
0
500
Numbe r o f The ate r S e ats
(a)
S upply Curve o f
S tradivarius Vio lins
0
X
Numbe r o f S tradivarius Vio lins
(b)
Determinants of Supply
•
•
•
•
•
Price of inputs
Technology
Number of sellers
Price expectations
Taxes and subsidies
Examples
• The computer market: The price of computer chips
decreases
• The fast food market: McDonalds opens three new
stores in Bakersfield
• The pencil market: The price of pencils increases
• The gasoline market: A tax is imposed on gas station
owners for each gallon of gas pumped out of their
station
Market Supply Curves
• Previous supply curve was for an individual
– Single seller
• How can we get the market curve from
individual supply curves?
– All sellers
• Sum the individual supply curves…
Therefore….
Deriving a Market Supply
Schedule & Curve
Part (a)
QUANTITY S UPPLIED
PRICE
BROWN
ALBERTS
OTHER S UPPLIERS ALL S UPPLIERS
$10
1
2
96
99
11
2
3
98
103
12
3
4
102
109
13
4
5
106
115
14
5
6
108
119
15
6
7
110
123
S upply
Pric e ($) Curve
(Bro wn)
12
11
Part (b)
upply
Pric e ($) SCurve
(Albe rts )
B1
A1
+
0
2 3
Quantity S upplie d
0
Pric e ($)
S upply Curve
(o the r
s upplie rs )
12
11
B3
+
A3
0
98 102
Quantity S upplie d
12
11
=
A2
B2
3 4
Quantity S upplie d
Marke t
Pric e ($) S upply
Curve
12
B4
11
A4
0
103 109
2 + 3 + 98 Quantity S upplie d
3 + 4 + 102
Deriving
a Market
Supply
Schedule
& Curve
Next Step….
Putting Supply and Demand
Together
Auction
Model
Can think of supply and
demand as an auction
where buyers bid the price
down and sellers bid the
price up until Qs and Qd
are equal at the same price
But…
• There is only one price where Qs=Qd
• This is called the equilibrium price
• The market is always working towards this price
Scissors and economics?
• Alfred Marshall compared Supply and demand
to a pair of scissors
– “It is impossible to say which blade is actually doing
the cutting just like it is impossible to say whether
demand or supply is responsible for the price
What determines the price?
• The interaction of supply and demand
Equilibrium
• Also called the market clearing price
– When Qs=Qd
• Disequilibrium
– When Qs=Qd
At Disequilibrium can have…
• Shortage (excess demand)
– Qd > Qs
– Price too low
– Price must increase to rid shortage
• Surplus (excess supply)
– Qd < Qs
– Price too high
– Price must decrease to rid surplus
Moving to Equilibrium
Pric e (do llars )
S
15
S urplus
10
PRICE
Qs
Qd
$15
150
50
S urplus
10
100
100
Equilibrium
5
50
150
S ho rtag e
E
S ho rtag e
5
D
0
CONDITION
50
100
Quantity
150
Moving to Equilibrium
• If we have a surplus, price must _______ to get
to equilibrium.
• Decrease
• If we have a shortage, price must _______ to
get to equilibrium.
• Increase
Do Shortage and Scarcity refer to
the same thing???
• NO!!
• Shortage is only when price is less than the
equilibrium price
• Scarcity is always present (at all prices)
Applications of Supply and Demand
• Romanee-Conti Wine
– Dated back to 1990 and sells for $800 a bottle or $8 a
sip…why?
• Ticket scalping
– Why would people pay higher prices to see an event?
– Prices must have been below equilibrium.
• Freeway
– Why would people be willing to pay a toll to use a road?
Remember..
• Equilibrium price and quantity are determined
by the INTERACTION of supply and demand
• A change in supply, demand, or both will
change the equilibrium price
• Exception: If supply and demand move in
same direction and magnitude so changes are
offset
Change in Supply and Demand but no change in
equilibrium price
What Happens???
•
•
•
•
•
•
•
•
Increase D and S constant?
Decrease D and S constant?
D constant and increase S?
D constant and decrease S?
D increase and S decreases by equal amounts?
D decrease and S increases by equal amounts?
D increases more than S decreases?
D increases less than S decreases?
A Summary Exhibit of a Market
MARKET
PRICE,
QUANTITY
DEMAND
Prefe renc e s
Inc o me
Numbe r
o f Buyers
Expe c tatio ns
o f Future Pric e
Pric e s o f
Re late d Go o ds
(S ubs titute s
and
Co mple me nts )
S UPPLY
Pric e s o f
Re le vant
Re s ouc e s
Numbe r
of
S e lle rs
Taxe s
and
S us idie s
Go ve rnme nt
Re s tric tio ns
Te c hno lo g y
Expe ctatio ns
of
Future Pric e
Price Controls
• Produces a barrier to which the economy can
no longer operate freely
– Can’t get to equilibrium price
• Two types
– Price ceiling
– Price Floor
Price Ceiling
• Government mandated maximum price
above which legal trades cannot be
made
• Price ceiling is below equilibrium price.
Pric e
(do llars
Price
Ceiling
S
18
Eq uilibrium
Pric e
Pric e
Ce iling
A pric e c e iling
c re ate s a s ho rtag e
12
8
S h o rtag e
D
0
100
150
190
Eq uilibrium
Qu antity
Qu antity o f Go o d X
Impacts of Price Ceilings
• Shortage sustained
• Fewer exchanges
• Non-price rationing schemes
– First come first served
• Buying & selling at prohibited prices
– Black markets
• Tie in Sales
– Pay certain amount for rent of the house and an amount for
renting the refrigerator
• Distort normal economic information and incentives
– Lower prices is supposed to mean greater availability
Price Floor
• Government mandated minimum price below
which legal trades cannot be made
• Price floor is above equilibrium price
Pric e
(do llars )
Pric e
Flo o r
Equilibrium
Pric e
Price
Floor
S
S urplus
20
A pric e flo o r
c re ate s a s urplus
15
D
0
90
130
180
Equilibrium
Quantity
Quantity o f Go o d X
Impacts of Price Floors
• Sustained surpluses
• Fewer exchanges
• Example: Minimum wage
Minimum Wage
• In California the minimum wage is $6.75 per
hour
– Increased from $6.26 on January 1, 2002
• Government mandated minimum wage is $5.15
– Last increase was on September 1, 1997
Impacts of Minimum Wage
•
•
•
•
Surplus of unskilled
Fewer workers overall employed
Supply and Demand would determine wage
Minimum wage doesn’t guarantee better
standards of living for low wage employees
Wag e Rate
(do llars )
Minimum
4.25
Wag e 5.75
S
S urplus
Effects of
the Minimum
Equilibrium
3.25
Wag e 4.25
Wage
D Numbe r o f
Uns kille d Wo rke rs
0
N
2
Numbe r o f Wo rke rs
Emplo ye d at
Minimum Wag e
N
1
Numbe r o f Wo rke rs
Emplo ye d
atEquilibrium Wag e
N3
Numbe r o f Wo rke rs
Who Want to Wo rk at
Minimum Wag e
Chapter 5
Elasticity
You are responsible for reading Chapter 4!!!
What have we done?
• Chapter 3 gave us downward sloping demand
curves
– Law of demand
• Now want to see how Qd changes when price
changes
Elasticity
• Response of one variable to a change in
another variable
• Price elasticity of demand
– Measure of the responsiveness of Qd of a product to
a change in the price of that product
%Q
Ed 
%P
Qd
Q
Ed 
P
P
So…
• What if Ed = 3?
– If price was increased from the prevailing
point the % change in Qd would be 3 times
the change in price
• Shouldn’t it be negative?
– So price increases and Qd decreases?
• Yes!!
– For ease we look at the absolute value, but
know that the law of demand holds
Point elasticity
• Measures the change between two observed
points.
Qb  Qa
Qd
Qa
Q
Ed 

P
Pb  Pa
P
Pa
example
•
•
•
•
•
•
•
P1 = 10
P2 = 12
Q1 = 100
Q2 = 50
Elasticity??
Which is Point A???
Big Problem!!!
50  100
100
A  1;
 2 .5
12  10
10
100  50
50
A  2;
6
10  12
12
Problem
• Answers vary depending on where you start
• Becomes more important the larger the change
Arc Elasticity
• To avoid the endpoint problem take elasticity at the
midpoint (average) of the two points
Qd
Qd 1  Qd 2
 Qd 1  Qd 2 
 Qd 1  Qd 2 




2
2




Ed 

P
P1  P2
 P1  P2 
 P1  P2 




 2 
 2 
Differences
• With arc elasticity it is clear which points are
used
• P1 is the first price
• P2 is the second price
• Qd and Qd are the first and second quantity
demanded respectively
1
2
Price elasticity of demand can yield
5 basic results
•
•
•
•
•
•
Numerator > Denominator
Numerator < Denominator
Numerator = Denominator
Numerator = 0
Denominator = 0
Each has a specific name and result
Elastic Demand
• Ed > 1
• % change in quantity demanded > % change in
price
• FLATTER CURVE
• What are some examples of an elastic good???
Inelastic Demand
• Ed<1
• % change in the price > percent change in
quantity demanded
• STEEPER CURVE
• What are some examples of an inelastic good?
Price Elasticity of Demand
Price
Part (a)
Price
Part (b)
Ed < 1
Inelastic
Ed > 1
Elastic
P2
P1
P2
10%
10%
P1
D
20%
4%
D
0
Q2
Q1
Quantity Demanded
0
Q2 Q1
Quantity Demanded
Unit Elastic Demand
• Ed=1
• % change in price = % change in quantity
demanded
• Change in price brings a proportionate change
in quantity demanded
• CURVE
Price Elasticity of Demand
Part (c)
Price
Ed = 1
Unit Elastic
P2
P1
10%
D
10%
0
Q2 Q1
Quantity Demanded
Perfectly Elastic Demand

• Ed =
(denominator = 0)
• % change in quantity demanded is A LOT in
response to a change in price
• Price increases and quantity demanded goes
to 0
• Totally flat --- horizontal
• Extreme
• Examples???
Perfectly inelastic demand
• Ed = 0
• % change in quantity demanded
DOESN’T CHANGE in response to a
change in price
• Totally steep --- vertical
• Extreme
• Examples???
Price Elasticity of Demand
Price
P2
P1
0
Part (d)
Price
Ed = 0
Perfectly Inelastic
Ed = 
Perfectly Elastic
1%
P2
D
Q1
Quantity Demanded
Part (e)
D
P1
0
10%
Q1
Quantity Demanded
Aren’t demand curve downward
sloping?
• Because the extremes (perfectly inelastic and
perfectly elastic) are not.
• Use as points of reference only
How does a change in price affect Total
Revenue of a Firm?
• Revenue depends on elasticity
• Michael Jordan and Nike shoes
– No substitutes -- inelastic demand
• What happens to Qd if price increases?
– Substitutes – elastic demand
• What happens to Qd if price increases?
What is total revenue??
• Total revenue = price*quantity
• Firm uses to decide if to produce more or less
examples
• Elastic demand
– Price increase
– Price decrease
• Inelastic demand
– Price increase
– Price decrease
• Unit elastic demand
– Price increase
– Price decrease
P
TR 
P
TR 
P
TR 
P
TR 
P
TR
P
TR
Ed > 1
Ed < 1
Ed = 1
Elasticities,
Price
Changes, and
Total
Revenue
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
A
B
C
D
E
F
G
P
8
7
6
5
4
3
2
Qd
3
4
5
6
7
8
9
Price Elasticity of Demand along
a Demand Curve
Price (dollars)
(3)
(1)
(2)
QUANTITY (4)
POINT PRICE DEMANDED Ed
Elastic
Range
8
A
7
Unit Elastic
Range
B
A
$8
3
2.14
B
7
4
1.44
C
6
5
1.00
D
5
6
0.69
E
F
G
4
7
3
C
5
Inelastic
Range
D
4
E
3
F
0.47
2
0.29
1
8
2
6
G
9
1
(a)
2
3 4 5 6 7 8
Quantity Demanded
(b)
9
D
Summary
• Upper end of Demand Curve
– Qd is low and price is high
– One unit change in demand is much larger
in terms of percent than change in price
• Lower end of Demand Curve
– Qd is high and price is low
– One unit change in demand is much
smaller in terms of percent than change in
price
So…
• As move down the demand curve from higher
prices to lower the price elasticity of demand
goes from elastic to inelastic
Determinants of price elasticity of
demand
• Number of substitutes available
– Increase substitutes increases elasticity
– More narrowly defined goods have more substitutes
(compared to broadly defined)
• Example: Fords vs all cars
More Determinants
• Percentage of one’s budget that is spent on the
good
– More expensive??? More elastic
– More affected by price (even small changes)
Final Determinants
• Amount of time that passed since price change
– Increase time passed gives more opportunity to
change behavior or react to price change
– Overtime can look for substitutes
– Increase time increases elasticity
– More elastic in long term than short
Cross Elasticity of Demand
• Measures the responsiveness of quantity
demanded to a change in price of ANOTHER
good
Qx 2  Qx1
 Qx 2  Qx1 


% Qdx 
2

Ec 

Py 2  Py1
% Py
 Py 2  Py1 


2


When would you use Cross Price
Elasticity?
• To determine if goods are substitutes or compliments
• Ec>0 – substitutes
– % change in quantity demanded and price move
in same direction
• Ec<0 – compliments
– % change in quantity demanded and price move
in opposite directions
• Ec=0 – goods unrelated
Income elasticity of demand
• Measures the responsiveness of
quantity demanded to the change in
income
Qx 2  Qx1
 Qx 2  Qx1 


%Qd
2


Ey 

Y2  Y1
%income
 Y2  Y1 


 2 
Why use income elasticity of
demand?
• Use to determine if a good is normal or inferior
• Ey>0 – normal good
– As income increases Qd increases
• Ey<0 – inferior good
– As income increases Qd decreases
Can also say…
• If |Ey| > 1
– % change in Qd > % change in Y
– Income elastic
• If |Ey| < 1
– % change in Qd < % change in Y
– Income inelastic
• If |Ey| = 1
– % change in Qd = % change in Y
– Income unit elastic
Can we use income elasticity in the
real world??
• If invest in the stock market do you want to
invest in a normal or inferior good?
• Normal
• Why
• Increase income would increase quantity
bought and increase stock prices
Price Elasticity of Supply
• Measures the responsiveness of quantity supplied of
a good to the change in the price of that good
Qs1  Qs 2
 Qs1  Qs 2 


%Qs 
2

Ed 

P1  P2
%P
 P1  P2 


 2 
Classification is like demand
• Es > 1
– Elastic
• Es < 1
– Inelastic
• Es = 1
– Unit elastic
• Each of these will result in a “normal” upward sloped
supply curve
Any extreme elasticities???
• Yes!!
• Es =
elastic or horizontal
– Perfectly
• Es = 0
– Perfectly inelastic or vertical
Price Elasticity of Supply
Price
Part (a)
Price
Part (b)
S
Es > 1
Elastic
P2
P1
S
P2
10%
P1
20%
0
Q1
Q2
Quantity Supplied
Es < 1
Inelastic
10%
4%
0
Q1 Q2
Quantity Supplied
Price Elasticity of Supply
Part (c)
Price
S
P2
P1
Es = 1
Unit Elastic
10%
10%
0
Q1 Q2
Quantity Supplied
Price Elasticity of Supply
Price
Part (d)

Es = •
Perfectly Elastic
P1
0
P2
S
Q1
Quantity Supplied
Part (e)
S
Price
P1
0
Es = 0
Perfectly
Inelastic
10%
Q1
Quantity Supplied
Does time play a role in elasticity of
supply?
• Yes!!
• Overtime producers are able to adjust their
behavior and production patterns
• Supply becomes more elastic as time passes
Elasticity and taxes
• If government levies a tax on a product who
pays the tax??
• Producers?? Consumers?? Share??
• Depends on the elasticity of demand and
supply
How find??
•
•
•
•
Find equilibrium price
Supply shifts left in the amount of the tax
Find new equilibrium
Find point of second equilibrium on ORGINAL
supply curve
– Shows the actual price realized by firm or
equilibrium price – tax = point in question
• Difference between points determines how much of
tax you pay
Who
Pays
the
Tax?
Price
(dollars)
Part of tax paid
by consumers in
terms of higher
price paid.
S2 (after tax)
S1 (before tax)
9.00
8.50
B
A
$1 Tax
8.00
7.50
Part of tax paid
by producers in
terms of lower
price kept.
D1
0
Q2 Q1
Quantity of VCR Tapes
Who pays more of the tax??
•
•
•
•
Perfectly inelastic demand
Perfectly elastic demand
Demand more elastic than supply
Supply more elastic than demand
Different Elasticities and Who
Part (a) Pays the Tax Part (b)
Price (dollars)
Price (dollars)
S2
D1
Producers pay
full tax
S1
9.00
S2
S1
$1 Tax
B
$1 Tax
B
8.00
A
A
8.00
D1
0
Q2
Q1
Quantity of VCR Tapes
Consumers pay
full tax
0
Q1
Quantity of VCR Tapes
Summary
• Ed > Es producer bears most of the tax burden
• Ed < Es consumer bears most of the tax burden
• Ed = Es equally share the tax burden
Chapter 6
Consumer Choice:
Maximizing Utility and
Behavioral Economics
Diamond-Water Paradox
• Why is water (necessary to life) so cheep while
a diamond (not necessary to life) is so
expensive?
Two types of value for a good
• Value of Exchange
– Price
• Utility
– Satisfaction or wellbeing
How do you measure utility?
• Construct an artificial measure called a UTIL
• Remember we assume people are rational
• What does it mean to be rational?
– Will not consume a bad voluntarily
• All consumed goods have utility or you would
not consume it.
Total Utility
• Amount of satisfaction or “use value” you
receive from consuming a particular good
• Thus…
Marginal Utility
• Additional utility gained from consuming an
additional unit of a good
• Change in total utility brought about by the
additional consumption
Thus…
Calculate the Marginal Utility
Quantity
1
Pizza Slices
Total Utility
10
2
16
3
18
4
19
Law of Diminishing Marginal Utility
• The more units of a good we consume during a
period of time the less additional satisfaction we
get from the additional units
(1) UNITS OF
GOOD X
(2) TOTAL
(3) MARGINAL
UTILITY (utils) UTILITY (utils)
0
1
2
3
4
5
—
10
9
8
7
6
0
10
19
27
34
40
Total Utility (utils)
Marginal Utility (utils)
TU
40
10
9
34
8
7
27
6
MU
19
10
0
1
2
3
4
5 Good X
0
1
2
3
4
5 Good X
Does the “law” always hold?
• Some goods have increasing MU initially then
decreasing later, but the law says satisfaction
should begin to decrease with the second unit
• Tennis
– As you get better you like it more, so the 10th game
may be more enjoyable
Soften the Law
• Principle of Diminishing Returns
– For a given period of time the MU gained from
consuming equal successive units of a good will
eventually decline as the amount consumed
increases.
Examples…
• Car rides
• Fads
• eating
Thus…the law says
• At some point successive units of a good
consumed by the SAME individual will become
less valuable to that individual
• What about to someone else or the
interpersonal utility?
– Can’t do because we don’t know with certainty
another person’s preferences
Example
• Who would value a dollar more: a poor person
or a millionaire?
• Money hungry millionaire?
– Answer would be millionaire
• Dollar is not much of a million
– Answer would be a poor person
• Don’t guess at utility
Diamond-Water Paradox revisited
• Goods have Total and Marginal Utility values
• Water
–
–
–
–
TU?
High because need it to live
MU?
Low because it is plentiful and we consume it in large
quantities
Diamond-Water Paradox continued
• Diamonds
– TU??
– Low because not really necessary to live
– MU??
– High because very limited supply and consume in
small quantities
Solution to Diamond-Water Paradox
• Things with great value in use have little value
in exchange
• Those with little use value have higher
exchange value
• Prices (value of exchange) are most often
determined by…
– Marginal Utility
Is gambling worth it?
• If only want to win??? NO!!
• If gain pleasure from the gambling process???
YES!!
How do we compare MU of different
units?
• Example: What is the MU of an apple vs. an
orange?
• Relative Marginal Utility of the good
• MU per dollar of purchase price
Decision Making Process
• If the MU of good A relative to its price is
greater than the MU of good B relative to its
price we should buy more of A and less of B
• Compare
of each good
MU
P
Example
•
•
•
•
MUorange = 30
MUapple = 20
Income = $20
Buy 10 oranges for $1 each and 10 apples for $1
each
• Good??
MU o MU A

Po
PA
Not Good…
• We could do better by buying more oranges
because per dollar it brings more satisfaction
• Buy one more orange and one less apple
increases TU
• What happens to the MU of oranges?
– Decreases MU of oranges
– Why?
– Diminishing MU when buy more
• What happens to the MU of apples?
– Increases MU of apples
– Why?
– Increasing MU when buy less
• When do we stop?
Consumer Equilibrium
• The combination of goods where our income
can’t be redirected to improve our situation
• Therefore:
MU o MU A

Po
PA
Example
P =$2; P =$1; Income=$60
M
c
# muffins
MUM
# cookies
MUc
5
11
44
6
6
8
46
5
7
6
48
4
8
3
50
3
What if the price of a good
changes?
• Must recalculate
MU
P
Pa=$1;Pb=$1? Pa=$0.50;Pb=$1?
Income = $7.00
#a
1
2
3
4
5
6
7
MUa
12
11.5
11
10
9
8
7
#b
1
2
3
4
5
6
7
MUB
22
20
18
16
14
12
10
Consumer Equilibrium and a Fall in Price
GOOD A
Orig inal
Purc has e
Ne w
Purc has e
Units of Go od A
1
2
3
4
5
6
7
12
11.5
11
10
9
8
7
Marg inal Utility
Ne w
Purc has e
GOOD B
Units o f Go o d B
Orig inal
Purc has e
1
2
3
4
5
6
7
22
20
18
16
14
12
10
Marg inal Utility
Orig inal
Purc has e
Go o d A
Go o d B
Ne w
Purc has e
Go o d A
Go o d B
12 utils
12 utils
=
$1.00
$1.00
8 utils
16 utils
=
$.50
$1.00
So…
• As price decreases relative MU increases so
consumers buy more to gain consumer
equilibrium again
• Shows a negative relationship between price
and amount people buy
– JUST LIKE THE DEMAND CURVE
Do RATS understand the inverse
relationship between price and quantity?
• Choice between two liquids
– Root beer
– Collins mix
• Given 300 pushes (each liquid had a different number
of pushes to get it – price)
• Found rats switched to the “cheaper” liquid when the
“price” changed
Why isn’t education and medical
care free?
• If cost = 0 when do we stop using it?
• When MU = 0
• Thus we will see a lot of frivolous use of
programs. It costs you nothing so use it.
Consumer Surplus
• The difference between the actual price buyers
pay for a good and the maximum amount they
are WILLING and ABLE to pay for it
• Dollar measure of benefit gained from a price
decrease
Consumer Surplus cont.
• Triangle under the demand curve and above
the equilibrium price out to the equilibrium
quantity
Consumers' Surplus
Part (a)
Pric e
Co ns ume rs ’
S urplus
Windo w
P
S
CS
S
$7
$5
$5
D
0
D
0
100
Quantity
50 100
Q
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
Pric e
S2
Part (b)
Windo w
A
A
S1
P2
P1
CS with S 1 :
B
C
P1
C
A
CS with S 2 :
P2
D1
0
Quantity
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
Pric e
Pric e
A
Bo b’s demand
fo r pairs o f
tro us e rs
$40
$30
Pric e
A
($30) F
Cas e whe n
e ac h
pair o f ($40) C
tro us e rs
D is $30 ($30)F
Cas e whe n
firs t
pair o f
B
tro us e rs
D is $40 and
E
s e c o nd pair
is $30
D
0
Pairs o f
Tro us e rs
D
D
0
1
2
Pairs o f
Tro us e rs
(a)
0
2
(b)
1
Pairs o f
Tro us e rs
2
(c )