Slides for Midterm


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Slides for Midterm

  1. 1. Chapter 1 What is Economics About
  2. 2. Definition of Economics SCIENCE of how individuals and societies deal with the fact that wants are greater than resources available to satisfy those wants
  3. 3. Scarcity <ul><li>Wants are greater than the resources available to fill those wants </li></ul><ul><li>What do you have scarcity of??? </li></ul><ul><ul><li>Money </li></ul></ul><ul><ul><li>Time </li></ul></ul><ul><li>What do firms have scarcity of??? </li></ul><ul><ul><li>Labor </li></ul></ul><ul><ul><li>Land </li></ul></ul><ul><ul><li>Capital </li></ul></ul>
  4. 4. Thus…. Economics is the SCIENCE of SCARCITY
  5. 5. Normative vs. Positive Economics <ul><li>Normative </li></ul><ul><ul><li>What “ought” to be </li></ul></ul><ul><li>Positive </li></ul><ul><ul><li>What is </li></ul></ul>
  6. 6. Examples: Positive or Normative? <ul><li>The government fought inflation during the early 1980s because it felt the inflation was damaging potential long-term economic growth. </li></ul><ul><li>The government should cut taxes in order to stimulate consumption. </li></ul><ul><li>Increases in consumer spending improved the Japanese economy last year. </li></ul><ul><li>Balancing the federal budget would be good for the economy. </li></ul>
  7. 7. Micro vs. Macro <ul><li>Microeconomics </li></ul><ul><ul><li>Study of human behavior and choices </li></ul></ul><ul><ul><li>Looks at SMALL units (individual, market, single firm) </li></ul></ul><ul><li>Macroeconomics </li></ul><ul><ul><li>Study of human behavior and choices </li></ul></ul><ul><ul><li>Looks at LARGE units (aggregated markets, whole economy) </li></ul></ul>
  8. 8. Economic Way of Thinking <ul><li>Watch </li></ul><ul><ul><li>“ An economist is someone that sees something working in practice and asks if it would would in principle” </li></ul></ul><ul><li>Think </li></ul><ul><li>Identify </li></ul>
  9. 9. Why Study Economics? <ul><li>Social Problems </li></ul><ul><ul><li>Discrimination </li></ul></ul><ul><ul><li>Crime </li></ul></ul><ul><li>Understand why things happen </li></ul><ul><ul><li>Coupons </li></ul></ul><ul><ul><li>Minimum Wage </li></ul></ul><ul><li>Understand the Political Process </li></ul>
  10. 10. Homework due Friday April 4 th <ul><li>Chapter 1 </li></ul><ul><ul><li>Questions 1 and 2 </li></ul></ul>
  11. 11. Beginning to Think Like an Economist …is this a good thing?
  12. 12. Defining Economic Goods <ul><li>Utility </li></ul><ul><ul><li>Satisfaction you receive from consuming a product </li></ul></ul><ul><ul><li>Good vs. Bad </li></ul></ul><ul><li>Tangibility </li></ul><ul><ul><li>Can the good be touched or is it a service? </li></ul></ul><ul><li>Resources or factors of production used </li></ul><ul><ul><li>Land: natural resources </li></ul></ul><ul><ul><li>Labor: Physical and mental talents of people </li></ul></ul><ul><ul><li>Capital: produced goods that can be used as inputs for further production </li></ul></ul><ul><ul><li>Entrepreneurship: talent of organizing resources, seeking new opportunities, and developing new ways of doing things </li></ul></ul>
  13. 13. Remember Scarcity Runs the Show… <ul><li>What was scarcity?? </li></ul><ul><li>So…how do we make sure that only those who REALLY need the good get it?? </li></ul><ul><li>Prices </li></ul><ul><ul><li>System of rationing of the good </li></ul></ul><ul><ul><li>Cause people to compete for the item </li></ul></ul>
  14. 14. Opportunity Cost <ul><li>Value of the next best alternative foregone </li></ul><ul><li>Pizza vs CD </li></ul><ul><ul><li>Pizza for $1.00 per slice; CD for $15.00 </li></ul></ul><ul><li>Revolutionary War </li></ul><ul><ul><li>The British and their red coats </li></ul></ul><ul><li>Big Macs </li></ul><ul><ul><li>Big Macs in Japan cost $8.25 </li></ul></ul><ul><li>Highway System </li></ul><ul><ul><li>Paid for with taxes </li></ul></ul>
  15. 15. Summary Statement of Scarcity and Related Concepts
  16. 16. Costs and Benefits at the Margin <ul><li>What is the margin?? </li></ul><ul><ul><li>The “last” or “additional” </li></ul></ul><ul><li>Marginal Cost </li></ul><ul><ul><li>The cost of the “last” unit employed </li></ul></ul><ul><li>Marginal Benefits </li></ul><ul><ul><li>The benefit of the “last” unit employed </li></ul></ul><ul><li>Unintended effects </li></ul><ul><ul><li>Minimum wage </li></ul></ul><ul><ul><li>Gun bounties </li></ul></ul><ul><ul><li>Seat belts </li></ul></ul>
  17. 17. Efficiency <ul><li>What is the “right amount” of time to study? </li></ul><ul><ul><li>Right amount = optimal or efficient amount </li></ul></ul><ul><ul><li>Marginal Costs = Marginal Benefits </li></ul></ul>
  18. 18. Economic way of thinking includes… <ul><li>Analyzing scarcity </li></ul><ul><li>Look at opportunity cost of decisions </li></ul><ul><li>Measure costs and benefits </li></ul><ul><li>Look at marginal effects </li></ul><ul><li>Examine unintended effects </li></ul>
  19. 19. Economic Thinking Errors <ul><li>Association vs. Causation </li></ul><ul><ul><li>You hit red lights because you are running late </li></ul></ul><ul><ul><li>Don’t study for a test so you fail </li></ul></ul><ul><li>Fallacy of Composition </li></ul><ul><ul><li>What is good for the individual is good for the group </li></ul></ul><ul><li>Forgetting Ceteris Paribus </li></ul><ul><ul><li>All else remains constant </li></ul></ul>
  20. 20. What is this?
  21. 21. Model <ul><li>Simplified version of reality </li></ul><ul><ul><li>Includes only the “important” aspects </li></ul></ul><ul><li>Why is a model necessary?? </li></ul>
  22. 22. Parts of a Theory <ul><li>Variables </li></ul><ul><ul><li>Magnitudes that can change </li></ul></ul><ul><li>Assumptions </li></ul><ul><ul><li>Ideas about event that will not allow to change </li></ul></ul><ul><li>Hypothesis </li></ul><ul><ul><li>Educated guess </li></ul></ul><ul><li>Predictions </li></ul><ul><ul><li>Based on hypothesis and assumptions </li></ul></ul>
  23. 23. Scientific Approach <ul><li>What do you want to predict/explain? </li></ul><ul><li>What variables are important? </li></ul><ul><li>State assumptions </li></ul><ul><li>State hypothesis </li></ul><ul><li>Test </li></ul><ul><li>If results are good…Yeah You!! </li></ul><ul><li>If results are bad…amend or reject theory </li></ul>
  24. 24. Building and Testing a Theory
  25. 25. How do we judge theories? <ul><li>Look at how well they predict </li></ul><ul><li>NOT by the assumptions </li></ul><ul><li>Example: Firms try to maximize profits </li></ul><ul><ul><li>Do they thing about this every second? </li></ul></ul><ul><ul><li>Probably not </li></ul></ul><ul><ul><li>Over the course of the year…make decisions to maximize profits </li></ul></ul>
  26. 26. Appendix A Working with Diagrams
  27. 27. Types of Relationships between variables <ul><li>Direct </li></ul><ul><ul><li>Positive </li></ul></ul><ul><li>Inverse </li></ul><ul><ul><li>Negative </li></ul></ul><ul><li>No Relationship </li></ul><ul><ul><li>Variables are independent </li></ul></ul>
  28. 28. Two-Variable Diagram Representing an Inverse Relationship
  29. 29. Two-Variable Diagram Representing a Direct Relationship
  30. 30. Two Diagrams Representing Independence between Two Variables
  31. 31. Slope <ul><li>Used to see how a variable changes in response to another variable changing </li></ul>
  32. 32. To calculate slope <ul><li>Find two points on any straight line </li></ul>
  33. 33. What sign do you expect the slope to have? <ul><li>Direct relationship </li></ul><ul><ul><li>Positive </li></ul></ul><ul><li>Inverse relationship </li></ul><ul><ul><li>Negative </li></ul></ul><ul><li>No Relationship </li></ul><ul><ul><li>0 or infinity </li></ul></ul>
  34. 34. Calculating Slopes
  35. 35. Calculating Slopes
  36. 36. The 45 Line
  37. 37. Appendix B Should you major in Economics??
  38. 38. Five myths about economics and an economics major <ul><li>Economics is all mathematics and statistics </li></ul><ul><li>Economics is only about inflation, interest rates, unemployment, and other such things </li></ul><ul><li>People become economists only if they want to “make money” </li></ul><ul><li>Economics wasn’t very interesting in high school, so it isn’t going to be interesting now </li></ul><ul><li>Economics is a lot like business, but business is more marketable </li></ul>
  39. 39. Chapter 2 Economic Activities: Producing and Trading
  40. 40. Efficiency <ul><li>Efficiency of Production is goal </li></ul><ul><li>If a firm is producing the max possible given available resources and technology </li></ul>
  41. 41. Production Possibility Frontier (PPF) <ul><li>Shows all possible combinations of goods for a particular economy at a particular point in time, given its resources and technology constraints </li></ul>
  42. 42. Production Possibilities Frontier for Grades
  43. 43. Production Possibilities Frontier for Grades
  44. 44. Where are we on the PPF? <ul><li>Can we be on the PPF? </li></ul><ul><ul><li>Yes! </li></ul></ul><ul><ul><li>efficient </li></ul></ul><ul><li>Can we be under the PPF? </li></ul><ul><ul><li>Yes! </li></ul></ul><ul><ul><li>Inefficient </li></ul></ul><ul><li>Can we be over the PPF? </li></ul><ul><ul><li>NO </li></ul></ul>
  45. 45. Two types of Production Possibility Frontiers <ul><li>Constant Opportunity Costs </li></ul><ul><li>STRAIGHT LINE </li></ul><ul><li>DOWNWARD SLOPED (inverse relationship) </li></ul><ul><li>1 to 1 relationship (slope constant) </li></ul>
  46. 46. Production Possibilities Frontier (Constant Opportunity Costs)
  47. 47. Production Possibilities Frontier (Constant Opportunity Costs)
  48. 48. Second Type of PPF <ul><li>Changing Opportunity Costs </li></ul><ul><li>BOWED OUT PPF </li></ul><ul><li>Real world PPF </li></ul><ul><li>Changing slope with every point </li></ul>
  49. 49. Production Possibilities Frontier (Changing Opportunity Costs)
  50. 50. Production Possibilities Frontier (Changing Opportunity Costs)
  51. 51. Law of Increasing Opportunity Costs <ul><li>Goes along with CHANGING OPPORTUNITY COSTS </li></ul><ul><li>As more of a good is produced the opportunity cost to produce that good increases. </li></ul>
  52. 52. A Summary Statement about Increasing Opportunity Costs and a Production Possibilities Frontier That Is Bowed Outward (Concave Downward)
  53. 53. Economic Concepts illustrated by PPF <ul><li>Scarcity </li></ul><ul><li>Choice </li></ul><ul><li>Opportunity Costs </li></ul><ul><li>Law of Increasing Opportunity Costs </li></ul>
  54. 54. Examples of Law of Increasing Opportunity Costs <ul><li>Armed Services </li></ul><ul><ul><li>WWI, WWII and Korean War draft was irrelevant of job or education level; Civil War education and job level mattered </li></ul></ul><ul><li>Home Improvements </li></ul><ul><ul><li>Swedish men make more improvements themselves compared to US men </li></ul></ul>
  55. 55. Economic Growth <ul><li>Increase in resources </li></ul><ul><li>Increase in technology </li></ul><ul><li>Shift of PPF outward </li></ul>
  56. 56. How would each of the following affect the US PPF? <ul><li>A rise in the unemployment rate </li></ul><ul><li>The invention of the computer </li></ul><ul><li>An increase in the number of birth in the United States </li></ul><ul><li>An increase in the number of births in Russia </li></ul>
  57. 57. Economic Growth within a PPF Framework
  58. 58. Production Possibilities Frontier for Grades
  59. 59. Production Possibilities Frontier for Grades
  60. 60. More Hours of Study Shifts the Production Possibilities Frontier
  61. 61. Efficiency…Again <ul><li>Produce max amount possible given resources and technology </li></ul><ul><li>ON PPF – EFFICIENT </li></ul><ul><li>UNDER PPF – INEFFICIENT </li></ul><ul><li>OVER PPF – NOT POSSIBLE </li></ul>
  62. 62. Unemployment <ul><li>Economy is not producing the maximum output given the resources and technology available </li></ul><ul><li>Efficient? </li></ul><ul><li>On, over, or under PPF? </li></ul>
  63. 63. Efficiency Criterion <ul><li>Will alternate arrangements of resources or goods make at least one person better off without hurting someone else? </li></ul><ul><li>Yes? Inefficient </li></ul><ul><li>No? Efficient </li></ul>
  64. 64. Efficiency, Inefficiency, and Unemployment Resources, within a PPF Framework
  65. 65. Trade or exchange <ul><li>Process of giving up one thing for something else </li></ul><ul><li>Why would you trade? </li></ul><ul><ul><li>Make yourself better off </li></ul></ul><ul><ul><li>Give up something that you value less for something you value more </li></ul></ul><ul><li>Example: a leather jacket is $100…what does this show?? </li></ul><ul><ul><li>Value the $100 less than you value the jacket </li></ul></ul>
  66. 66. Periods relevant to trade <ul><li>Before the trade takes place </li></ul><ul><ul><li>Ex ante </li></ul></ul><ul><ul><li>Decision takes place  $2000 of other goods or the $2000 television set? </li></ul></ul><ul><ul><li>Which makes me better off? </li></ul></ul><ul><li>At the point of the trade </li></ul><ul><ul><li>The $2000 changing hands </li></ul></ul><ul><li>After the trade </li></ul><ul><ul><li>Ex post </li></ul></ul><ul><ul><li>No guarantee that trade will meet expectations </li></ul></ul><ul><ul><li>Buyers remorse </li></ul></ul>
  67. 67. Benefits of Trade <ul><li>Compare the consumer’s and producers point of views </li></ul><ul><ul><li>Consumer Surplus </li></ul></ul><ul><ul><ul><li>Maximum buying price – price paid </li></ul></ul></ul><ul><ul><ul><li>Satisfaction gained by not having to pay as much </li></ul></ul></ul><ul><ul><li>Producer Surplus </li></ul></ul><ul><ul><ul><li>Price received – minimum selling price </li></ul></ul></ul><ul><ul><ul><li>Satisfaction gained by getting more than anticipated for the good </li></ul></ul></ul>
  68. 68. Which makes you better off? <ul><li>Increases in Consumer or Producer Surplus? </li></ul><ul><ul><li>Consumer </li></ul></ul><ul><li>Why? </li></ul><ul><ul><li>Price that you pay will be lower </li></ul></ul>
  69. 69. Terms of Trade <ul><li>Trade is where things are given up to get something else </li></ul><ul><ul><li>What things? </li></ul></ul><ul><ul><ul><li>Money, goods, services… </li></ul></ul></ul><ul><li>Terms of trade is how much is given up </li></ul><ul><li>Which part does buyers remorse fit into? </li></ul><ul><ul><li>terms of trade </li></ul></ul><ul><ul><li>Where the money usually comes in </li></ul></ul>
  70. 70. Costs of Trade <ul><li>Transaction costs </li></ul><ul><ul><li>Time and effort needed to search out, negotiate, and consummate a trade </li></ul></ul><ul><ul><li>May cause trades to not take place </li></ul></ul><ul><ul><ul><li>Don’t know about the good </li></ul></ul></ul><ul><ul><ul><li>Shipping costs are too high </li></ul></ul></ul><ul><ul><ul><li>Don’t like to work with salesperson </li></ul></ul></ul><ul><li>Third-party effects </li></ul><ul><ul><li>Impacts of trade on parties not immediately involved </li></ul></ul><ul><ul><ul><li>Second hand smoke (negative externality) </li></ul></ul></ul>
  71. 71. Producing and trading <ul><li>Two people: Elizabeth and Brian </li></ul><ul><li>Each produce two goods: Bread and Apples </li></ul><ul><li>Elizabeth  10 loaves of bread and 10 apples </li></ul><ul><li>Brian  5 loaves of bread and 15 apples </li></ul>20 0 10 10 0 20 Elizabeth Bread Elizabeth Apples 0 30 5 15 10 0 Brian Bread Brian Apples
  72. 72. Comparative Advantage <ul><li>Should both produce apples and bread or should they specialize? </li></ul><ul><li>What does specialize mean? </li></ul><ul><ul><li>Produce the good that you do best </li></ul></ul><ul><ul><li>Produce at a lower costs than other person(s) can </li></ul></ul><ul><ul><li>Called comparative advantage </li></ul></ul><ul><ul><li>Looks at opportunity cost </li></ul></ul><ul><ul><ul><li>What was that? </li></ul></ul></ul><ul><ul><ul><li>What you have to give up </li></ul></ul></ul><ul><ul><ul><li>Give up less?? Have the comparative advantage </li></ul></ul></ul>
  73. 73. What are the opportunity costs? <ul><li>Elizabeth </li></ul><ul><ul><li>If give up 10 apples how much more bread can she produce? </li></ul></ul><ul><ul><ul><li>10 units </li></ul></ul></ul><ul><ul><li>If give up 10 loaves of bread how many more apples can she produce? </li></ul></ul><ul><ul><ul><li>10 units </li></ul></ul></ul><ul><li>Opportunity Costs </li></ul><ul><ul><li>10 Bread = 10 Apples </li></ul></ul><ul><ul><li>1 Bread = 1 Apple </li></ul></ul>20 0 10 10 0 20 Elizabeth Bread Elizabeth Apples
  74. 74. What are the opportunity costs? <ul><li>Brian </li></ul><ul><ul><li>If give up 15 apples how much more bread can he produce? </li></ul></ul><ul><ul><ul><li>5 units </li></ul></ul></ul><ul><ul><li>If give up 5 loaves of bread how many more apples can he produce? </li></ul></ul><ul><ul><ul><li>15 units </li></ul></ul></ul><ul><li>Opportunity Costs </li></ul><ul><ul><li>5 Bread = 15 Apples </li></ul></ul><ul><ul><li>1 Bread = 3 Apples </li></ul></ul><ul><ul><li>1/3 Bread = 1 Apple </li></ul></ul>0 30 5 15 10 0 Brian Bread Brian Apples
  75. 75. Should we specialize? <ul><li>Elizabeth </li></ul><ul><ul><li>1 Bread = 1 Apple </li></ul></ul><ul><li>Brian </li></ul><ul><ul><li>1 Bread = 3 Apples </li></ul></ul><ul><ul><li>1/3 Bread = 1 Apple </li></ul></ul><ul><li>Who produces apples cheaper? </li></ul><ul><ul><li>What does cheaper mean? </li></ul></ul><ul><ul><ul><li>Lower opportunity cost (give up less) </li></ul></ul></ul><ul><ul><li>Brian!!! Give up only 1/3 loaves of bread </li></ul></ul><ul><li>Who produces bread cheaper? </li></ul><ul><ul><li>Elizabeth!!! Give up only 1 apple </li></ul></ul>
  76. 76. Here is the deal <ul><li>Elizabeth produces only bread (20 loaves) </li></ul><ul><li>Brian produces only apples (30 apples) </li></ul><ul><li>Trade 8 loaves of bread for 12 apples </li></ul><ul><li>Breakdown of end result </li></ul><ul><ul><li>Elizabeth Bread? </li></ul></ul><ul><ul><ul><li>12 loaves (20 - 8 traded) </li></ul></ul></ul><ul><ul><li>Elizabeth Apples? </li></ul></ul><ul><ul><ul><li>12 apples (0 + 12 traded) </li></ul></ul></ul>
  77. 77. <ul><li>Brian Bread </li></ul><ul><ul><li>8 loaves (0 + 8 traded) </li></ul></ul><ul><li>Brian Apples </li></ul><ul><ul><li>18 apples (30 -12 traded) </li></ul></ul><ul><li>Are they better off?? </li></ul>
  78. 78. Are they better off?? Brian Apples Brian Bread Elizabeth Apples Elizabeth Bread Gains from trade Specialization and Trade No Specialization or Trade
  79. 79. Are they better off?? 15 Brian Apples 5 Brian Bread 10 Elizabeth Apples 10 Elizabeth Bread Gains from trade Specialization and Trade No Specialization or Trade
  80. 80. Are they better off?? 18 15 Brian Apples 8 5 Brian Bread 12 10 Elizabeth Apples 12 10 Elizabeth Bread Gains from trade Specialization and Trade No Specialization or Trade
  81. 81. Are they better off?? +3 18 15 Brian Apples +3 8 5 Brian Bread +2 12 10 Elizabeth Apples +2 12 10 Elizabeth Bread Gains from trade Specialization and Trade No Specialization or Trade
  82. 82. Are they better off?? Brian Apples Brian Bread Elizabeth Apples Elizabeth Bread Gains from trade Specialization and Trade No Specialization or Trade
  83. 83. Both are Better off!!
  84. 84. Economic System <ul><li>The way in which a society decides to answer key economic questions </li></ul><ul><ul><li>What goods will be produced? </li></ul></ul><ul><ul><li>How will the goods be produced? </li></ul></ul><ul><ul><li>For whom will the goods be produced? </li></ul></ul><ul><ul><li>Where on the PPF will the economy operate? </li></ul></ul><ul><ul><li>What is the nature of trade? </li></ul></ul><ul><ul><li>What function do prices serve? </li></ul></ul>
  85. 85. Two major economic systems <ul><li>Capitalism </li></ul><ul><ul><li>An economic system based on private ownership of capital </li></ul></ul><ul><ul><li>Market economy </li></ul></ul><ul><li>Socialism </li></ul><ul><ul><li>An economic system based on state ownership of capital </li></ul></ul><ul><li>Most use pieces of each  mixed capitalism </li></ul>
  86. 86. How do they differ <ul><li>PPF </li></ul><ul><ul><li>Capitalist: Buying behavior of consumers signal for producers to produce more/less </li></ul></ul><ul><ul><li>Socialist: Government sets up how much to produce </li></ul></ul><ul><li>What good to produce? </li></ul><ul><ul><li>Capitalist: Consumers and producers decide </li></ul></ul><ul><ul><li>Socialist: Government decides </li></ul></ul>
  87. 87. <ul><li>How goods will be produced? </li></ul><ul><ul><li>Capitalist: producers decide </li></ul></ul><ul><ul><li>Socialist: government decides </li></ul></ul><ul><li>For whom to produce? </li></ul><ul><ul><li>Capitalist: Consumers decide if they are able and willing to purchase the good </li></ul></ul><ul><ul><li>Socialist: Government may redistribute funds to get certain people certain items </li></ul></ul><ul><li>Trade </li></ul><ul><ul><li>Capitalist view: Trade benefits both sides </li></ul></ul><ul><ul><li>Socialist view: Trade benefits one side at the expense of the other </li></ul></ul>
  88. 88. <ul><li>Prices </li></ul><ul><ul><li>Capitalism views </li></ul></ul><ul><ul><ul><li>Rations goods and services </li></ul></ul></ul><ul><ul><ul><li>Conveys information </li></ul></ul></ul><ul><ul><ul><li>Serves as an incentive to respond to information </li></ul></ul></ul><ul><ul><li>Socialism views </li></ul></ul><ul><ul><ul><li>Price is set by greedy businesses with much economic power </li></ul></ul></ul><ul><ul><ul><li>Price controls (can’t charge more or less than a certain price) </li></ul></ul></ul>
  89. 89. Now we want to use these questions for the next chapter as we look at: What a market is and how is it established.
  90. 90. Chapter 3 Supply, Demand: Theory
  91. 91. Market <ul><li>Market is an arrangement by which people exchange goods and services including money </li></ul><ul><li>Two sides </li></ul><ul><ul><li>Buyer </li></ul></ul><ul><ul><li>Seller </li></ul></ul>
  92. 92. Starting with the Buyer Side <ul><li>Quantity demanded </li></ul><ul><ul><li>Amount of a good people are willing and able to buy at a particular price at a particular point in time </li></ul></ul>
  93. 93. Important parts of definition <ul><li>Willing </li></ul><ul><li>Able </li></ul><ul><li>Particular Price </li></ul><ul><li>Particular point in time </li></ul>
  94. 94. Demand <ul><li>Quantity demanded over all prices during a specific point in time </li></ul><ul><li>Important parts: </li></ul><ul><li>Quantity demanded </li></ul><ul><li>All prices </li></ul><ul><li>Specific point in time </li></ul>
  95. 95. So…. <ul><li>So…. </li></ul>
  96. 96. Who does what in the Market? <ul><li>Consumers </li></ul><ul><ul><li>Buy goods </li></ul></ul><ul><ul><li>Sell Labor </li></ul></ul><ul><li>Firms </li></ul><ul><ul><li>Sell goods </li></ul></ul><ul><ul><li>Buy Labor </li></ul></ul>
  97. 97. Circular Flow <ul><li>Depiction of how the market works in the economy </li></ul><ul><li>Includes both buyers and sellers </li></ul><ul><li>Shows the flow of goods and services between consumers and firms </li></ul>
  98. 99. Law of Demand <ul><li>As price of a good (decreases) increases the Quantity demanded of that good (increases) decreases </li></ul>
  99. 100. Demand Schedule <ul><li>Numerical table of quantity demanded at different prices </li></ul>40 1 30 2 20 3 10 4 Quantity Price
  100. 101. Demand Curve <ul><li>Graphical representation of the demand schedule </li></ul><ul><li>Used to represent the relationship between price and quantity </li></ul><ul><li>Why type of relationship do you expect price and quantity to have? </li></ul>
  101. 102. Demand Schedule and Demand Curve
  102. 103. Market Demand Curves <ul><li>Previous demand curve was for an individual </li></ul><ul><ul><li>Single buyer </li></ul></ul><ul><li>How can we get the market curve from individual demand curves? </li></ul><ul><ul><li>All buyers </li></ul></ul><ul><li>Sum the individual Demand curves… </li></ul>
  103. 104. Therefore….
  104. 105. Deriving a Market Demand Schedule & Curve
  105. 106. Deriving a Market Demand Schedule & Curve
  106. 107. Determinants of Demand <ul><li>Income </li></ul><ul><ul><li>Normal good </li></ul></ul><ul><ul><li>Inferior good </li></ul></ul><ul><li>Preferences </li></ul><ul><li>Prices of Related Goods </li></ul><ul><ul><li>Substitutes </li></ul></ul><ul><ul><li>Compliments </li></ul></ul>
  107. 108. Determinants Continued … <ul><li>Number of Buyers </li></ul><ul><li>Expectations of Future </li></ul>
  108. 109. Change in Demand vs. Change in Quantity Demanded <ul><li>Change in Demand </li></ul><ul><ul><li>SHIFT OF CURVE </li></ul></ul><ul><ul><ul><li>Due to any non-price determinate </li></ul></ul></ul><ul><li>Change in Quantity demanded </li></ul><ul><ul><li>MOVEMENT ON ORIGINAL CURVE </li></ul></ul><ul><ul><ul><li>Due only to a change in price </li></ul></ul></ul>
  109. 110. Change in Demand versus Change in Quantity Demanded
  110. 111. Change in Demand <ul><li>SHIFT OF CURVE </li></ul><ul><li>SHIFT LEFT?? </li></ul><ul><ul><li>DECREASE IN DEMAND </li></ul></ul><ul><li>SHIFT RIGHT?? </li></ul><ul><ul><li>INCREASE IN DEMAND </li></ul></ul>
  111. 112. Shifts in the Demand Curve
  112. 113. Shifts in the Demand Curve
  113. 114. Change in price of related goods <ul><li>Substitutes </li></ul><ul><ul><li>Something used in replace of another good </li></ul></ul><ul><ul><li>Price of Coke increases... </li></ul></ul><ul><li>Compliments </li></ul><ul><ul><li>Something used with another good </li></ul></ul><ul><ul><li>Price of Tennis Rackets increase </li></ul></ul>
  114. 115. Substitutes and Complements
  115. 116. Substitutes and Complements
  116. 117. SELF TEST-Do we understand?? <ul><li>Substitutes </li></ul><ul><ul><li>Coke vs. Pepsi --- what happens if the price of Coke increases? </li></ul></ul><ul><ul><li>Qd of Pepsi? </li></ul></ul><ul><ul><ul><li>NOTHING </li></ul></ul></ul><ul><ul><li>Qd of Coke? </li></ul></ul><ul><ul><ul><li>DECREASES </li></ul></ul></ul><ul><ul><li>Demand for Coke? </li></ul></ul><ul><ul><ul><li>NOTHING </li></ul></ul></ul><ul><ul><li>Demand for Pepsi? </li></ul></ul><ul><ul><ul><li>INCREASES </li></ul></ul></ul>
  117. 118. <ul><li>Compliments </li></ul><ul><ul><li>Tennis Balls and Tennis Rackets --- what happens if the price of Tennis Rackets increase? </li></ul></ul><ul><ul><li>Qd of Tennis Balls? </li></ul></ul><ul><ul><ul><li>NOTHING </li></ul></ul></ul><ul><ul><li>Qd of Tennis Rackets? </li></ul></ul><ul><ul><ul><li>DECREASES </li></ul></ul></ul><ul><ul><li>Demand for Tennis Balls? </li></ul></ul><ul><ul><ul><li>DECREASES </li></ul></ul></ul><ul><ul><li>Demand for Tennis Rackets? </li></ul></ul><ul><ul><ul><li>NOTHING </li></ul></ul></ul>
  118. 119. Examples <ul><li>The housing market: Consumer’s income increases </li></ul><ul><li>The sugar market: Saccharine is found to lead to cancer </li></ul><ul><li>The jelly market: The price of peanut butter increases </li></ul><ul><li>The beer market: The price of beer decreases </li></ul>
  119. 120. Does the Law of Demand Hold? <ul><li>The price of eating out increases from $10 to $15 and the quantity demanded of restaurants increases from 10 to 14 meals. </li></ul>
  120. 121. The Law of Demand Holds
  121. 122. The other side…supply <ul><li>Quantity supplied </li></ul><ul><ul><li>Amount of a good that producers are willing and able to sell at a particular point in time at a particular price </li></ul></ul>
  122. 123. Important Parts <ul><li>Able </li></ul><ul><li>Willing </li></ul><ul><li>Particular price </li></ul><ul><li>Particular point in time </li></ul>
  123. 124. Supply <ul><li>Quantity Supplied at all prices during a specific time period </li></ul><ul><li>Thus… </li></ul>
  124. 125. Law of Supply <ul><li>As the price of a good increases (decreases) the quantity supplied of that good increases (decreases) </li></ul>
  125. 126. Supply Schedule <ul><li>Numerical table of quantity supplied at different prices </li></ul>10 1 20 2 30 3 40 4 Quantity Price
  126. 127. Supply Curve <ul><li>Supply Curve </li></ul><ul><ul><li>Graphical representation of the relationship between price and quantity supplied </li></ul></ul><ul><li>What type of relationship do we have between price and quantity supplied? </li></ul>
  127. 128. Supply Curve Exhibit 7
  128. 129. Stuff continued… <ul><li>Change in supply </li></ul><ul><ul><li>SHIFT OF SUPPLY CURVE </li></ul></ul><ul><li>Change in quantity supplied </li></ul><ul><ul><li>MOVEMENT ALONG ORIGINAL SUPPLY CURVE </li></ul></ul><ul><li>Increase in supply --- shift right </li></ul><ul><li>Decrease in supply --- shift left </li></ul>
  129. 130. Change in Supply versus Change in Quantity Supplied
  130. 131. Shifts in the Supply Curve
  131. 132. Shifts in the Supply Curve
  132. 133. Question??? <ul><li>Can the supply curve ever be vertical? </li></ul><ul><li>First…what does a vertical curve indicate about the relationship between price and quantity supplied? </li></ul>
  133. 134. Supply Curves When There Is No Time to Produce More or No More Can Be Produced
  134. 135. Determinants of Supply <ul><li>Price of inputs </li></ul><ul><li>Technology </li></ul><ul><li>Number of sellers </li></ul><ul><li>Price expectations </li></ul><ul><li>Taxes and subsidies </li></ul>
  135. 136. Examples <ul><li>The computer market: The price of computer chips decreases </li></ul><ul><li>The fast food market: McDonalds opens three new stores in Bakersfield </li></ul><ul><li>The pencil market: The price of pencils increases </li></ul><ul><li>The gasoline market: A tax is imposed on gas station owners for each gallon of gas pumped out of their station </li></ul>
  136. 137. Market Supply Curves <ul><li>Previous supply curve was for an individual </li></ul><ul><ul><li>Single seller </li></ul></ul><ul><li>How can we get the market curve from individual supply curves? </li></ul><ul><ul><li>All sellers </li></ul></ul><ul><li>Sum the individual supply curves… </li></ul>
  137. 138. Therefore….
  138. 139. Deriving a Market Supply Schedule & Curve
  139. 140. Deriving a Market Supply Schedule & Curve
  140. 141. Next Step…. Putting Supply and Demand Together
  141. 142. Auction Model <ul><li>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 </li></ul>
  142. 143. But… <ul><li>There is only one price where Qs=Qd </li></ul><ul><li>This is called the equilibrium price </li></ul><ul><li>The market is always working towards this price </li></ul>
  143. 144. Scissors and economics? <ul><li>Alfred Marshall compared Supply and demand to a pair of scissors </li></ul><ul><ul><li>“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 </li></ul></ul>
  144. 145. What determines the price? <ul><li>The interaction of supply and demand </li></ul>S D Quantity Price
  145. 146. Equilibrium <ul><li>Also called the market clearing price </li></ul><ul><ul><li>When Qs=Qd </li></ul></ul><ul><li>Disequilibrium </li></ul><ul><ul><li>When Qs=Qd </li></ul></ul>
  146. 147. At Disequilibrium can have… <ul><li>Shortage (excess demand) </li></ul><ul><ul><li>Qd > Qs </li></ul></ul><ul><ul><li>Price too low </li></ul></ul><ul><ul><li>Price must increase to rid shortage </li></ul></ul><ul><li>Surplus (excess supply) </li></ul><ul><ul><li>Qd < Qs </li></ul></ul><ul><ul><li>Price too high </li></ul></ul><ul><ul><li>Price must decrease to rid surplus </li></ul></ul>
  147. 148. Moving to Equilibrium
  148. 149. Moving to Equilibrium <ul><li>If we have a surplus, price must _______ to get to equilibrium. </li></ul><ul><li>Decrease </li></ul><ul><li>If we have a shortage, price must _______ to get to equilibrium. </li></ul><ul><li>Increase </li></ul>
  149. 150. Do Shortage and Scarcity refer to the same thing??? <ul><li>NO!! </li></ul><ul><li>Shortage is only when price is less than the equilibrium price </li></ul><ul><li>Scarcity is always present (at all prices) </li></ul>
  150. 151. Applications of Supply and Demand <ul><li>Romanee-Conti Wine </li></ul><ul><ul><li>Dated back to 1990 and sells for $800 a bottle or $8 a sip…why? </li></ul></ul><ul><li>Ticket scalping </li></ul><ul><ul><li>Why would people pay higher prices to see an event? </li></ul></ul><ul><ul><li>Prices must have been below equilibrium. </li></ul></ul><ul><li>Freeway </li></ul><ul><ul><li>Why would people be willing to pay a toll to use a road? </li></ul></ul>
  151. 152. Remember.. <ul><li>Equilibrium price and quantity are determined by the INTERACTION of supply and demand </li></ul><ul><li>A change in supply, demand, or both will change the equilibrium price </li></ul><ul><li>Exception: If supply and demand move in same direction and magnitude so changes are offset </li></ul>
  152. 153. Change in Supply and Demand but no change in equilibrium price quantity Price S S' D D' Q1 Q2 P
  153. 154. What Happens??? <ul><li>Increase D and S constant? </li></ul><ul><li>Decrease D and S constant? </li></ul><ul><li>D constant and increase S? </li></ul><ul><li>D constant and decrease S? </li></ul><ul><li>D increase and S decreases by equal amounts? </li></ul><ul><li>D decrease and S increases by equal amounts? </li></ul><ul><li>D increases more than S decreases? </li></ul><ul><li>D increases less than S decreases? </li></ul>
  154. 155. A Summary Exhibit of a Market
  155. 156. Price Controls <ul><li>Produces a barrier to which the economy can no longer operate freely </li></ul><ul><ul><li>Can’t get to equilibrium price </li></ul></ul><ul><li>Two types </li></ul><ul><ul><li>Price ceiling </li></ul></ul><ul><ul><li>Price Floor </li></ul></ul>
  156. 157. Price Ceiling <ul><li>Government mandated maximum price above which legal trades cannot be made </li></ul><ul><li>Price ceiling is below equilibrium price. </li></ul>
  157. 158. Price Ceiling
  158. 159. Impacts of Price Ceilings <ul><li>Shortage sustained </li></ul><ul><li>Fewer exchanges </li></ul><ul><li>Non-price rationing schemes </li></ul><ul><ul><li>First come first served </li></ul></ul><ul><li>Buying & selling at prohibited prices </li></ul><ul><ul><li>Black markets </li></ul></ul><ul><li>Tie in Sales </li></ul><ul><ul><li>Pay certain amount for rent of the house and an amount for renting the refrigerator </li></ul></ul><ul><li>Distort normal economic information and incentives </li></ul><ul><ul><li>Lower prices is supposed to mean greater availability </li></ul></ul>
  159. 160. Price Floor <ul><li>Government mandated minimum price below which legal trades cannot be made </li></ul><ul><li>Price floor is above equilibrium price </li></ul>
  160. 161. Price Floor
  161. 162. Impacts of Price Floors <ul><li>Sustained surpluses </li></ul><ul><li>Fewer exchanges </li></ul><ul><li>Example: Minimum wage </li></ul>
  162. 163. Minimum Wage <ul><li>In California the minimum wage is $6.75 per hour </li></ul><ul><ul><li>Increased from $6.26 on January 1, 2002 </li></ul></ul><ul><li>Government mandated minimum wage is $5.15 </li></ul><ul><ul><li>Last increase was on September 1, 1997 </li></ul></ul>
  163. 164. Impacts of Minimum Wage <ul><li>Surplus of unskilled </li></ul><ul><li>Fewer workers overall employed </li></ul><ul><li>Supply and Demand would determine wage </li></ul><ul><li>Minimum wage doesn’t guarantee better standards of living for low wage employees </li></ul>
  164. 165. Effects of the Minimum Wage 5.75 4.25
  165. 166. Chapter 5 Elasticity You are responsible for reading Chapter 4!!!
  166. 167. What have we done? <ul><li>Chapter 3 gave us downward sloping demand curves </li></ul><ul><ul><li>Law of demand </li></ul></ul><ul><li>Now want to see how Q d changes when price changes </li></ul>
  167. 168. Elasticity <ul><li>Response of one variable to a change in another variable </li></ul><ul><li>Price elasticity of demand </li></ul><ul><ul><li>Measure of the responsiveness of Q d of a product to a change in the price of that product </li></ul></ul>
  168. 169. or rewrite as
  169. 170. So… <ul><li>What if E d = 3? </li></ul><ul><ul><li>If price was increased from the prevailing point the % change in Q d would be 3 times the change in price </li></ul></ul><ul><li>Shouldn’t it be negative? </li></ul><ul><ul><li>So price increases and Q d decreases? </li></ul></ul><ul><li>Yes!! </li></ul><ul><ul><li>For ease we look at the absolute value, but know that the law of demand holds </li></ul></ul>
  170. 171. Point elasticity <ul><li>Measures the change between two observed points. </li></ul>
  171. 172. example <ul><li>P 1 = 10 </li></ul><ul><li>P 2 = 12 </li></ul><ul><li>Q 1 = 100 </li></ul><ul><li>Q 2 = 50 </li></ul><ul><li>Elasticity?? </li></ul><ul><li>Which is Point A??? </li></ul><ul><li>Big Problem!!! </li></ul>
  172. 173. Problem <ul><li>Answers vary depending on where you start </li></ul><ul><li>Becomes more important the larger the change </li></ul>
  173. 174. Arc Elasticity <ul><li>To avoid the endpoint problem take elasticity at the midpoint (average) of the two points </li></ul>
  174. 175. Differences <ul><li>With arc elasticity it is clear which points are used </li></ul><ul><li>P 1 is the first price </li></ul><ul><li>P 2 is the second price </li></ul><ul><li>Q d 1 and Q d 2 are the first and second quantity demanded respectively </li></ul>
  175. 176. Price elasticity of demand can yield 5 basic results <ul><li>Numerator > Denominator </li></ul><ul><li>Numerator < Denominator </li></ul><ul><li>Numerator = Denominator </li></ul><ul><li>Numerator = 0 </li></ul><ul><li>Denominator = 0 </li></ul><ul><li>Each has a specific name and result </li></ul>
  176. 177. Elastic Demand <ul><li>Ed > 1 </li></ul><ul><li>% change in quantity demanded > % change in price </li></ul><ul><li>FLATTER CURVE </li></ul><ul><li>What are some examples of an elastic good??? </li></ul>
  177. 178. Inelastic Demand <ul><li>E d <1 </li></ul><ul><li>% change in the price > percent change in quantity demanded </li></ul><ul><li>STEEPER CURVE </li></ul><ul><li>What are some examples of an inelastic good? </li></ul>
  178. 179. Price Elasticity of Demand
  179. 180. Unit Elastic Demand <ul><li>E d =1 </li></ul><ul><li>% change in price = % change in quantity demanded </li></ul><ul><li>Change in price brings a proportionate change in quantity demanded </li></ul><ul><li>CURVE </li></ul>
  180. 181. Price Elasticity of Demand
  181. 182. Perfectly Elastic Demand <ul><li>Ed = (denominator = 0) </li></ul><ul><li>% change in quantity demanded is A LOT in response to a change in price </li></ul><ul><li>Price increases and quantity demanded goes to 0 </li></ul><ul><li>Totally flat --- horizontal </li></ul><ul><li>Extreme </li></ul><ul><li>Examples??? </li></ul>
  182. 183. Perfectly inelastic demand <ul><li>E d = 0 </li></ul><ul><li>% change in quantity demanded DOESN’T CHANGE in response to a change in price </li></ul><ul><li>Totally steep --- vertical </li></ul><ul><li>Extreme </li></ul><ul><li>Examples??? </li></ul>
  183. 184. Price Elasticity of Demand
  184. 185. Aren’t demand curve downward sloping? <ul><li>Because the extremes (perfectly inelastic and perfectly elastic) are not. </li></ul><ul><li>Use as points of reference only </li></ul>
  185. 186. How does a change in price affect Total Revenue of a Firm? <ul><li>Revenue depends on elasticity </li></ul><ul><li>Michael Jordan and Nike shoes </li></ul><ul><ul><li>No substitutes -- inelastic demand </li></ul></ul><ul><ul><ul><li>What happens to Qd if price increases? </li></ul></ul></ul><ul><ul><li>Substitutes – elastic demand </li></ul></ul><ul><ul><ul><li>What happens to Qd if price increases? </li></ul></ul></ul>
  186. 187. What is total revenue?? <ul><li>Total revenue = price*quantity </li></ul><ul><li>Firm uses to decide if to produce more or less </li></ul>
  187. 188. examples <ul><li>Elastic demand </li></ul><ul><ul><li>Price increase </li></ul></ul><ul><ul><li>Price decrease </li></ul></ul><ul><li>Inelastic demand </li></ul><ul><ul><li>Price increase </li></ul></ul><ul><ul><li>Price decrease </li></ul></ul><ul><li>Unit elastic demand </li></ul><ul><ul><li>Price increase </li></ul></ul><ul><ul><li>Price decrease </li></ul></ul>
  188. 189. Elasticities, Price Changes, and Total Revenue
  189. 190. Important to look at because… <ul><li>Elasticity of the demand determines if with a price increase… </li></ul><ul><ul><li>Total revenue increases </li></ul></ul><ul><ul><li>Total revenue decreases </li></ul></ul><ul><ul><li>Total revenue remains the same </li></ul></ul>
  190. 191. Price elasticity of demand and a straight line <ul><li>Demand is downward sloping </li></ul><ul><li>Along the line elasticity varies from highly elastic to highly inelastic </li></ul><ul><li>But…remember SLOPE is constant </li></ul>
  191. 192. P Q G F E D C B A Find Total Revenue and Elasticity of Demand 9 2 G 8 3 F 7 4 E 6 5 D 5 6 C 4 7 B 3 8 A Q d P Point
  192. 193. Price Elasticity of Demand along a Demand Curve
  193. 194. Summary <ul><li>Upper end of Demand Curve </li></ul><ul><ul><li>Q d is low and price is high </li></ul></ul><ul><ul><li>One unit change in demand is much larger in terms of percent than change in price </li></ul></ul><ul><li>Lower end of Demand Curve </li></ul><ul><ul><li>Q d is high and price is low </li></ul></ul><ul><ul><li>One unit change in demand is much smaller in terms of percent than change in price </li></ul></ul>
  194. 195. So… <ul><li>As move down the demand curve from higher prices to lower the price elasticity of demand goes from elastic to inelastic </li></ul>
  195. 196. Determinants of price elasticity of demand <ul><li>Number of substitutes available </li></ul><ul><ul><li>Increase substitutes increases elasticity </li></ul></ul><ul><ul><li>More narrowly defined goods have more substitutes (compared to broadly defined) </li></ul></ul><ul><ul><ul><li>Example: Fords vs all cars </li></ul></ul></ul>
  196. 197. More Determinants <ul><li>Percentage of one’s budget that is spent on the good </li></ul><ul><ul><li>More expensive??? More elastic </li></ul></ul><ul><ul><li>More affected by price (even small changes) </li></ul></ul>
  197. 198. Final Determinants <ul><li>Amount of time that passed since price change </li></ul><ul><ul><li>Increase time passed gives more opportunity to change behavior or react to price change </li></ul></ul><ul><ul><li>Overtime can look for substitutes </li></ul></ul><ul><ul><li>Increase time increases elasticity </li></ul></ul><ul><ul><li>More elastic in long term than short </li></ul></ul>
  198. 199. Cross Elasticity of Demand <ul><li>Measures the responsiveness of quantity demanded to a change in price of ANOTHER good </li></ul>
  199. 200. When would you use Cross Price Elasticity? <ul><li>To determine if goods are substitutes or compliments </li></ul><ul><li>Ec>0 – substitutes </li></ul><ul><ul><li>% change in quantity demanded and price move in same direction </li></ul></ul><ul><li>Ec<0 – compliments </li></ul><ul><ul><li>% change in quantity demanded and price move in opposite directions </li></ul></ul><ul><li>Ec=0 – goods unrelated </li></ul>
  200. 201. Income elasticity of demand <ul><li>Measures the responsiveness of quantity demanded to the change in income </li></ul>
  201. 202. Why use income elasticity of demand? <ul><li>Use to determine if a good is normal or inferior </li></ul><ul><li>E y >0 – normal good </li></ul><ul><ul><li>As income increases Q d increases </li></ul></ul><ul><li>E y <0 – inferior good </li></ul><ul><ul><li>As income increases Q d decreases </li></ul></ul>
  202. 203. Can also say… <ul><li>If |E y | > 1 </li></ul><ul><ul><li>% change in Q d > % change in Y </li></ul></ul><ul><ul><li>Income elastic </li></ul></ul><ul><li>If |E y | < 1 </li></ul><ul><ul><li>% change in Q d < % change in Y </li></ul></ul><ul><ul><li>Income inelastic </li></ul></ul><ul><li>If |E y | = 1 </li></ul><ul><ul><li>% change in Q d = % change in Y </li></ul></ul><ul><ul><li>Income unit elastic </li></ul></ul>
  203. 204. Can we use income elasticity in the real world?? <ul><li>If invest in the stock market do you want to invest in a normal or inferior good? </li></ul><ul><li>Normal </li></ul><ul><li>Why </li></ul><ul><li>Increase income would increase quantity bought and increase stock prices </li></ul>
  204. 205. Price Elasticity of Supply <ul><li>Measures the responsiveness of quantity supplied of a good to the change in the price of that good </li></ul>
  205. 206. Classification is like demand <ul><li>Es > 1 </li></ul><ul><ul><li>Elastic </li></ul></ul><ul><li>Es < 1 </li></ul><ul><ul><li>Inelastic </li></ul></ul><ul><li>Es = 1 </li></ul><ul><ul><li>Unit elastic </li></ul></ul><ul><li>Each of these will result in a “normal” upward sloped supply curve </li></ul>
  206. 207. Any extreme elasticities??? <ul><li>Yes!! </li></ul><ul><li>Es = </li></ul><ul><ul><li>Perfectly elastic or horizontal </li></ul></ul><ul><li>Es = 0 </li></ul><ul><ul><li>Perfectly inelastic or vertical </li></ul></ul>
  207. 208. Price Elasticity of Supply
  208. 209. Price Elasticity of Supply
  209. 210. Price Elasticity of Supply
  210. 211. Does time play a role in elasticity of supply? <ul><li>Yes!! </li></ul><ul><li>Overtime producers are able to adjust their behavior and production patterns </li></ul><ul><li>Supply becomes more elastic as time passes </li></ul>
  211. 212. Elasticity and taxes <ul><li>If government levies a tax on a product who pays the tax?? </li></ul><ul><li>Producers?? Consumers?? Share?? </li></ul><ul><li>Depends on the elasticity of demand and supply </li></ul>
  212. 213. How find?? <ul><li>Find equilibrium price </li></ul><ul><li>Supply shifts left in the amount of the tax </li></ul><ul><li>Find new equilibrium </li></ul><ul><li>Find point of second equilibrium on ORGINAL supply curve </li></ul><ul><ul><li>Shows the actual price realized by firm or equilibrium price – tax = point in question </li></ul></ul><ul><li>Difference between points determines how much of tax you pay </li></ul>
  213. 214. Who Pays the Tax?
  214. 215. Who pays more of the tax?? <ul><li>Perfectly inelastic demand </li></ul><ul><li>Perfectly elastic demand </li></ul><ul><li>Demand more elastic than supply </li></ul><ul><li>Supply more elastic than demand </li></ul>
  215. 216. Different Elasticities and Who Pays the Tax
  216. 217. Summary <ul><li>E d > E s producer bears most of the tax burden </li></ul><ul><li>E d < E s consumer bears most of the tax burden </li></ul><ul><li>E d = E s equally share the tax burden </li></ul>
  217. 218. Chapter 6 Consumer Choice: Maximizing Utility and Behavioral Economics
  218. 219. Diamond-Water Paradox <ul><li>Why is water (necessary to life) so cheep while a diamond (not necessary to life) is so expensive? </li></ul>
  219. 220. Two types of value for a good <ul><li>Value of Exchange </li></ul><ul><ul><li>Price </li></ul></ul><ul><li>Utility </li></ul><ul><ul><li>Satisfaction or wellbeing </li></ul></ul>
  220. 221. How do you measure utility? <ul><li>Construct an artificial measure called a UTIL </li></ul><ul><li>Remember we assume people are rational </li></ul><ul><li>What does it mean to be rational? </li></ul><ul><ul><li>Will not consume a bad voluntarily </li></ul></ul><ul><li>All consumed goods have utility or you would not consume it. </li></ul>
  221. 222. Total Utility <ul><li>Amount of satisfaction or “use value” you receive from consuming a particular good </li></ul><ul><li>Thus… </li></ul>Total Utility = Utility gained from consuming each unit
  222. 223. Marginal Utility <ul><li>Additional utility gained from consuming an additional unit of a good </li></ul><ul><li>Change in total utility brought about by the additional consumption </li></ul>
  223. 224. Thus… Marginal Utility = TU Q
  224. 225. Calculate the Marginal Utility 19 4 18 3 16 2 10 1 Pizza Slices Total Utility Quantity
  225. 226. Law of Diminishing Marginal Utility <ul><li>The more units of a good we consume during a period of time the less additional satisfaction we get from the additional units </li></ul>
  226. 228. Does the “law” always hold? <ul><li>Some goods have increasing MU initially then decreasing later, but the law says satisfaction should begin to decrease with the second unit </li></ul><ul><li>Tennis </li></ul><ul><ul><li>As you get better you like it more, so the 10 th game may be more enjoyable </li></ul></ul>
  227. 229. Soften the Law <ul><li>Principle of Diminishing Returns </li></ul><ul><ul><li>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. </li></ul></ul>
  228. 230. Examples… <ul><li>Car rides </li></ul><ul><li>Fads </li></ul><ul><li>eating </li></ul>
  229. 231. Thus…the law says <ul><li>At some point successive units of a good consumed by the SAME individual will become less valuable to that individual </li></ul><ul><li>What about to someone else or the interpersonal utility? </li></ul><ul><ul><li>Can’t do because we don’t know with certainty another person’s preferences </li></ul></ul>
  230. 232. Example <ul><li>Who would value a dollar more: a poor person or a millionaire? </li></ul><ul><li>Money hungry millionaire? </li></ul><ul><ul><li>Answer would be millionaire </li></ul></ul><ul><li>Dollar is not much of a million </li></ul><ul><ul><li>Answer would be a poor person </li></ul></ul><ul><li>Don’t guess at utility </li></ul>
  231. 233. Diamond-Water Paradox revisited <ul><li>Goods have Total and Marginal Utility values </li></ul><ul><li>Water </li></ul><ul><ul><li>TU? </li></ul></ul><ul><ul><li>High because need it to live </li></ul></ul><ul><ul><li>MU? </li></ul></ul><ul><ul><li>Low because it is plentiful and we consume it in large quantities </li></ul></ul>
  232. 234. Diamond-Water Paradox continued <ul><li>Diamonds </li></ul><ul><ul><li>TU?? </li></ul></ul><ul><ul><li>Low because not really necessary to live </li></ul></ul><ul><ul><li>MU?? </li></ul></ul><ul><ul><li>High because very limited supply and consume in small quantities </li></ul></ul>
  233. 235. Solution to Diamond-Water Paradox <ul><li>Things with great value in use have little value in exchange </li></ul><ul><li>Those with little use value have higher exchange value </li></ul><ul><li>Prices (value of exchange) are most often determined by… </li></ul><ul><ul><li>Marginal Utility </li></ul></ul>
  234. 236. Is gambling worth it? <ul><li>If only want to win??? NO!! </li></ul><ul><li>If gain pleasure from the gambling process??? YES!! </li></ul>
  235. 237. How do we compare MU of different units? <ul><li>Example: What is the MU of an apple vs. an orange? </li></ul><ul><li>Relative Marginal Utility of the good </li></ul><ul><li>MU per dollar of purchase price </li></ul>
  236. 238. Decision Making Process <ul><li>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 </li></ul><ul><li>Compare of each good </li></ul>
  237. 239. Example <ul><li>MU orange = 30 </li></ul><ul><li>MU apple = 20 </li></ul><ul><li>Income = $20 </li></ul><ul><li>Buy 10 oranges for $1 each and 10 apples for $1 each </li></ul><ul><li>Good?? </li></ul>
  238. 240. Not Good… <ul><li>We could do better by buying more oranges because per dollar it brings more satisfaction </li></ul><ul><li>Buy one more orange and one less apple increases TU </li></ul><ul><li>What happens to the MU of oranges? </li></ul><ul><ul><li>Decreases MU of oranges </li></ul></ul><ul><ul><li>Why? </li></ul></ul><ul><ul><li>Diminishing MU when buy more </li></ul></ul><ul><li>What happens to the MU of apples? </li></ul><ul><ul><li>Increases MU of apples </li></ul></ul><ul><ul><li>Why? </li></ul></ul><ul><ul><li>Increasing MU when buy less </li></ul></ul><ul><li>When do we stop? </li></ul>
  239. 241. Consumer Equilibrium <ul><li>The combination of goods where our income can’t be redirected to improve our situation </li></ul><ul><li>Therefore: </li></ul>
  240. 242. Example P M =$2 ; P c =$1; Income=$60 3 50 3 8 4 48 6 7 5 46 8 6 6 44 11 5 MU c # cookies MU M # muffins
  241. 243. What if the price of a good changes? <ul><li>Must recalculate </li></ul>
  242. 244. P a =$1;P b =$1? P a =$0.50;P b =$1? Income = $7.00 10 7 7 7 12 6 8 6 14 5 9 5 16 4 10 4 18 3 11 3 20 2 11.5 2 22 1 12 1 MU B # b MU a # a
  243. 245. Consumer Equilibrium and a Fall in Price
  244. 246. So… <ul><li>As price decreases relative MU increases so consumers buy more to gain consumer equilibrium again </li></ul><ul><li>Shows a negative relationship between price and amount people buy </li></ul><ul><ul><li>JUST LIKE THE DEMAND CURVE </li></ul></ul>
  245. 247. Do RATS understand the inverse relationship between price and quantity? <ul><li>Choice between two liquids </li></ul><ul><ul><li>Root beer </li></ul></ul><ul><ul><li>Collins mix </li></ul></ul><ul><li>Given 300 pushes (each liquid had a different number of pushes to get it – price) </li></ul><ul><li>Found rats switched to the “cheaper” liquid when the “price” changed </li></ul>
  246. 248. Why isn’t education and medical care free? <ul><li>If cost = 0 when do we stop using it? </li></ul><ul><li>When MU = 0 </li></ul><ul><li>Thus we will see a lot of frivolous use of programs. It costs you nothing so use it. </li></ul>
  247. 249. Consumer Surplus <ul><li>The difference between the actual price buyers pay for a good and the maximum amount they are WILLING and ABLE to pay for it </li></ul><ul><li>Dollar measure of benefit gained from a price decrease </li></ul>
  248. 250. Consumer Surplus cont. <ul><li>Triangle under the demand curve and above the equilibrium price out to the equilibrium quantity </li></ul>
  249. 251. Consumers' Surplus
  250. 252. Changes in Supply affect Consumer Surplus <ul><li>Decrease in the number of sellers </li></ul><ul><li>Advance in technology </li></ul><ul><li>Increase in the price of relevant resources </li></ul><ul><li>A per-unit subsidy placed on producers/seller </li></ul>
  251. 253. Consumers' Surplus
  252. 254. Sales schemes <ul><li>Consumer is willing to buy </li></ul><ul><ul><li>One pair of shorts for $40 </li></ul></ul><ul><ul><li>Second pair of shorts for $30 </li></ul></ul><ul><li>Store has a choice </li></ul><ul><ul><li>Sell shorts for $30 </li></ul></ul><ul><ul><li>Have sale where buy first for $40 get $10 off second pair? </li></ul></ul><ul><ul><li>Which has more CS??? (hint only use the demand curve) </li></ul></ul>
  253. 255. Consumers’ Surplus and Two Pricing Schemes