2. QUIZ 1-3. Draw a budget line and 3 indifference curves I1, I2, and I3 in one set of axes, where I1< I2< I3. Label a point A where I2 is tangent to the budget line. Label each properly.
3. QUIZ 4. TRUE OR FALSE: If I have 8 waffles and 2 cups of milk tea, I would be more willing to give up waffles to get an additional unit of milk tea. 5. What condition must be satisfied at the optimum? (Hint: What two values must be equal?)
4. RECAP Reality: You don’t have all the money in the world. You have to make choices between goods that you can afford. You are limited by your BUDGET LINE.
5. BUDGET LINE Below it – can afford but inefficient Along it – can afford and maximizes your money/utility Above it – can’t afford Slope is the relative prices of goods
6. UTILITY Measure of happiness or satisfaction Goal: Get to the highest level of utility Different bundles (or combinations) of goods give you different levels of utility
7. INDIFFERENCE CURVES Trace the bundles (or set) of goods that give you the same level of utility Any point along it will give you the same level of happiness You can draw an infinite number of indifference curves in an indifference map
8. INDIFFERENCE CURVES Higher indifference curves are preferred. If the quantity of one good is reduced, the quantity of the other must be increased (IC is downward sloping)
9. INDIFFERENCE CURVES Two indifference curves will never cross. People will be more willing to give up goods that they have more of (IC is bowed inward)
10. MARGINAL RATE OF SUBSTITUTION Rate at which you are willing to give up one good for the other How much milk tea you are willing to give up to get more waffles
11. MARGINAL RATE OF SUBSTITUTION Slope of the indifference curve Not the same at all points of the IC
12. PERFECT SUBSTITUTES Amount you exchange for one good to the other good is constant MRS is constant 7 sickles = 1 galleon 1 Coke = 1 Pepsi $1 = P43.23
13. PERFECT COMPLEMENTS Doesn’t matter how much 1 good increases if the other good does not increase Always paired up Ex: L and R shoes
14. OPTIMIZATION Reach highest IC possible Indifference curve must be tangent to the budget line Slope of IC = slope of BL MRS = relative prices
15. CHANGE IN INCOME More income = more goods But, relative prices same (so slope of BL does not change) Parallel shift Outward = more income Inward = less income
16. CHANGE IN INCOME For an increase in income, If both are normal goods, consumption of both goods increase If one good is inferior and the other is normal: Consumption of normal increases while consumption of inferior decreases
17. CHANGE IN INCOME – NORMAL GOODS Quantity consumed of both goods increase
18. CHANGE IN INCOME – 1 NORMAL GOOD, 1 INFERIOR GOOD X is inferior quantity consumed decreased Y is normal quantity consumed increased
19. CHANGE IN PRICE Since slope of BL is relative prices, slope changes Decrease in price – outward Increase in price – inward For the good which changed prices, the amount of it that you can buy (if you buy none of the other) increases
20. CHANGE IN PRICE Usually, consumption of the NOW cheaper good increases Consequently, consumption of the other good decreases BUT, this may not always be the case Change in IC will still depend on your preferences
21. CHANGE IN PRICE MILK TEA Price of MT falls (P20P10) Q consumed of MT increases Q consumed of W decreases 10 8 IC2 5 3 IC1 4 2 10 WAFFLES
22. CHANGE IN PRICE Two effects that usually are combined Income effect Substitution effect Income effect – movement to HIGHER IC resulting from a change in price Substitution effect – movement along the SAME IC but with higher MRS
23. CHANGE IN PRICE If price of milk tea falls: Income has greater purchasing power. Feel richer than before. Buy more waffle and more milk tea. Get more milk tea for every waffle you give up. Buy less waffle and more milk tea.
24. INCOME AND SUBSTITUTION EFFECTS MILK TEA Draw your initial BL1 and IC1 The initial optimum level is at point A A IC1 WAFFLES BL1
25. INCOME AND SUBSTITUTION EFFECTS MILK TEA Due to a decrease in P of milk tea, BL1 shifts to BL2 BL2 WAFFLES BL1
26. INCOME AND SUBSTITUTION EFFECTS MILK TEA Draw a new IC2 tangent to your BL2 Label the new optimum as point C BL2 C IC2 WAFFLES
27. INCOME AND SUBSTITUTION EFFECTS MILK TEA Draw an imaginary BL3 parallel to your BL2 Draw it tangent to IC1 Label the new optimum as point B BL3 B IC1 WAFFLES
28. INCOME AND SUBSTITUTION EFFECTS MILK TEA AB: subs effect Same IC1 BC: inc effect Different IC AC total effect C B A WAFFLES
29. INCOME AND SUBSTITUTION EFFECTS MILK TEA YELLOW – income effect GREEN – subst. effect C B A WAFFLES
35. DERIVING THE DEMAND CURVE Changes in price changes BL changes quantities of goods you buy Reflected in the demand curve Demand curve – traces the points where consumption is maximized at every price
36. DERIVING THE DEMAND CURVE MILK TEA Price of milk tea falls P20 P10 BL moves outward Increases purchase of milk tea At P10 = 8 B At P20 = 5 A WAFFLES
37. DERIVING THE DEMAND CURVE Price of milk tea falls P20 P10 BL moves outward, increases purchase of milk tea
39. DEMAND CURVE P – price Y – per capita income PR – price of related goods T – Tastes N – population
40. DEMAND FORECASTING a0 to a6 are parameters Represent the change of consumer demand per unit change in each determinant If any parameter is 0, no effect from that determinant Plug in values to parameters get demand forecast
41. DEMAND FORECASTING a0 – autonomous consumption a1 – ΔQD per P1 change in price a2 – ΔQD per P1000 change in per capita income a3 – ΔQD per P1 change in P of rel. good a4 – ΔQD per P1 change per year a1 – ΔQD per P1M change of population
42. DEMAND FORECASTING - Rootbeer PRB = P10 Y = 12,000 N = 70M PSODA= P10 Data collected in 1999, T = 1
44. CONSUMER THEORY Describes how people make decisions When you go to the caf, do you compute for the optimum level of consumption? In reality, no one draws BL’s and IC’s It is just a model framework for thinking
45. COST THEORY Costs of production All firms have a cost of production Key determinant of production and pricing decisions Goal of each firm: maximize profit
46. REVENUE Amount that the firm receives for the sale of its output When you buy bread at a bakery, the P20 you give the cashier (or baker) is revenue What seller receives Price x Q = PQ
47. TOTAL COST Amount that the firm (bakery) pays for its inputs (flour, yeast, salt) How much the firm spends to produce and deliver to the market its goods and services
49. ACCOUNTING COST The total amount of money or goods expended in an endeavour. It is money paid out at some time in the past and recorded in journal entries and ledgers. Explicit cost
50. ECONOMIC COST Cost of the alternative chosen and the benefit that the best alternative would have provided if chosen Explicit cost (accounting cost) + implicit cost Market Value – how the market valuates a certain good
51. IMPLICIT AND EXPLICIT COST Explicit cost – money was given out by the firm Baker pays P1,000 per bag of flour Implicit cost – no money given out by the firm Baker who was an Ateneo grad could have earned P1000/hour in corporate
52. ACCOUNTING COST Buy PC at P50,000 in year 2000 If straight-line depreciation is P10,000 per year 2001 = P40,000 2002 = P30, 000 2003 = P20,000 2004 = P10,000 2005 = P0
53. ECONOMIC COST Buy PC at P50,000 in year 2000 In 2005, PC still sells for P5,000 Economic cost = P5,000 Accounting cost = P0 In making decisions then, economic cost is more appropriate to use
54. PROFIT Economic Profit vs Business (Accounting) Profit Economic Profit – total revenue minus explicit and implicit costs Accounting Profit – total revenue minus explicit costs
55. ACCOUNTING PROFIT Investment on estate yields P1M per P10 million invested Accounting profit is P1M or 10% rate of return Estate seems like a good venture
56. ECONOMIC PROFIT Investment on estate yields P1M per P10 million invested Opportunity cost: Investment on pharmaceuticals yields P3M per P10M Economic Profit = P1M – P3M = -P2M Investing P10M in estate misses opportunity of making P2M more in investing P10M in pharmaceuticals
57. PRODUCTION Transformation of inputs into goods and services Short-run – Q of bread produced can only be changed by changing number of workers Production Function – Relationship between Q of inputs (workers) and Q of outputs (bread)
