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170902 entrepreneurial economics1

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In this slides deck, you will understand
- How to understand Elasticity
- Why on earth the S/D curves shift by taxation
- Welfare and Dead Weight Loss.
- The secret relation of MRS(Marginal Rate of Substitute) and indifference curve

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170902 entrepreneurial economics1

  1. 1. Entrepreneurial Economics A supplemental lecture on BMA5001 Organized by NUS MBA Entrepreneurship Club 2nd September, 2017 1
  2. 2. About author Ryosuke ISHII (RYO) β€’ MIT Microeconomics graded 93% (on edX, 3 months online course)
  3. 3. Agenda / Topics covered - How to understand Elasticity - Why on earth the S/D curves shift by taxation - Welfare and Dead Weight Loss. - The secret relation of MRS(Marginal Rate of Substitute) and indifference curve
  4. 4. Quick questions - Do you like mathematics? - How about calculus (especially differential) - if you are not good at calculus, might [advanced] section is difficult. But this is not today’s scope. - I have one-day long calculus entrance course as well
  5. 5. Elasticity See also; Lecture notes 2 Part A
  6. 6. Elasticity is Sensitivity. Price Elasticity means how sensitive to price they are? I change the price Market reacts. Elasticity
  7. 7. Elasticity So, the dividend(denominator) should be Price 𝑒 = π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’
  8. 8. Elasticity 𝑒 = π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ 𝑃 𝑄 𝑃 𝑄 Larger 𝑒 means Very sensitive Smaller 𝑒 means Little sensitive
  9. 9. ElasticityActually, it’s not just change, it’s % of Change. 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ , but how to measure β€œ% of Change”? Mesuring 1: PointElasticity % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑄 𝑄 = | 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑄 𝑄 | % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑃 𝑃 = | π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃 𝑃 | So, 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = ( Δ𝑄 𝑄 ) ( Δ𝑃 𝑃 ) = | Δ𝑄 Δ𝑃 𝑃 𝑄 | 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400 Δ𝑄 = 300 𝐿𝑒𝑑′ 𝑠 π‘π‘Žπ‘™π‘π‘’π‘™π‘Žπ‘‘π‘’ 𝑒 ←Elasticity of this point
  10. 10. Elasticity 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400 Δ𝑄 = 300 Actually, its not just change, its % of Change. 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ , but how to measure β€œ% of Change”? Mesuring 1: Point Elasticity % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑄 𝑄 = | 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑄 𝑄 | = 300 100 % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑃 𝑃 = | π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃 𝑃 | = | βˆ’20 100 | So, 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = | (3) ( βˆ’1 5 ) | = 15 β‰₯ 1 (it can be done because the Curve is Linear Function)
  11. 11. Elasticity 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400 Δ𝑄 = 300 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ , how to measure β€œ% of Change”? Mesuring 1: Point Elasticity [advanced] Or, use 𝑒 = d𝑄 d𝑃 𝑃 𝑄 (this is point elasticity, so make Ξ” β‡’ 𝑑) First, make an equation Q = 𝑓(𝑃) form. So, Q = βˆ’15𝑃 + 1600 d𝑄 d𝑃 = βˆ’15, 𝑃 = 100, 𝑄 = 100 |𝑒| = d𝑄 d𝑃 𝑃 𝑄 = βˆ’15 = 15 > 1
  12. 12. Elasticity 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ , how to measure β€œ% of Change”? Mesuring 2: Arc Elasticity If the price and value change from A to B. We would like to use average as dividend of % change. % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑄 𝑄 = 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑄 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑄) % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑃 𝑃 = π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑃) So, 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = ( 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑄 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ 𝑄 ) ( π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑃) ) 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400 Δ𝑄 = 300 π‘Žπ‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑄) π‘Žπ‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑃) 𝐿𝑒𝑑′ 𝑠 π‘π‘Žπ‘™π‘π‘’π‘™π‘Žπ‘‘π‘’ 𝑒! 𝐴 𝐡
  13. 13. Elasticity Actually, its not just change, its % of Change. 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ , but how to measure β€œ% of Change”? Mesuring 2: Arc Elasticity % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑄 𝑄 = 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑄 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑄) = 300 250 % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = Δ𝑃 𝑃 = π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑃) = βˆ’20 90 So, 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ = ( 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑄 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ 𝑄 ) ( π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃 π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑃) ) = | 1.2 βˆ— 9 βˆ’2 | = 5.4 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400 Δ𝑄 = 300 π‘Žπ‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑃) π‘Žπ‘£π‘’π‘Ÿπ‘Žπ‘”π‘’(𝑄)
  14. 14. Elasticity Why β€œ%” important? Think about the Case: 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 125 (𝑄, 𝑃) = 100,100 (𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ, π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ) = 125,80 (1)What is arc 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ ? (2)What is the Revenue before and after?
  15. 15. Elasticity Why β€œ%” important? Think about the Case: 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 125 (𝑄, 𝑃) = 100,100 (𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ, π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ) = 125,80 (1)What is arc 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ ? 𝑒 = βˆ’20/90 25/112.5 = | βˆ’ 1| (2)What is the Revenue before and after? 𝑅𝑒𝑣 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 𝑃𝑄 = 10,000 𝑅𝑒𝑣 π‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 10,000 So, if we define 𝑒 such that, 𝑒 = 1 means Revenue doesn’t change.
  16. 16. Elasticity 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 125 (𝑄, 𝑃) = 100,100 (𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ, π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ) = 125,80 (1)What is arc 𝑒 = % π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘¦ πΆβ„Žπ‘Žπ‘›π‘”π‘’ % π‘ƒπ‘Ÿπ‘–π‘π‘’ πΆβ„Žπ‘Žπ‘›π‘”π‘’ ? 𝑒 = βˆ’20/90 25/112.5 = | βˆ’ 1| (2)What is the Revenue before and after? 𝑅𝑒𝑣 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 𝑃𝑄 = 10,000 𝑅𝑒𝑣 π‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 10,000 So, if we define 𝑒 such that, 𝑒 = 1 means Revenue doesn’t change. 𝑃𝑄 Why β€œ%” important? Think about the Case:
  17. 17. Elasticity 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 (𝑄, 𝑃) = 100,100 (1) If we think 𝑒 = 5.4 ≫ 1 case. (2)What is the Revenue before and after? 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400 Why β€œ%” important? Think about the Case:
  18. 18. Elasticity Why β€œ%” important? Think about the Case: 𝑃 𝑄 𝑃 = 100 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 80 Δ𝑃 = βˆ’20 𝑄 = 100 (𝑄, 𝑃) = 100,100 (1) If we think 𝑒 = 5.4 ≫ 1 case. (2)What is the Revenue before and after? 𝑅𝑒𝑣 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 𝑃𝑄 = 10,000 𝑅𝑒𝑣 π‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 32,000 So, if e > 1, - Price down gain Revenue - Price Up lose Revenue 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 400
  19. 19. Elasticity Summary and special case 𝑒 > 1 𝑒 = 1 𝑒 < 1 𝑒 = ∞ 𝑒 = 0 If you change price, Nothing happens. So, price sensitivity = 0 If you change price Bit higher than before Everyone run away. Bit lower than before Everyone buy. So, Infinitely sensitive. Value Price down Price up |𝑒| < 1 R decrease↓ R increase↑ |𝑒| = 1 R same R same |𝑒| > 1 R increase↑ R decrease↓
  20. 20. Elasticity FYI[advanced] 𝑒 can be changed in Linear curve. 𝑃 𝑄 𝑒 = d𝑄 d𝑃 𝑃 𝑄 When we take a look at the equation: This Part is constant. Because this is Linear function. So, if 𝑄 β‡’ πΏπ‘Žπ‘Ÿπ‘”π‘’π‘Ÿ and 𝑃 β‡’ π‘ π‘šπ‘Žπ‘™π‘™π‘’π‘Ÿ then, 𝑒 β‡’ π‘ π‘šπ‘Žπ‘™π‘™π‘’π‘Ÿ |𝑒 𝐷| = 1 |𝑒 𝐷| < 1 |𝑒 𝐷| > 1
  21. 21. Surplus and Welfare
  22. 22. Welfare can be calculate: 𝑃 𝑄 Consumer Surplus(CS) + Producer Surplus(PS) CS PS But Why the CS / PS is the Area on the graph?
  23. 23. 𝑃 𝑄 CS Why the CS can be calculated by the Area on the graph? To make the things easy: - Imagine this market has only 4 people.
  24. 24. 𝑃 𝑄 Imagine this β€œApple” market has only 4 people(buyer/consumer). And each of them have a budget to get an Apple. So, the Demand Curve will be: This budget means: maximum how much willing to pay to get an Apple. $100 80 50 40 Name Budget Akira $100 Chieko $80 Rocky $50 Tomo $40 1 2 3 4
  25. 25. 𝑃 𝑄 If the price of an apple become $60 what will happen? Name Budget Akira $100 Chieko $80 Rocky $50 Tomo $40 $100 80 50 40 60 1 2 3 4
  26. 26. 𝑃 𝑄 If the price of an apple become $60 what will happen? 2 people can buy an apple each. And the consumer surplus each is below: Because the Budget means maximum how much willing to pay to get an Apple. Name Budget Akira $100 Chieko $80 Rocky $50 Tomo $40 $100 80 50 40 60 1 2 3 4 $40 $20
  27. 27. 𝑃 𝑄 CS This is because the CS can be calculated by the Area on the graph.
  28. 28. Producer Surplus(PS) can be calculated same way. 𝑃 𝑄 PS
  29. 29. 𝑃 𝑄 Imagine this Apple market has 4 sellers. The sellers differ their cost structure so, COST = MINIMUM How much they want to charge is below: That means if the price is equal to the Cost, it means they can get No profit. $100 80 50 40 Name Cost Neha $40 Federico $50 Joe $80 David $100 1 2 3 4
  30. 30. 𝑃 𝑄 If the price set as $60, What will happen? $100 80 50 40 Name Cost Neha $40 Federico $50 Joe $80 David $100 1 2 3 4 60
  31. 31. 𝑃 𝑄 Neha got $20 profit while Federico got $10 So the profit = Producer Surplus is $30 $100 80 50 40 Name Cost Neha $40 Federico $50 Joe $80 David $100 1 2 3 4 60 $20 $10
  32. 32. 𝑃 𝑄 Neha got $20 profit while Federico got $10 So the profit = Producer Surplus is $30 $100 80 50 40 1 2 3 4 60 $20 $10 Revenue 60 20 COSTβˆ’ = π‘π‘Ÿπ‘œπ‘“π‘–π‘‘
  33. 33. So, Welfare can be calculate: 𝑃 𝑄 Consumer Surplus(CS) + Producer Surplus(PS) CS PS
  34. 34. How tax change D/S curves and the Dead Weight Loss See also; Lecture notes 2 Part B
  35. 35. Government can decide from which side (Demand/Supply) The Government collect tax. The curve affects depends of the decision. 𝑃 𝑄 Supply Curve Demand Curve Let’s us think about Government decides that They collect tax from Buyer(demand side) And the tax is $10 each goods.
  36. 36. Demand Side Taxation: 3 steps thinking: 𝑃 𝑄 Supply Curve Demand Curve Before 1.Demand Curve should be affected. 2.Demand must be lower than before, because they should pay +$10 each than market price. 3.So, taxation makes Demand curve shift inward. Demand Curve After We could understand if we take a look at 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’, π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = (0,100) Should become 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ, π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = (0,90) Because π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ + π‘‘π‘Žπ‘₯ = π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ 100 90
  37. 37. Who, how much, really bear? 𝑃 𝑄 Supply Curve Demand Curve Before After Taxation, we got new Equilibrium (π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ, 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ) But, what consumers really pay is: π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ + π‘‘π‘Žπ‘₯ = 𝑃𝑅𝐸𝐴𝐿 𝑃𝑅𝐸𝐴𝐿 βˆ’ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ βˆ’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ + π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯ Demand Curve After π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃𝑅𝐸𝐴𝐿
  38. 38. Let’s calculate for this example! 𝑃 𝑄 𝑃𝑆 = 5𝑄 Demand Curve Before Demand curve before tax: 𝑃 𝐷 𝑏 = 120 βˆ’ 3𝑄 Supply Curve before tax: 𝑃𝑆 = 5𝑄 𝒕𝒂𝒙 = $πŸ– for Consumers What is: 𝑃𝑅𝐸𝐴𝐿 βˆ’ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ βˆ’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃 𝐷 𝑏 = 120 βˆ’ 3𝑄
  39. 39. Let’s calculate for this example! 𝑃 𝑄 𝑃𝑆 = 5𝑄 Demand Curve Before Calculate before Equilibrium, π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75, 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 The new demand curve will be 𝑃 𝐷 π‘Ž = 112 βˆ’ 3𝑄 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 70, 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14 But, what consumers really pay is: π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ + π‘‘π‘Žπ‘₯ = 𝑃𝑅𝐸𝐴𝐿 = 78 𝑃𝑅𝐸𝐴𝐿 βˆ’ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ = 3 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ βˆ’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ = 5 π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ + π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯Demand Curve After π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃𝑅𝐸𝐴𝐿 𝑃 𝐷 𝑏 = 120 βˆ’ 3𝑄
  40. 40. Next: supply side taxation: 𝑃 𝑄 Supply Curve Demand Curve Let’s us think about Government decides that They collect tax from Seller(Supply side)
  41. 41. Supply Side Taxation: 3 steps thinking: 𝑃 𝑄 Supply Curve Demand Curve 1.Supply Curve should be affected. 2.The price must be higher than before, because sellers should pay +$10 each after the deal made. 3.So, taxation makes supply curve shift upward. We could understand if we take a look at 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’, π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = (0,10) Should become 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ, π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = (0,20) Because π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ π‘‘π‘Žπ‘₯ = π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’
  42. 42. Supply Side Taxation: 3 steps thinking: 𝑃 𝑄 Supply Curve Demand Curve After Taxation, we got new Equilibrium (π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ, 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ) π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ is what consumers pay. But, what sellers really get: π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ π‘‘π‘Žπ‘₯ = 𝑃𝑅𝐸𝐴𝐿 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿβˆ’π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’= π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ βˆ’ 𝑃𝑅𝐸𝐴𝐿 = π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ + π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃𝑅𝐸𝐴𝐿
  43. 43. Let’s calculate for this example! 𝑃 𝑄 𝑃𝑆 = 5𝑄 Demand Curve Demand curve before tax: 𝑃 𝐷 𝑏 = 120 βˆ’ 3𝑄 Supply Curve before tax: 𝑃𝑆 = 5𝑄 π‘‘π‘Žπ‘₯ = $8 for Sellers. What is: 𝑃𝑅𝐸𝐴𝐿 βˆ’ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ βˆ’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃 𝐷 𝑏 = 120 βˆ’ 3𝑄
  44. 44. Supply Side Taxation: 3 steps thinking: 𝑃 𝑄 Supply Curve Demand Curve π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃𝑅𝐸𝐴𝐿 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 𝑃𝑆 𝐴 = 5𝑄 + 8 Calculate before Equilibrium, π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75, 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 The new supply curve will be 𝑃𝑆 𝐴 = 5𝑄 + 8 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78, 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14 But, what sellers really get is: π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ π‘‘π‘Žπ‘₯ = 𝑃𝑅𝐸𝐴𝐿 = 70 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿβˆ’π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’= π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ = 3 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ βˆ’ 𝑃𝑅𝐸𝐴𝐿 = π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ = 5 π‘‘π‘Žπ‘₯ π‘π‘œπ‘›π‘ π‘’π‘šπ‘’π‘Ÿ + π‘‘π‘Žπ‘₯ π‘π‘Ÿπ‘œπ‘‘π‘’π‘π‘’π‘Ÿ = π‘‘π‘Žπ‘₯
  45. 45. Dead Weight Loss
  46. 46. Let’s Calculate CS and PS before tax 𝑃 𝑄 Supply Curve Demand Curve π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃𝑅𝐸𝐴𝐿 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 CS PS
  47. 47. Let’s Calculate CS and PS before tax 𝑃 𝑄 Supply Curve Demand Curve 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 CS PS Calculate before Equilibrium, 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 , π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 120 0 𝐢𝑆 = (120 βˆ’ 75) Γ— 15 2 = 337.5 𝑃𝑆 = (75 βˆ’ 0) Γ— 15 2 = 562.5
  48. 48. Let’s Calculate CS and PS after tax $8 (for producer) 𝑃 𝑄 Supply Curve Demand Curve 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 120 0 𝑃𝑆 𝐴 = 5𝑄 + 8 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 𝑃𝑅𝐸𝐴𝐿 = 70 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14
  49. 49. Let’s Calculate CS and PS after tax $8 (for producer) 𝑃 𝑄 Supply Curve Demand Curve 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 120 0 𝑃𝑆 𝐴 = 5𝑄 + 8 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 𝑃𝑅𝐸𝐴𝐿 = 70 CS PS The Welfare should be calculated based on - What consumer really pay - What producer really get So, for consumers they really pay π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 for producers they really get 𝑃𝑅𝐸𝐴𝐿 = 70 Yes, taxation makes price difference Between consumers and producers.𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14
  50. 50. Let’s Calculate CS and PS after tax $8 (for producer) 𝑃 𝑄 Supply Curve Demand Curve 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 120 0 𝑃𝑆 𝐴 = 5𝑄 + 8 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 𝑃𝑅𝐸𝐴𝐿 = 70 𝐢𝑆 π‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃𝑆 π‘Žπ‘“π‘‘π‘’π‘Ÿ 𝐢𝑆 π‘Žπ‘“π‘‘π‘’π‘Ÿ = (120 βˆ’ 78) Γ— 14 2 = 294 𝑃𝑆 π‘Žπ‘“π‘‘π‘’π‘Ÿ = (70 βˆ’ 0) Γ— 14 2 = 490 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14
  51. 51. Let’s Calculate Sum of Tax, collected from market. 𝑃 𝑄 Supply Curve Demand Curve 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 120 0 𝑃𝑆 𝐴 = 5𝑄 + 8 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 𝑃𝑅𝐸𝐴𝐿 = 70 Where is tax and why? 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14
  52. 52. Let’s Calculate Sum of Tax, collected from market. 𝑃 𝑄 Supply Curve Demand Curve 𝑃𝑆 𝐡 = 5𝑄 𝑃 𝐷 = 120 βˆ’ 3𝑄 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 75 120 0 𝑃𝑆 𝐴 = 5𝑄 + 8 π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 𝑃𝑅𝐸𝐴𝐿 = 70 consumers really pay π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ = 78 producers really get 𝑃𝑅𝐸𝐴𝐿 = 70 The difference is a tax so π‘ƒπ‘Žπ‘“π‘‘π‘’π‘Ÿ βˆ’ 𝑃𝑅𝐸𝐴𝐿 = π‘‘π‘Žπ‘₯ each consumption. And the quantity is 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14. So Sum of Tax = 78 βˆ’ 70 Γ— 14 = 112𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ = 15 𝑄 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 14
  53. 53. Compare before and after 𝑃 𝑄 Demand Curve 0 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’π‘„ π‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃 𝑄 CS PS 0 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ before after 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’
  54. 54. Dead Weight Loss 𝑃 𝑄 Demand Curve 0 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’π‘„ π‘Žπ‘“π‘‘π‘’π‘Ÿ 𝑃 𝑄 CS PS 0 π‘ƒπ‘π‘’π‘“π‘œπ‘Ÿπ‘’ before after 𝑄 π‘π‘’π‘“π‘œπ‘Ÿπ‘’ This is Dead Weight Loss This is a Social Welfare Loss that caused by tax
  55. 55. Before After Ξ” = π΄π‘“π‘‘π‘’π‘Ÿ βˆ’ π΅π‘’π‘“π‘œπ‘Ÿπ‘’ Consumer Surplus -43.5 Producer Surplus -72.5 Tax +112 Social Welfare 900 896 -4 Dead Weight Loss Summary 𝐢𝑆 = 337.5 𝑃𝑆 = 562.5 𝐢𝑆 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 294 𝑃𝑆 π‘Žπ‘“π‘‘π‘’π‘Ÿ = 490 π‘‡π‘Žπ‘₯ = 112
  56. 56. Consumer Theory
  57. 57. We all are facing trade-offs - Because fundamental assumption economist have is β€œpeople are facing trade-off” The management of society’s resources is important because resources are scarce. Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. -Nicholas Gregory Mankiw See also https://en.wikiquote.org/wiki/Greg_Mankiw#Ch._1._Ten_Principles_of_Economics
  58. 58. Budget constrain. β€’ You have a budget. Say $96/week. β€’ You will allocate this money to maximize your utility. β€’ Imagine you are living in hell, which has only 2 goods: Pizza and Movie. β€’ And you should allocate all the money. β€’ Pizza = $16, Movie=$8
  59. 59. Budget Constrain (make sure both axis is Q) - Pizza($16 each) and Movie($8 each) - Your weekly budget is $96 - Let’s draw a line and equation π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 6
  60. 60. Budget Constrain (make sure both axis is Q) - Pizza($16 each) and Movie($8 each) - Your weekly budget is $96 π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 6 12 But this curve is nothing to do With your Utility. (imagine, if you hate movie) 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 8𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 Don’t think this equation by looking curve. Just think π‘ƒπ‘Ÿπ‘–π‘π‘’ Γ— π‘„π‘’π‘Žπ‘›π‘‘π‘–π‘‘π‘–π‘¦ = 𝐡𝑒𝑑𝑔𝑒𝑑, πΆπ‘œπ‘ π‘‘
  61. 61. Consumer’s preference and Utility If you are rational consumer,(Lecture note 3) β€’ Complete binary ordering β€’ Between any two bundles of goods, a consumer can tell whether she prefers one to another or indifferent. β€’ Reflectivity β€’ Any bundle is just as good as any other identical bundle. β€’ Transitivity β€’ If a consumer prefers bundle 1 to bundle 2 and prefers bundle 2 to bundle 3, then she must prefer bundle 1 to bundle 3. β€’ Non-satiation β€’ Consumers prefer more units of a good than less.
  62. 62. Consumer’s preference and Utility - Holding a pizza makes you happy - but it’s non- linear. - in this case, for example, π‘ˆ = 𝑄 π‘ƒπ‘–π‘§π‘§π‘Ž π‘π‘–π‘§π‘§π‘Ž 𝑄 π‘ˆπ‘‘π‘–π‘™π‘–π‘‘π‘¦ 12 2 4 5 5
  63. 63. Marginal Utility When we have 0 Pizza and get +1 pizza, Our utility increase 0 to 1 If we already have 4 pizza and get +1. How much our utility change? π‘π‘–π‘§π‘§π‘Ž 𝑄 π‘ˆπ‘‘π‘–π‘™π‘–π‘‘π‘¦ 12 2 4 5 5
  64. 64. Marginal Utility If we already have 4 pizza and get 1. How much our utility change? π‘ˆ4 = 4 = 2 π‘ˆ5 = 5 π‘ˆ5 βˆ’ π‘ˆ4 = 5 βˆ’ 2 = 0.236. . While the 1st pizza increase U=1 If we imagine real situation, The utility change of 5th pizza Might nearly zero.π‘π‘–π‘§π‘§π‘Ž 𝑄 π‘ˆπ‘‘π‘–π‘™π‘–π‘‘π‘¦ 12 2 4 5 5
  65. 65. Marginal Utility [advance] is a the additional satisfaction a consumer gains from consuming one more unit of a good or service.* π‘€π‘ˆ π‘π‘–π‘§π‘§π‘Ž = πœ•π‘ˆ πœ•π‘„ π‘π‘–π‘§π‘§π‘Ž = 1 2 𝑄 π‘π‘–π‘§π‘§π‘Ž *http://www.investopedia.com/terms/m/marginalutility.asp π‘π‘–π‘§π‘§π‘Ž 𝑄 π‘ˆπ‘‘π‘–π‘™π‘–π‘‘π‘¦ 12 2 4 5 5
  66. 66. Indifference curve Imagine your utility function, not only Pizza, but a combination Of Pizza and Movie π‘ˆ = 𝑄 𝑀 𝑄 𝑃. And indifference means π‘ˆ = π‘π‘œπ‘›π‘ π‘‘π‘Žπ‘›π‘‘. π‘ π‘Žπ‘¦, π‘ˆ = 2 π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 6
  67. 67. Indifference curve Imagine your utility function, not only Pizza, but a combination Of Pizza and Movie π‘ˆ = 𝑄 𝑀 𝑄 𝑃. And indifference means π‘ˆ = π‘π‘œπ‘›π‘ π‘‘π‘Žπ‘›π‘‘. π‘ π‘Žπ‘¦, π‘ˆ = 2 π‘Žπ‘›π‘‘ 3 π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 2
  68. 68. Indifference curve Imagine your utility function, not only Pizza, but a combination Of Pizza and Movie π‘ˆ = 𝑄 𝑀 𝑄 𝑃. And indifference means π‘ˆ = π‘π‘œπ‘›π‘ π‘‘π‘Žπ‘›π‘‘. π‘ π‘Žπ‘¦, π‘ˆ = 2 π‘Žπ‘›π‘‘ 3 π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 3
  69. 69. MRS(Marginal Rates of Substitute) on Indifference curve Think about π‘ˆ = 2 = 𝑄 𝑀 𝑄 𝑃. π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 2 𝐴 𝐡 𝐢 When you are point A You have Movie, Pizza = (1,4) And this is indifferent with point B Which is Movie, Pizza = (2,2) That means you can give up 2 pizza to get 1 more movie. In mathematical form, MRSPointA = Ξ”π‘Œ Δ𝑋 = 2βˆ’4 2βˆ’1 = βˆ’2
  70. 70. MRS(Marginal Rates of Substitute) and Marginal Utility [advance] π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 2 𝐴 𝐡 𝐢 𝑀𝑅𝑆 = π›₯π‘Œ π›₯𝑋 = π‘€π‘ˆ 𝑋 π‘€π‘ˆ π‘Œ Because MU is a the additional satisfaction a consumer gains from consuming one more unit of a good or service. If π‘€π‘ˆ 𝑃𝐼𝑍𝑍𝐴 = 1, which means if you got 1 more, pizza your utility change +1. So, if you got 1 Pizza, get +π‘€π‘ˆ 𝑃𝐼𝑍𝑍𝐴 as an additional Utility And, you got 1 Movie, get +π‘€π‘ˆ π‘€π‘œπ‘£π‘–π‘’ as an additional Utility. How to determine MRS from MU? π‘π‘–π‘§π‘§π‘Ž 𝑄 π‘ˆπ‘‘π‘–π‘™π‘–π‘‘π‘¦ 12 2 4 5 5
  71. 71. MRS(Marginal Rates of Substitute) and Marginal Utility [advance] So, if you got 1 Pizza, get +π‘€π‘ˆ 𝑃𝐼𝑍𝑍𝐴 = 1 And, at a same point, you got 1 Movie, get +π‘€π‘ˆ π‘€π‘œπ‘£π‘–π‘’ = 2 They can get rid of 2 pizza and get 1 movie. This means your Trade-ratio Pizza and Movie is +1 Movie is 2 times better off than +1 Pizza. So, 𝑀𝑅𝑆 = π›₯π‘Œ π›₯𝑋 = π‘€π‘ˆ 𝑋 π‘€π‘ˆ π‘Œ π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 2 𝐴 𝐡 𝐢 π‘π‘–π‘§π‘§π‘Ž 𝑄 π‘ˆπ‘‘π‘–π‘™π‘–π‘‘π‘¦ 12 2 4 5 5
  72. 72. Budget constrain and MRS Return back to Indifference curve and Budget constrain. When the tangent of budget constrain Equals to MRS, the utility within the budget constrain become maximum. π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 2 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 8𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96
  73. 73. Budget constrain and MRS 1. How to calculate tangent of Budget constrain? π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 8𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 6 According to the graph, Y axis = Qpizza and X axis = Qmovie So, let’s make the equation π‘Œ = π‘Žπ‘‹ + 𝑏 format that is Qpizza = π‘ŽQmovie + 𝑏 format. 16Qpizza + 8Qmovie = $96 ↔ Qpizza = βˆ’ 1 2 Qmovie + $6 And it is known βˆ’ P π‘€π‘œπ‘£π‘–π‘’ Ppizza = βˆ’ P 𝑋 PY
  74. 74. Budget constrain and MRS[advance] π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 8𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 2. How to calculate MRS 𝑀𝑅𝑆 = βˆ’ π›₯π‘Œ π›₯𝑋 = βˆ’ π‘€π‘ˆ 𝑋 π‘€π‘ˆ π‘Œ = βˆ’ πœ•π‘ˆ πœ•π‘„ 𝑋 πœ•π‘ˆ πœ•π‘„ π‘Œ = βˆ’ ( πœ•π‘ˆ πœ•π‘„ 𝑀𝑂𝑉𝐼𝐸 ) ( πœ•π‘ˆ πœ•π‘„ π‘ƒπ‘–π‘§π‘§π‘Ž ) If we calculate it…
  75. 75. Budget constrain and MRS[advance] π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 8𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 2. How to calculate MRS 𝑀𝑅𝑆 = βˆ’ π›₯π‘Œ π›₯𝑋 = βˆ’ π‘€π‘ˆ 𝑋 π‘€π‘ˆ π‘Œ = βˆ’ πœ•π‘ˆ πœ•π‘„ 𝑋 πœ•π‘ˆ πœ•π‘„ π‘Œ = βˆ’ ( πœ•π‘ˆ πœ•π‘„ 𝑀𝑂𝑉𝐼𝐸 ) ( πœ•π‘ˆ πœ•π‘„ π‘ƒπ‘–π‘§π‘§π‘Ž ) π‘Žπ‘›π‘‘ πœ•π‘ˆ πœ•π‘„ 𝑃 = 𝑄 𝑀 2 𝑄 𝑀 𝑄 𝑃 , πœ•π‘ˆ πœ•π‘„ 𝑀 = 𝑄 𝑃 2 𝑄 𝑀 𝑄 𝑃 So, 𝑀𝑅𝑆 = βˆ’ 𝑄 𝑃 𝑄 𝑀
  76. 76. So, where is the optimal? (Max U under the badget) π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 𝑄 12 4 2 2 4 93 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 2. How to calculate MRS 𝑀𝑅𝑆 = tangent So, 𝑀𝑅𝑆 = βˆ’ 𝑄 𝑃 𝑄 𝑀 , π‘Žπ‘›π‘‘ π‘‘π‘Žπ‘›π‘”π‘’π‘›π‘‘ = βˆ’ P π‘€π‘œπ‘£π‘–π‘’ Ppizza = βˆ’ P 𝑋 PY therefore, βˆ’ 𝑄 𝑃 𝑄 𝑀 = βˆ’ P 𝑀 𝑃 𝑃 = βˆ’ 1 2 ↔ 2𝑄 𝑃 = 𝑄 𝑀 Using above, the equation (π‘Ž) should be 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 16𝑄 π‘π‘–π‘§π‘§π‘Ž = $96 π‘†π‘œπ‘™π‘£π‘’ 𝑖𝑑 π‘Žπ‘›π‘‘ 𝑄 𝑝 = 3, 𝑄 𝑀 = 6 π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 18
  77. 77. http://www.wolframalpha.com/input/?i=3Dplot+Z%3Dsqrt(XY),+X%3D0+to+10,+Y%3D0+to+10 Indifference curve in the 3D format [advance] π‘ˆ = 𝑄 𝑀 𝑄 𝑃 = 4
  78. 78. Income effect and Substitution effect
  79. 79. Let us think in Qualitative first. You like Cake very much. But cake cost you $5 each and Sweet pastry cost you $2 each. So, everyday you eat (morning) 1 pastry $2 (lunch) 2 pastry $4 (dinner) 1 cake $5 In total, you spend $11 every day. Cakes $5 Pastry $2
  80. 80. Let us think in Qualitative first. One day, you thought you are the Luckiest girl in the world! Cakes are sold just $1 today! So, decide (morning) 1 cake $1 (lunch) 2 cake $2 (dinner) 1 cake $1 This is substitution effect. You like more cake than Pastry. Cakes $5 ↓ $1 Pastry $2
  81. 81. Let us think in Qualitative first. In the end of the day, You calculate. (morning) 1 cake $1 (lunch) 2 cake $2 (dinner) 1 cake $1 In total just $4 you use. While everyday spend $11 So, you decide to buy more cake Before you sleep. The demand increase. This is Income Effect. Cakes $5 ↓ $1 Pastry $2
  82. 82. Remember Budget constrain π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 8𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 6 - Pizza($16 each) and Movie($8 each) - imagine, the Movie become cheaper ($6 each) 1 How your budget constrain change? 2 What is your newequation? 16
  83. 83. Remember Budget constrain π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 It become like this. So what? 16 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 6𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96
  84. 84. Remember Budget constrain π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 It become like this. This difference is Total Effect. The demand of Movie increase. And the demand of Pizza also increase. Let’s break down in into income/substitution. 16 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 6𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96𝐴 𝐡
  85. 85. Move the new Budget constrain to tangent of Indifference curve. π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 16 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 6𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 We would like to parallel translate this Red Line, a new budget constrain, to a Tangent of indifferent curve before. If we do so, we got point 𝐢on indifferent curve before. The change point A to 𝐢 implies the effect caused by β€œthe change of price ratio : from ($16,$8) to ($16, $6)” 𝐴 𝐡 𝐢
  86. 86. Move the new Budget constrain to tangent of Indifference curve. π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 16 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 6𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 This is called π‘†π‘’π‘π‘ π‘‘π‘–π‘‘π‘’π‘‘π‘–π‘œπ‘› 𝐸𝑓𝑓𝑒𝑐𝑑 Because, the change of movie price cause the Change of ratio of Pizza and Movie. And the new tangent on the same indifference curve as before, represent the effect of change ratio only.
  87. 87. Move the new Budget constrain to tangent of Indifference curve. π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 16 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 6𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96 Remember this π‘†π‘’π‘π‘ π‘‘π‘–π‘‘π‘’π‘‘π‘–π‘œπ‘› 𝐸𝑓𝑓𝑒𝑐𝑑 works negative for Pizza. Decreasing the cost of movie means Pizza became relatively expensive. So, the effect works negative in general.
  88. 88. Remember Budget constrain π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 This is called πΌπ‘›π‘π‘œπ‘šπ‘’ 𝐸𝑓𝑓𝑒𝑐𝑑 The change (cheaper) of movie price Makes you richer (you can buy more goods by same budget). This is also change your demand. 16 𝑄 π‘šπ‘œπ‘£π‘–π‘’ 16𝑄 π‘π‘–π‘§π‘§π‘Ž + 6𝑄 π‘šπ‘œπ‘£π‘–π‘’ = $96
  89. 89. Summary of Income Effect and substitution effect π‘€π‘œπ‘£π‘–π‘’ π‘ƒπ‘–π‘§π‘§π‘Ž 𝑄 π‘π‘–π‘§π‘§π‘Ž 12 4 2 2 4 93 6 Substitution Effect Income Effect Total Effect Pizza Pizza became Relatively expensive. So decrease. Consumers become Richer So the amount of consumption increase Depends on Sub/income effect. Movie (Cheaper) Movie became Relatively cheap. So increase. Demand Increase.
  90. 90. Want to learn more? β€’ See Entrepreneurial Economics #2! β€’ https://www.slideshare.net/ryouen/170925-entrepreneurial- economics2
  91. 91. Reference NUS MBA BMA5001 Lecture Note 2, 3 Principles of Microeconomics (Mankiw's Principles of Economics) MITx: 14.100x Microeconomics https://en.wikiquote.org/wiki/Greg_Mankiw#Ch._1._Ten_Principles_of_Economics

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