ECON 200 Week 2 Notes
ECON 200 Week 2 Notes ECON 200
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This 7 page Class Notes was uploaded by Rachel Pollard on Friday January 15, 2016. The Class Notes belongs to ECON 200 at University of Washington taught by Haideh Salehi-Esfahani in Winter2015. Since its upload, it has received 20 views.
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Date Created: 01/15/16
Session 3 Tuesday, January 12, 2016 10:28 AM Example: Sooki's MV and TV of various quantities of blue jeans per year: Q MV ($) Total Value ($) 1 50 50 2 40 90 3 30 120 4 20 140 5 10 150 6 0 150 • We said that if P=$30, then Sooki will buy __ 3_ pairs of jeans per year. • For the first pair she is willing to forgo $50 worth of other goods to acquire the first pair but she is only asked to forgo $30. • When you buy a pair of jeans, you have to forgo something else because of scarcity. • Rule: You buy a quantity such that you're marginal value equals the price o This rule implies that her consumer surplus is maximized at quanti ty 3 • She buys three units • At 3 units, the marginal value equals the market price!!!!! Q MV TV Total Exp CS 1 50 50 30 20 2 40 90 60 30 3 30 120 90 30 4 20 140 120 20 5 10 150 150 0 6 0 150 180 -30 • The concept of consumer surplus: CS=Total Value -Total Expenditure • Total Value = Sum of MV up to the quantity we purchase! • Consider the market price at $40 per pair. • What is the CS at different quantities? o At 1 unit, it's $20 o At 2 units, it's $30 o Etc. • At what quantity is her consumer surplus maximized? o At quantity 2 and 3, her CS is maximized. o Why are they the same? o Why does she choose quantity 3? • For our example, with "discrete" numbers, the consumer surplus has a flat top! • Therefore at a quantity where the marginal value = t he price, the consumer surplus is maximized. • If the rate of consumption of blue jeans were on a more "continuous" scale: Q MV($) 1 50 1.1 49 1.2 48 1.3 47 . . 2 40 2.1 39 Choose Q* in a way such that the consumer surplus is maximized CS= TV-TE (TE=P*Q) d(CS) = d(TV) - d(P*Q) = 0 dQ dQ dQ MV - P = 0 Q* ----> MV - P = 0 ----> MV=P Using the continuous rule, we choose quantity three. The continuous numbers are the correct ones. Consider the market price for a good to be $40 per unit. At quantity W where MV = $40. A consumer maximizes his consumer surplus. Concept of Demand: • Explains the regularity of behavior among people who buy goods and services. o The demand of a particular good • A demand curve, shows the quantities of a good that consumers are willing to buy at different prices (keeping everything else constant). • Example: o Deriving Sooki's demand curve! o Go to the original table of MV and TV o Suppose that the market price is $50 per pair. How many pairs of jeans does she buy per year? 1 unit. At this price, price = marginal value o If P = $40, Q= 2. CS= $10 o If P = $30, Q= 3, CS =$30 o If P = $20, Q =4, CS= $60 • She's maximizing at each different rice • Drawing the MV curve against Quantity per year and find out what her "Demand" is. o At each price, it's telling me what to purchase • MV curve when market prices are improved conditions. • The law of demand: Keeping all else (income, prices of other goods and services, etc.) constant, if the price of the good per unit increases, then the quantity purchased will fall. • If the price decreases, then the quantity will go up. • We understand it's a downward sloping curve. • Quantity is dependent on the market price. • Sooki's demand curve for blue jeans: • Which area shows the total expenditure on 3 pairs of blue jeans per year? o The area is OACG (rectangle) • Which area shows the total value of purchase of 3 pairs of blue jeans per year? o The area is OBCG (trapezoid) • CS is the area between the price and the demand. o Area is ABC (Triangle) • Clicker question: If the price of a good falls, the consumer will purchase more according to the P = MV rule • How can you tell that consumers usually retain some CS? • Example of law of demand: donations to charity as an application of the law of demand o They say people are less charitable now than some 60 years ago. Did people just become less charitable o r has there been a change in some constraint? o In the US, charitable donations are deducted from income before taxes are calculated. o In the 1950s and 60s, the top tax bracket was 70%. So a dollar given to charity would cost only 30 cents since $1 less of in come would be reported ( and 70 cents tax on it would have been paid). o Then in 1980s tax codes changed and fell to about 34%. Did giving to charity cost more or less than before? It went down o After 1980, the opportunity cost of giving to charity caught 68 cents. • Deriving the market demand from individual demand curves. o Just adding Jane and Jack's quantity at a given market price. Session 4 Thursday, January 14, 2016 10:23 AM Water-Diamond Paradox • Diamonds are much more highly priced than water. Does it mean that we "value" diamonds more than water? • It is the applications of concepts of marginal value and total value • Back to the example of blue jeans. o We diminishing marginal values. o As the quantity becomes large, the total value grows larger. o With the increasing quantity, the marginal value decreases, but the total value increases. • Diamonds have a much higher price. However, the price of a good reflects Marginal Value, not Total Value. • The Marginal Value of a good depends on the amount of that good already available. • While the Marginal value of an extra unit of water may be small - due to large supply water - its TOTAL VALUE is much larger than that of diamonds. Also, the amount of Consumer Surplus is much larger in consumption of water relative to consumption of diamonds. • If you take the total value, we see that water is valued more. • Just because the price of diamonds is so high, it doesn't mean that we value them more than water. • The amount of consumer surplus is much larger in consumption of water relative to consumption of diamonds. • Therefore, while diamonds are highly priced, implying that they have a high Marginal Value, their Total Value is less than water, the more essential good. • Suppose both the producers of diamonds and the City Water Authority threaten to cut off supplies unless we pay them a bribe. o We are willing to pay off the supplier not to reduce their supply? Water • Clicker question: The total value of all the quantities of a good you purch ase is reflected fully in the amount you paid for that good. False • The Insights: o Neither the Price nor the Total Expenditure on a good measure the Value of the quantity of that good for the consumers. o There is some consumer surplus • Applications: o Of plumbers and nurses, which one earns a higher salary? • Plumbers • Does this mean that people care more about their kitchen sinks than their health? § No. We pay plumbers more but that doesn't mean we value them more. The marginal value of the services of a nurse is l ower. But that is not the total value. The wages reflect how much we MARGINALLY value a service, not totally value. o Would you expect university professors to earn the same salary across all fields? • No. • Does the lower salary of humanities professors reflect the fact that we do not value them as much as computer science professors? • Humanities professors are like water Application of Diminishing Marginal Value • Why do people attempt to "smooth out" their consumption over time, lea ding to the phenomenon of lending and borrowing? • Smooth consumption: as income an age change, the consumption stays constant. • Example: o Suppose you get paid in pizzas every two days! o On the pay day, today, you get two fresh -off-the oven pizzas o You are not getting any pizza tomorrow. o Do you consume both pizzas today, or, do you keep one for tomorrow? o Consumption smoothing! • You keep one for today and one for tomorrow o Use the Postulate of diminishing MV (or law of Demand) to explain why people tend to save (and lend) or dis-save (borrow) in various phases of their lifetime. o Consider the Marginal Value of the follow two choices. In which case is the MV of consumption higher? a. Consuming the second pizza today b. Keeping the second pizza and consuming it tom orrow. • B has the higher marginal value. Meaning that you're better off if you eat the pizza tomorrow. • Present consumption versus future consumption • The Marginal Value of present consumption is: What a consumer is willing to give up of future consumption to consume today • Erratic consumption versus smooth consumption • People in engage in lending and borrowing because of smooth consumption. • Clicker Question: When income (and therefore) consumption today is low relative to future income its MV is relatively high. 23. According to the law of demand, if vacations become cheaper, people should take more vacations. However, most people take exactly one vacation per year, whatever the cost. Does the law of demand not apply here? Aspects of the Law of Demand: understanding the difference between relative versus dollar price • Law of demand: keeping all else constant, as the Price rises, then the Quantity demanded falls and vice versa. • The prices of goods and services generally do n ot stay constant • Inflation • Example: Alfredo buys only two goods and spends all his incomes on the two goods; salad and pizza. The prices of these goods in 2014 and 2015 are: Price 2014 Price in 2015 Salad $2 per LB $4 per LB Pizza $12 $18 o The price of both of these goods is rising. o Suppose Alfredo has enough income in 2015 to buy the same amounts as in 2014. Will Alfredo buy more, less or the same number of pizzas in 2015 (as compared with 2014)? • He will be buy more pizza in 2015 compared to 2014. • The relative price (or opportunity cost) of a pizza in 2014 is 6 ($12/$2) salads foregone. This means that for every additional pizza consumed Alfredo has to give up 6 salads. In 2015 the opportunity cost of a pizza is 4.5. According to the law of demand as the opportunity cost of a good decreases, the quantity of that good purchased increases. • So pizza is relatively cheaper even though its dollar price has increased! • What matters to the law of demand is the relative price of a good.
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