Microeconomics Week 4 Notes
Microeconomics Week 4 Notes Econ-UA
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This 9 page Class Notes was uploaded by Cindy Notetaker on Sunday October 2, 2016. The Class Notes belongs to Econ-UA at New York University taught by Professor Bhiladwalla in Fall 2016. Since its upload, it has received 22 views.
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Date Created: 10/02/16
September 27th, 2015 Chapter 6: Consumer Choice --we are constantly making economic decisions -can be as obvious as deciding whether to live with your parents (because more directly to cost) or less clear like getting up early to do work or sleeping in -all of these decisions require us allocate our scarce resources -in order to understand this entirely, we must understand our goals and the limitations (constraints) we face in order to achieve those goals Remember from last week... Individual demand depends on people's preferences --you're looking at a price in terms of OC/sacrifice --slope of budget constraint reflects what one is able to buy Drawing budget constraint ...(refer to the above graph to help understand the following) -what happens as income changes? ex) if Max's income rises to $200, he is capable of buying more if prices are kept the same -this results in a totally new budget constraint NOTE: it is parallel to original because IPcI and IPmI are the same NOTE: A change in price (P) will change THE SLOPE ex) changing (P) in movies only (this would lead to sleeper curve, rather than a parallel shift Pm10-->Pm5 --we can now get more movies --if P of concerts change, it is fixed on the y-axis and changes on the x-axis In conclusion... --budget constraints indicate the trade offs that consumers are willing or ABLE to make --the trade off that --line is parallel because the price of movies and concerts remains the same --increase in income and line shifts right (like above), decrease and line shifts left Budget Preferences -in spire to such wide differences in preferences(some read Jane Austen while others read John Grisham,etc), we can find some basic, common factors recall: all consumers want to maximize utility satisfaction Theory: preferences are RATIONAL and satisfy the following --any two alternatives can be compared/ranked -either one is preferred OR the two are equally valued ex) bundle b= (M(movies)=8,C(concerts)=2) bundle e=(M=4,C=4) If Max's preferences are rational, he chooses ONLY 1 of the following NOTE: AND (rather than OR above) would be IRRATIONAL Comparisons/Rankings are Transitive (aka logically consistent) 3 Different Bundles B (M=8, C=2) D (M=4, C=4) E (M=2, C=4) --if you prefer B to D and D to E, then you prefect B to E **transitivity is a basic consistency requirement** More Is Better --if we get more of some type of good or service, and nothing else has or will be taken from us, we will generally fell better off --consumers always prefer a bundle with more of both goods OR more of at least 1 good and no less of the other Why is this important? think finance risk vs return -risk is garbage and return is good Why do we need this? NEVER buy a bundle inside (below) the budget constraint; the consumer will always choose a budget on the line Which point maximizes satisfaction? in order to figure this out, we also need something called the indifference curve --it slopes downward because more is better and we would have to sacrifice something when we get more of the other good --when we're on this indifference curve, we become indifferent to the bundles as long as they are on the curve --Max must be WILLING to give up/trade off -bear in mind, the more one has of one good, the more they value the other good NOTE: The indifference curve tells us THE WILLINGNESS of the buyer "willingness to trade=marginal rate of substitution (MRSxy)" movies=good Y measured on Y axis concerts=good X measured on the X axis then we can define... =marginal rate of substitution X and y along segment line of indifference curve (IC) MRS depends on the segment considering @G, Max is willing to trade of 9 movies for 1 concert @H, Max is willing to trade off 5 movies for 1 concert **there are different indifference curves depending on income, preferences, and pricing** Putting them together: Combining Indifference Curve and Budget Constrain --we use the one that maximizes happiness level from price indifference curve to the first budget constrain Making Choices given the budget constraint and preferences, we now look at Individual Demand Income (I)=100 Pm=10 Pc=20 Qc=3 Pc=10 Qc=5 Pc=5 Qc=8 Which bundle will be picked? Now is when we need the indifference curve Consumer Decision Making with Indifference Curves Point D will give him (Max) maximum satisfaction (also known as maximizing utility bundle) What do you notice at D? --the lines are TANGENT (this means that the slopes are equal) "Optimal" Combination --bundle/combination that maximizes utility given the budget line -optimal=utility maximizing --HAS to be on the budget constraint Summarizing it... --if they're not = to each other, then Max can do better --if slope of the indifference curve is greater, then Max can do better --If Max moves away from D, he becomes worse off and moves to a lower indifference curve Endgame: what you want to have happen the rate @ which the rate @ which ABLE to trade for = WILLING to trade Y and x Y for X --this means consumer has reached a stable point --has achieved "consumer's equilibrium": no incentive to move Recall: --if either income or prices change, the BC will shift or rotate -consumer's optimal bundle will also change Consider a Change in Income --if Max's income/budget increases, this will shift the budget constraint (BC) to the right -Max will always be looking to see where both BC and Indifference curve (IC) are tangent to each other because that will be his best choice -an increase in the quantity of the good demanded --if Max's income/budget decreases, this would lead to a lower indifference curve --if both goods are normal... -MRS remains the same because slops of BC are the same If a good is inferior... CONCLUDE: determining whether a good is normal or inferior depends on the shape of a con- sumer's preferences Consider a Change in Price Suppose change in Pc falls from $20 to $10.. income is unchanged @$100 and Pm is unchanged @$10 --the BC rotates outwards on the x-axis When price increases, quantity decreases --Slope of the BC @D=I-Pc/PmI=I-20/10I=2 MRS --New Slope BC@J=I-Pc/PmI=I-10/10I=1 *you can see the Law of Demand holds; a fall in price of concerts increases the quantity de- manded** If Pc falls to $5... 5/10I-1/2I=1/2 The third blue curve you see here is if the Pc falls to 5$, and it is noticeably rotated more outward Optimizing Behavior --going from one tangency point to another **what you see below is a hypothetical situation(Max)** --every point you see comes from a tangency --inverse relation This Next Part is VERY abstract --Why does the utility-maximizing Q of concert (good x) increase when price (P) of the good falls??? -when you have money leftover, if feels like an increase in income -when the good is relatively cheaper, the slope of the BC has changed become flatter; aka, the consumer buys more of the relatively cheaper good a) Substitution Effect --when price (P) falls, consumers will buy more of the relatively cheaper goods --this is where the Law of Demand comes from --a price cut gives the effect that the consumer has more in his or her pocket --when price of a good decreases, quantity demanded increases; when price of a good increases, quantity demanded decreases NOTE: they move in opposite directions ex) In Max's case, if price of concert as falls while price of movies stay the same, con- certs are cheaper relative to movies b) Income Effect --as price (P) falls, purchasing power increases (not budget) --wider range of options is now available; can consumer more of both ex) Max's entertainment budget is still $100, but when Pc falls to $10 (from $20), Max's BC shifts out -with the leftover money that he now as, Max can buy more movies from point D (not optimal anymore) to point J **the additional stuff that max can buy is called the income effect** Combining the two effects... NOTE: while the hypothetical situation of income effect being stronger is mentioned above, it is the substitution effect that virtually always dominates Deriving the Market Demand Curve for a Good --market demand curve tells us quantity is consumed by ALL consumers as a group --you add Qd from ALL consumers at each price to obtain the entire market demand curve -adding up Q is horizontal adding across each of the individual demand curves --as long as each individual's demand curve is downward sloping, the market demand curve will also be downward sloping
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