### Create a StudySoup account

#### Be part of our community, it's free to join!

Already have a StudySoup account? Login here

# INTERMED MICROECON ECON 301

ISU

GPA 3.53

### View Full Document

## 6

## 0

## Popular in Course

## Popular in Economcs

This 136 page Class Notes was uploaded by Ms. Ari Lesch on Saturday September 26, 2015. The Class Notes belongs to ECON 301 at Iowa State University taught by Staff in Fall. Since its upload, it has received 6 views. For similar materials see /class/214446/econ-301-iowa-state-university in Economcs at Iowa State University.

## Reviews for INTERMED MICROECON

### What is Karma?

#### Karma is the currency of StudySoup.

#### You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!

Date Created: 09/26/15

Chapter 9 Applying are Compeu39u39ve Mndel quantlty But now does thls affect eonsumers and producers7 How muen do they lose or galn7 And what about me soerel 7 Flrst to what extentls eonsumer affected7 We need some measure for that Utlllty ean beeause othe followlng reason 1 It ls hardto obtaln rndwrdual39s unllty functlon 2 hardto eompare So we measure consumerwelfare lntel39ms of dollars I n are Consumer welfare from agoodls the bene t a eonsumer gets from consumlng that good mlnus whatthe consumerpaldto buy matgood you Want to buy it Thls ls ealled willingness to payquot a a money measure of satlsfactlon orwelfare We are asklng a consumerto evaluate a er exchangequot between agood and money Thus me money amountls ofthe same value as me good l The pnee on the demand eurye snows eonsumers39 Wllllngness to payquot Flgure 9 1 lal David Cunsumex Surplus a u Memmea pa week Flgure 9 l If you buy 3 magazlnes rn tlne market ean we know your wllllngness to pay for tlnem togetlner and for eaeln unrtv eTlne lnformauon ls m tlne emand eurye wny7 buy m r Mlle p at a nee gt 35 oryou wrll not buy rt at 35 At pnee 34 you buy two unrts Tne seeond or would not buy rt at 4 2 The surplus Take Flgure 9 l a tlne transaetron ls 3 unrts at 33 F rm Flr Vule l are wllllng to pay 35 buy only pard 33 so tlne surplus ls 2 and 1 for tlne seeond unrt and so for tlne tlnrrd unrt wnat ls tlne total value a eonsumergets from tlnrs transaeuon T otal wllllngness to pay Area under demand eurye And Payment reetangle under pnee We deflne tlne welfare measur s Consumers surplus tlne total value wllllngness to pay epayment gt Consumer surplus c5 between D eurye and prree F 9 l b b Steven39s Consumersurplus E 8 5 E a r E i ounsumer surplusES D1 Expenditume 39 Demand t Matglnulwalllngnesslu pay luv Ihe lasl mm a 0mm q Tmmng cams per year Flgure 9 l b 2 How does eonsumer surplus elnange wrtln prree Flgure 9 27 mill1r b Is my mluion 116 125 a Human ruse scans pnrycm Flgure 9 2 As P goes up quanth deereases me mangle area c5 reducedto A from ABC P up gt cs down How does elastlclty affect ACS Problem 9 07 Problem 9 1 Suppose thattwo llnear demand eurves go through me rmnal equlllbnum 2 one at 2 e a a lncrease eause the larger eonsumer surplus 10557 Answer 1 less elasne steeper demand eume 2 Ithe pnee mereases cs falls by only ec wlnle rCrD forless melasne demand eume p sperum Relallvelv lnelasnc demard lal e Halallvcly clam demand at or 0 Units per week Problem 9 l 217rnrlllcerwelfare m The surplus ls the s arnountyou get exceedlng what you pay ueer surplus Revenu rTotal vanable eost We do not countflxed eost beeause rtrs sunk eost eannotbe avorded already spent Frrrns39 welfare wlll notbe affected by rt d l M ls exactly the s eurve Total eost sum the eost ofeach unrts area underMc Flgure 9 3 lelt panel La A rm Fvuduuer surmus p 5 pa unit 949 P52 2 F55 s a 4 Unns per vsek Fxgure 93a m A Markuw mm 5mmquot g Mama anan Curve i E a pmq r uvymx ps 0 a um peryear Figure 9 3b Mn u n Note thatPs ls not pro t the dlfferenee ls the xed eost How does PS change vvrtln pnee Problem 9 27 E m 1 s l 05 m lllion W Y p c perslem D Sl 144 milllon 115 I 5 a Eilllun ruse slams per year Problem 9 2 As pnee decreases PS reduces to F from DEF P down 9 PS down 3Cnmp2titinnmaximi12swalfare 1 Soelal welfare m amarket ls tlne sum of surplus ofboth Butlater on we wlll face dlfferent govemm nt olleles And when government ls rnvolved e ere ls alssue of gove entrevenu Lh n Lh mm eexpenddture And we should add ls government revenueexpendture rnto soelal welfare tlne soelety7 vae vvantto maxlmlze soelal welfare vvlnatrs tlne best arrangement7 D eonsumers39 valuatron of an extra umt ofgood s produeers39 eost m produclng extxau mt We ean see that when D ls hlghe than 5 tlne good snouldbe produeed D ls lovver than 5 rt snouldnot The best rst o stop atD and s eross gt equlllbnum quanutv another group from an aeta oh that alters a market equlllbnum 2 Underrproductlon e To th soclal welfare at Q1 ls Flgure 9 4 cs ABC and PS DE E a a u a A Suwlv pa 1 5 c e W Pr 5 Demand D M03 1 2 I n um plvye r Flgure 9 4 Ifwe regulate produeers to produee at Q2 andregulahhg phee to be P2 gt Pl the welfare ls cs A andPS BD AC rBrC ahol APS BrE The mangle AW 7cE ls rhrssrhg Note that eohsurhers lose Bc butproolueers gam B andlose E The part B slmply changes handsquot 3 Overrproductlon The consequence ofproduclng over the equlllbnum ls also DW39L Flgure 9 5 i Supply MC 5 H W n as E 5 Bernard F G H 4 z a Unns pevyezr Flgure 9 5 wae regulate the frrrns to prooluee at Q2 gt Q1 and pnee to be P2 lt P1 so that eonsurners wlll buy the unrts above Ql have values lower than therr eost The soclal welfare ls reolueeol Produee at Ql cs A and PS cl Produee at Q2 cs ACDE and PS FGHrBrDrEeGe 7 ACS cDE anol APS BrCrDrE The new mangle AW e B ls a negatrve arnount eonsurn ers 4 Why study welfare measure7 e rnarket equrlrbnurn rt changes eonsurners39 anol proolueers39 welfare In the next seeuon we wlll analyze a few pollcles 417nlicies and welfare m ntn l bad and we can vote to ln uenee rt 1 Pollcles that shrft supply eurve Two common types llmtts on the nurrber of rms In a market lelts on e amount of output that rm can produce Three ways to llmlt the nurrber offlrm Restnct the number of rms Bar some mennber of soclety Ralse the entry cost or out cost only applled new rms not to the one rennalnsgt Let s conslder the rst WayiResmcLlng the number offlrms whlch when the restnctlon IS lmposed bene t fromhlgner pro t Appllcatlon Regulatlon oftaxrcab lmposed a Cat Flm 1b Markul 1quot 3 2 an Act m 52 a e 22 1r 5 C t 5 Fl 1 E 1 ma quotI Hz 411 0 7t c Flues per monl39l u Rldes per month 1 The welfare of competltlve equlllbnum when there IS no restnctlon on number of rms In the longrrun rm wlll produce atthe mlnlmum ofayerage cost and supply curve ls horlzontal llne S he market equlllbrlum ls at polnt E and equlllbnum pnce ls p equlllbnum quantlty ls Q Thee are n rms ln themarket We know In the longrrun produces have a zero pro t therefore 1930 And cs 15 the area between Dennand curve and p up to Q ABC 21the restnctlon IS lmposed let s say to rms In the market and n 01 Then each rm is producing ql at price p1 So when price is equal to p1 the market supply equals to 71qu If the market needs more production more cab rms price has to rise ie follow the MC When Q gt n2 qz the supply curve is the sum of all n2 rms supply curve The new supply curve is S 2 And the new equilibrium is at point E2 New market price is p2 quantity is Q 3 Compare 1 CSABC Ps0 WABC 2 CSA PSB WAB u CSBC u PSB u w CDWL Interpretation By preventing other cab rms from entering the market economic pro t is created the area It So the rms that are in the market bene t from the restriction but consumers lose because of higher price In most cities permits can be rented or sold So the owners of permits can charge this It and we call this Rent The rent for the permit causes the cab driver s average cost to rise to AC 2 Then for new rms they don t have positive pro ts anymore because market price is equal to the minimum of AC Producer surplus B go to original owner rather than to the current owner 2 Policies that create a wedge between Supply and Demand Most common policies are sale taxes or subsidy and price controls These policies create a wedge between MC and price and either too little or too much is produced 1 Welfare effects ofa sale taX Figure 97 If we assume that government will impose this taX on producers supply curve will shift to left and price will increase 2 Suaply E u 12 2 r 10 1 D E Deman zl F o l l a l 25 1 HlHInn nx 51H pen yam Flgure 9 7 Onglnal eqmllbnum ls atpomt 2 wlule the new equlllbnum ls atpomt 22 Pnee atproducer enarges ls 32 cents but produeers ean only recelve 32r1121ents 32 cents And only 1 market No tax csABc PSDEF WABcDEF With tax cs P Tax reven w BDF Acsysec APS7DE AW C E lost area cE DW39L The extra 2 cents per stem that buyers pay eauses eonsurner surplus to fall by Be241 And olue to 9 cents olrop m the pnee that rms reeerve they lose PS ofDE108 45 The govemmentgams tax revenue ofBD127 o revenue so welfare olrops beeause ofunder produeuon Welfare effects of a subsldy Subsldy tax 50 lnstead oftakmg sornellung away gov39twlll subsldlze eonsurnersproolueers m buylng selllng goods A perrumt subsldy to eonsurners wlll eause the olernanol curve to shlftnght and Let p pDpnceproducersrecelvesthen pep pt a pal stem Supply 119 E Demand l5 LS4 a slum al was Emma pe39 ycal gure 9 8 No subsldy CAB PSDG Wrth subsldy c ABDG BDE PsBcDG Gov39terrpendrture CDEF wABDGeF 5o Am DEAPSBCAW7FDW39L Interpretatron Consumers gam beeause they ean pay less anol getmore goods Produ ers reeewe ahrgherprree anol sell more output u the gams for eonsumers an proolueer government expendrture so the soerety expenences aD from two mueh prooluetron where prooluetron eost ls hlgher than alue 3 Welfare of a pnee H or In some market gov39t sets aprree oor whreh ls the lowest pnee a eonsumer ean pay legally for the good In ehapter 3 we learneolthat an effectlve pnee oor mustbe set abo e the equlllbnum prree Let39s see how thrs polrey affects the Applreau on Soybean market Flgure 9 9 Government pledges to buy as mueh output as farmers wantto sell E 3 Supury 5 5 A Puea suapnn u E c at 39 Derrind s F 3 5 MG 0 u a 9 g m DIEIH101 hueuets of soyhenns peryeer Frgure 9 9 ofgoods So eonsurners wru on1y purehase Q However when pnee rs hrgher farmers wru produee more and wants to sell Q arnount of soybeans m the rnarket Beeause ofthe pnee support pohey farmers wr11seuQto eonsurners and sell Q 79 unrts of soybeans to goyernrnent at pnee 5 per unrt No pnee oor csABc PSEF wABcE1 P ee oor PsBcDEF gov39texpenddturerCDFG BErG Am 37c APSBCD AWYCeFemDWL Interpretatron Pnee oor pnce support mcurs a dstonron m the rn et ark xcess produeuon rnore outputrs produeedthan rs eonsurned 50 extra output rs stored or destroyed Lnef ereney m eonsurnpuon At 9 eonsurners are wuhng to pay 5 for the last good whreh rs more than the rnargrna1 eost 3 on of produerng thrs last one 4 Welfare effects of apnee eerhng below the pnce equurbnum P 1 n n uu ea uryru becau nr du vs recewe a lowerprrce and sell fewerumts would hkeddeadwexght loss E E a E a R A Supply 539 c p D gt I g Pnce cemng F Demand 05 DE 1 d o Poms par yuar Frgure 9 10 No resmcuon csABc P DEF WABCDEF Pnce ceumg c BD P F w ABDF ACSDrC APE DrE Awyceg ons ers gam because ofa lower prrce gam area D buLLhey cannotbuy more outputbecause suppuers now produce less lose area c Producers loseDEbecause they sell less and recewe a lower pnce Deadwergm loss occurs because ofunderproducuon Chapter 4 Consumer Choice Introduction We have learned supply demand model which is used to analyze the behavior of market Market consists of a lot of consumers and rms The market demand curve is the sum of all individual demand curves Similarly the market supply is the sum of all supply curves So how is the individual demand curve decided How does each individual decide the amount of goods he is going to buy To analyze this kind of question supply demand model is not useful here We have to learn how consumers7 choices are made All consumers must choose which goods to buy how much to buy because limits on wealth prevent them from buying everything that catches their attention Therefore con sumers buy the goods that give them the most pleasure subject to the constraint that they cannot spend more money than they have When economists describe consumers7 behavior they always use positive statement rather than normative statements Economists want to predict behavior instead of judging it They want to know for example whether Jack will smoke more next year if the price of cigarettes decreases In this chapter we examine four topics 1 Preference We use three properties of preferences to predict which combination or bundle of goods an individual prefers to other combinations 2 Utility Economists summarize a consumer s preference using a utility function which assigns a numerical value to each possible bundle of goods re ecting the consumer s relative ranking of these bundles 3 Budget constraint Prices income and government restrictions limit a consumer s ability to make purchases 4 Constrained consumer choice Consumer maximize their pleasure from consuming various possible bundles of goods given their income which limits the amount of goods they can purchase Preference Consumers always choose goods which give the most pleasure So how do we measure about the pleasure And how do we rank the goods Economists assume that consumers have a set of tastes or preferences that they use to guide them in choosing between goods These preferences have to satisfy three properties 1 Completeness When consumers face a choice between any two bundles of goods a consumer can always rank them by the following relationships For choice between A and B either A gt B or B gt A or A B Here 77gt77 means 77prefer to while 7777 means 77indifferen 7 This property rules out the possibility that consumers cannot decide which bundle is preferable 2 Transitivity the ranking must be consistent in the sense that if consumer weakly prefer Bundle 2 to Bundle y and weakly prefer Bundle y to Bundle m then it must be true that consumers prefer z to z weakly prefer77 means that z is at least as good as y 3 More is better If all else the same more of a good is always preferred to less of that good 77Good77 here is de ned by economist as a commodity for which more is better than less 77Bad77 is de ned as a commodity for which less is preferred for example 77pollution Since consumers can always throw away the extra goods that they don t want so more goods at least don t make consumer worse off That is why this property is here Now with these three properties we can tell a lot about a consumer s preference Example Lisa loves fast food She has to decide how many pizzas and burritos to eat Here she faces several bundles a3212b3010c1525d1510e2515f3020 7y777777 Now let s decide about lisa s preference By property 3 e gt d c gt d a gt I f gt e b gt d Then by transitivity we know that f gt e gt d and a gt b gt 1 But we still don t know the relationship between e c and a We cannot use any property to justify them Indifference Curve Suppose we ask Lisa to identify all the bundles that gave her the same amount of pleasure as consuming bundle 5 Using her answers we draw curve I Curve I is an indifference curve the set of all bundles of goods that a consumer views as being equally desirable So consumers are indifferent among bundles along the same indifference curve because they give consumers same pleasure Indifference curve I includes bundle c e and a Then from this indifference curve we know that Lisa prefer e to b How do we know that Lisa prefers a to I while 5 and a give the same pleasure so Lisa will prefer e to 1 Similarly we can decide the relationships among all bundels If we asked Lisa many many questions in principle we could draw an entire set of indifference curves through every possible bundle This set is called indifference map or perference map which is a complete set of indifference curves that summarize a consumer s tastes We assume that indifference curve is continuous and no gaps Indifference curve maps have the following four important properties 1 Bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin 2 There is an indifference curve through every possible bundle 3 Indifference curves cannot cross 4 Indifference curves slope downward To prove the rst one we can always draw a line from the origin and cross that with two indifference curves By more is better the one on the indifference curve farther from origin is prefered to the one close to the origin but any bundles on the farther 10 are indifferent so by transitivity those bundles will be preferred to all the bundels on closer 10 By completeness given any bundles consumers can rank them For proporty 3 if 10 crosses then there is one bundle which is on two different le And this will cause all bundles on these two le be indifferent But this is wrong By more is better some bundles must be better than others To prove the last proporty just use more is better Bundles on this 10 are indifferent but by more is better they are not So 10 must be downward slope Marginal Rate of Substitution We can notice that if we move along the IQ consumers are getting more of one good while less of the other good This means that consumers are willing to make trades between goods How do we measure this willingness to trade We use marginal rate of substitution MRS is the maximum amount of one good a consumer will sacri ce to obtain one more unit of another good dB MRS 7 dZ where dZ is the number of pizzas that Lisa will give up to get dB MRS is the slope of indifference curve For example suppose point a is 38 point I is 45 then move from a to 1 causes burritoes to drop 3 while pizzas have been increased from 3 to 4 So MRST373 Curvature of Indifference Curve First let s talk about convex and concave curve Convex means that the line connecting any two points on an IC is above this lC while Concave means the opposite In the reality we notice that when people have a large amount of one good they tend to value that good less which implies they are willing to give up a larger amount of that good to trade for other goods When they have relatively less amount of one good then they tend to value more of that good which implies that they are willing to give up a small amount of that good to trade for other goods This is the situation when IC is convex For concave case people are willing to give up more of a good that is scarce for them This is hard to imagine though sometimes it does happen But in this course we will only talk about convex case Convex lV re ects a diminishing marginal rate of return Two extreme cases 1 Straight line perfect substitutes The slope of IC is always constant Consumers view two goods as perfect substitutes He doesn t care which one he is consuming They all give the same pleasure Therefore no matter which bundle he is consuming his willingness to trade is the same along the 1C For example seven up and sprite if you cannot tell the difference 2 Right angle perfect complements Consumers is interested in consuming only in xed portions Give more of one good is useless to him and it is on the same lC as that xed portion bundle For example left and right shoes Giving more of left shoes doesn t do people any good Any convex IC is in between this right angle and straight line and it implies these two goods are imprefect substitutes Chapter 6 Firms and Production The ownership and management of firms Production Short run production one variable and one xed input Long run production two variable inputs Returns to scale Productivity and technical change 1 The ownership and management of firms 0 A Firm is an organization that converts inputs such as labor materials and capital into outputs the goods and services that it sells The ownership of rms Proprietorships Partnerships and Corporations Management Vs Owners 2 The ownership and management of firms 0 Inputs Capital K Labor L and Materials M 0 Production function 7 the relationship between the quantities of inputs used and the maximum quantity of output that can be produced given current knowledge about technology and the organization q fLKM q fLK 0 Short run 7 a period of time that at least one factor of production cannot be varied practically 0 Long run a period of time that all input can be varied o Fixed input 7 a factor that cannot be varied practically in the short run 0 Variable input 7 a factor whose quantity can be changed readily by the rm during the relevant time period 3 Short run production One variable and one xed input q fLK 0 Total Product 0 Marginal Product of labor 0 Average Product of laor 4 Long run production two variable inputs Isoquant 7 shows the efficient combinations of labor and capital that can produce a single level of output Isoquants have most of the same properties as IC 0 The farther isoquant the greater the level of output 0 Isoquants do not cross 0 Isoquants slope downward The only difference is that Isoquant holds quantity constant while IC holds utility constant Curvature of Isoquants 7 shows how readily a rm can substitute one input for another Marginal Rate of Technical Substitution MRTS 7 slope of isoquant where it shows the ability of a firm to replace one input with another while holding output constant 5 Returns to scale Supply and demand quantity demanded demand function and demand curve market demand quantity supplied supply function and supply curve The market supply When we consider demand what are the possible factors that will affect your decision about how much to purchase this good For example cars Price of cars your income price of gas price of bus ticket preference etc At this point we will consider about the first four factors The other factors are not that important to economists maybe yes to psychologists Demand function is the relationship between quantity demanded and all the factors Qfppgpty Demand curve is the relationship between quantity and its own price given all other factors constant It basically says what will happen to the quantity you purchase when price ofthat good goes up or down For most of goods when price goes up people buy less of that good So demand curve has a negative slope and this is called LAW OF DEMAND Now how do we derive demand curve from demand function Notice that demand curve doesn t say anything about any other factors except for its own price So what we do is to give any number to all those other factors and the we find the demand curve For example Q17120p20pg3pt2y Then let pg4 pt13y125 and we can plug all those numbers into the above equation then we get Q17120p2043 132 125 1 1720p The above equation is called demand curve If we put it into a graph then it looks like 11720 Slove 120 117 When price goes up you want to buy less of that good It is a movement along the demand curve We call the demand for a given price as quantity demanded Now let s look what will happen if other factors change For example if pg increase When pg goes up to 5 then demand curve becomes Q17120p20 53 132 125 9720p So for a given price p the quantity demanded actually goes down when pg goes up The demand curve will shift to the left Notice that pg and p have the same effects on Q And this means that car and gas are complementary goods Complementary goods means that when you consume more of one good you have to consume more of the other one Those two goods are like a bundle They have to go together There are a lot of examples of complementary goods For example milk and cereal camera and film What will happen if pt goes up When pt goes up to 1 demand curve becomes Q17120p204332 125 15020p So for a given price p the quantity demanded goes up when pt goes up Demand curve shift to the right Here bus price has a positive effect on the amount of cars you purchase And these two goods are called substitution goods They mean that when you consume more of this good you consume less of the other good They give the same usage So if dQdother pricegt0 then substitutes If dQdother pricelt0 then complements What happens if income goes up If income goes up to 20 then demand curve will shift right With higher income for a given price p people would like to buy more cars Things to notice here 1 What factors shift the demand curve All factors except for its own price When we talk about a particular demand curve what factors have been held constant All other factors PQ change is along the demand curve FactorQ change is the shift of demand curve How do we interpret intercepts Paxis intercept says that when price is 11720 people don t want to buy any of that good stop buying Qaxis says that when price is 0 free people would like to buy 117 of cars 3 SlopeApAq120 How to get it 4 AqAp20 When price goes up by 1 unit people will consume 20 less of cars 5 pgp is an inverse demand curve It will be useful for later studies The market demand Demand curve gives out how much one person is going to buy for a given price If we have another demand curve for another person we can simply add these two quantities for the same price and then we have the market demand if the market is consist of these two people So the way to derive market demand is simply to nd demand curve rst and then add these two equations together Chp 5 Applying Consumer Theory m m wmmfvwrl w Rwy mm w w e rrr r remnants E flea s Fig51 ehoree th m mum t wlw m Hquot to L2 and optrmal bundle moves from pornt s to s Thls movementtells us alot of rnformauon Frrst when p6 drops from 12 to so eonsumers rnerease therr eonsumptron of beers from 28 7 gallons to 44 5 gallons andlfwe put these on graph b we ean denve the demand eurve forbeers Graph b tells us that beerrs not a glffenquot good beeause glffen lmplles that when pnee drops eonsumers buy less ofthatgood Seeond eons mpuon ofthatgood rneome effect and substrtuuon effect If p6 falls beers beeome relauvely eheaper whlle wrne beeomes relauvely more expenslve Beeause eonsumer expenslve one Thls ls the substrtuuon effect Also when p6 falls eonsumers have 58 9 when p6 falls from 12 to 34 measures the sum of these two effects To analyze those two effects we have to learn how to deeompose the effect ofapnce change lnto rneome effect and subsumuon effect Wlllar a lens per year 26750 6 say Been Gallnns Del veer Subs mvanquot I m 9 ever quotW as malrnnn Fig 52 eonsumers substitute other novvrelauvelv cheapergoods format one urn p r least some goods llnewlll shl lnwardto L anlmaglnaryllne tangentto 1 The tangentpolnt ls e39 The ge f to 239 ln honzontal drreeuon measures are subsumuon effect Consumer stays at are same uullty level Hovvever wth arelauvelv eneaper p6 are eonsumervvrll rnerease hls eonsumpuon ofbeer from 26 7 gallons to 30 6 gallons Tne shl from L to L2 shows an rnerease ln are eonsumer39s rneome Hls opumal bundle moves from 239 to 21Whlch measures the rneome effect on eonsumpuon ofboth goods The eonsumernovv eonsumes 58 9 gallons ofbeer lnstead of 30 6 gallons SE3067267 39 1558 9730 6 28 3 27545445 2 258 97267 nn r for an mfenor good7 i 3 e Baskalha Toat enact gt Subsnlu on enact Movres mm WM 4 ncume ewect Fig 53 Thrs graph rs a ddfferent example Mome rs an mfenorgoodm thrs ease Pnee of momes falls and eauses an outward rotaaon ofthe budgethne e to 239 sun measures the substrtunon etfeet 2 to 22 measures the rneome etfeet Smce meme 5 an mfenorgood SE steam gt 0 15 2 7239 lt0 TESEIEgt 0 xf SEgtIEx e SE domrnateer lt0 xf mm 15 t r e IE domrnates SE quotfofenquot good Grtfen good says when pnee of the good falls peop1e aetuany buy 1ess ofthatgood whreh a1so rmphes thatthe demand eurve for the goodrs upward s1oprng Praetreel What wouldthe value ofthe subsntuaon effecth for two goods that are perfeet eomp1ements7 Use a graph to demonstrate your answer Bonus 5pt Sarah allocates her income of 500 between the consumption of donuts and colTee Her tastes and preferences are indicated by the indifference curves shown in Figure 51 The price of donuts is 50 each Initially the price of coffee is 100 per cup Subsequently the price of coffee falls to 50 per cup On the graph below show the initial utility maximizing position the new utility maximizing position and separate the income and substitution effects For Sarah is colTee a normal or inferior good Deriving labor supply curve Labor supply curve is the relationship between wage and quantity supplied of labor From the labor supply curve we can tell how much one consumer is going to work for a given wage Most of supply curves come from producers side ie firms side However since labor supply is a decision made by consumers we can apply consumer theory to derive the labor supply curve So the question transforms to how much consumer want to consume the labor for every given wage But this question looks weird Let s put it this way Everyone has a fixed time endowment of 24 hours among these 24 hours people work and enjoy leisure Here we denote all other kinds of activities except for work as leisure Now we can rephrase the question For a given wage how much is the leisure demanded by consumers We let N denote the time spent on leisure H the time spent on working Then we have the following relationship H 24 N Assume an individual has a preference U Y N and his budget line is Y Y wH Y w24 N where Y is any income other than laborincome Y can be thought of all other goods Here we let Y be zero 1a1ldlkmgt2 cums a Comams gt 2 quotus mum rraummmmwwa u 2 11 a uwmeuuwuu 21 11 temara Cm m Wane per mu inward 1amquot 4 v Were wow u wmrxumpcrau Fig 54 0 works full ume 24 hours he aehreves hrs maxrrhurh rheorhe at 24w and hrs 1ersure 15 0 The s1ope ofbudget hhe 15 w Note that wag d as the pnce oflexsure That 15 beeause to get 1 umt oflexsure peop1e have to gwe up 1 umt ume oflabor1e1ncome of w If wruh 1 11 to L2 the budgemhe opurha1 eohsurhpuoh moves from s to 22 1hrua11yeohsurherrs ehjoyrhg 16 hours oflexsure whr1e oh1y works for 8 hours But a erthe Wage rate has quot1quot r 12hours 12 hours also So1fwe putthese oh the demand eurve forlexsure we can see 1t15 a H7247N a Lemur Damn M Leno suww De vvdud Vur exsmz Suaul 1 wuvk hauls 2 V 9 5 e e 1 m n V 15 x N meme how he my H mm lmmh Dummy Fig 55 Nowlet s deeompose TE mto IE and SE when leisure 15 anomal good a Time wns ualm Gnods per day v o N M N2 24 gtNLasuvs houmpemay 24 H M H o HWavkhouvsperday I Subsmuliurl eHeCI Total HI ad I Ifecl Fig 55 w m reaseslexsurebecomes he e ewe o consumerswxshto work 1 SE when e mo Xpen s more enjoylesslexsure They are gomgto substitute labor forlexsure e to e39measunes the SE IE to L2 Accordmgly opumalbundle moves from Etc 22 Because lexsurexs anormal good eonsumems gomg to menease his eonsumphon oflexsure N lt 0 IE IN gt 0 Commonly TE SEIEgt0 e when Wage meneases peop1e decrease hen eonsumphon oflexsure and work more Nonnally when wage ls qulte low lelsune ls vlewed as an mfenorgood And when wage ls suf clendy hlgh lelsune beeonnes as anonnal good a LHJM39LEVNJM C Mme 0 Supply km a Lalmv 5 L I Tlma eonshasnl f 5 S gt i 24 H2 H H a a H H2 H2 24 as wm mum pcr ny H Wummms pm any Fig 5 7 Lhey Want to workto eam lneonne so that they eonsunne othergoods So for them they wouldllke to work more when wage mcreases However when they beeonne ncher they have had enough we th Lelsune beeonnes nonnal good They Want to enjoy lelsune eyen wage ls qulte hlgh So when wage mcreases they wlll supply less labor Supply and demand quantity demanded demand function and demand curve market demand quantity supplied supply function and supply curve The market supply When we consider demand what are the possible factors that will affect your decision about how much to purchase this good For example cars Price of cars your income price of gas price of bus ticket preference etc At this point we will consider about the first four factors The other factors are not that important to economists maybe yes to psychologists Demand function is the relationship between quantity demanded and all the factors Qfppgpty Demand curve is the relationship between quantity and its own price given all other factors constant It basically says what will happen to the quantity you purchase when price ofthat good goes up or down For most of goods when price goes up people buy less of that good So demand curve has a negative slope and this is called LAW OF DEMAND Now how do we derive demand curve from demand function Notice that demand curve doesn t say anything about any other factors except for its own price So what we do is to give any number to all those other factors and the we find the demand curve For example Q17120p20pg3pt2y Then let pg4 pt13y125 and we can plug all those numbers into the above equation then we get Q17120p2043 132 125 1 1720p The above equation is called demand curve If we put it into a graph then it looks like 11720 Slove 120 117 When price goes up you want to buy less of that good It is a movement along the demand curve We call the demand for a given price as quantity demanded Now let s look what will happen if other factors change For example if pg increase When pg goes up to 5 then demand curve becomes Q17120p20 53 132 125 9720p So for a given price p the quantity demanded actually goes down when pg goes up The demand curve will shift to the left Notice that pg and p have the same effects on Q And this means that car and gas are complementary goods Complementary goods means that when you consume more of one good you have to consume more of the other one Those two goods are like a bundle They have to go together There are a lot of examples of complementary goods For example milk and cereal camera and film What will happen if pt goes up When pt goes up to 1 demand curve becomes Q17120p204332 125 15020p So for a given price p the quantity demanded goes up when pt goes up Demand curve shift to the right Here bus price has a positive effect on the amount of cars you purchase And these two goods are called substitution goods They mean that when you consume more of this good you consume less of the other good They give the same usage So if dQdother pricegt0 then substitutes If dQdother pricelt0 then complements What happens if income goes up If income goes up to 20 then demand curve will shift right With higher income for a given price p people would like to buy more cars Things to notice here 1 What factors shift the demand curve All factors except for its own price When we talk about a particular demand curve what factors have been held constant All other factors PQ change is along the demand curve FactorQ change is the shift of demand curve How do we interpret intercepts Paxis intercept says that when price is 11720 people don t want to buy any of that good stop buying Qaxis says that when price is 0 free people would like to buy 117 of cars 3 SlopeApAq120 How to get it 4 AqAp20 When price goes up by 1 unit people will consume 20 less of cars 5 pgp is an inverse demand curve It will be useful for later studies The market demand Demand curve gives out how much one person is going to buy for a given price If we have another demand curve for another person we can simply add these two quantities for the same price and then we have the market demand if the market is consist of these two people So the way to derive market demand is simply to nd demand curve first and then add these two equations together Supply When we consider about supply there aren t too many factors that affect producers to decide how much to produce Price of goods cost of labor cost of machine etc Normally we put the good s own price and cost into the supply function For the previous example that we use Qsgp wage capital cost When p increases firmsproducers want to produce more goods because it will provide them with more profit When cost increase produce would like to reduce their supply given same capital constraint So P increases b Quantity supplied increases along the supply curve Wage increases cost increases supply curve shift to the left for same price An example of supply function Qsl7840p20w60r Where wwage of labor rinterest rate for producer s loan When w55 rl05 Qsl7840p25560 105 10440p Suppose w10 then Qsl7840p2860 105 9940p So when wage rises supply curve shifts to the left which means that for a given price producers will supply less goods than before The market supply Similarly market supply will be the sum of quantity supplied for a given price If Qsl 10440p Qs2 8620p And Market supply is Qsm 19060p More examples about market supply How do we find out the market supply when there is import Scenario 1 Japan imports lice from America but Japanese put a ban on imports What is the effect of this policy on market supply Solution Compare with the market demand when there is no demand For Japan there is a domestic supply and also foreign supply therefore the market supply for Japan will be the sum of these two supply curve Suppose Qsd204p and st103p then Japan s market supply will be 507 And this is the case when there is not a ban When there is a ban which says that imports is illegal then st0 and Japan s new supply curve is Q204p Hence when there is a ban Japan has a less supply of lice comparing with when there is no ban Also Show the effect by the graph Insert gure 2 05 2 America imports steel from other countries But America puts a quota on the imports Quota means that the imp01ted steel from other countries cannot exceed Q Show the effect graphically Insert gure 21 here Explanation foreign supplysupply curve when Qf lt Q Q when Qf EQ Therefore when market supplydomestic supply foreign supply when Qf ltQ domestic supply Q when Qf EQ So when is a quota restriction the foreign supply is cut off MARKET EQUILIBRIUM Def Equilibrium is a situation in which no participant wants to change its behavior Example Figure 26 Qd28620p Qs8840p To solve out a equilibrium just let QdQs and we can get P33 Q220 What happens if the market is in disequilibrium Say plt33 then there is excess demand Price is too low for producers so producers will supply less goods while consumers would like to buy more than what has been supplied in the market therefore excess demand happens Since consumers want more some one will try to olTer a higher price to get the good otherwise no producer is going to supply more So this kind of behavior will bid the price up and nally price will move to equilibrium price where everybody is satis ed ie no one wants to deviate If pgt33 then excess supply rises Producers have been producing more than enough what consumers want to buy at this high price Therefore producers will lower the price and seeing that price is lower now consumers will buy more goods And this will force price to move down toward equilibrium price Again at equilibrium no one wants to deviate Now what happens if market environment changes How will equilibrium price and equilibrium quantity respond to that SHOCKS IN THE MARKET If D shift right then p goes up and q goes up caz more demand drives price up If D shift left then P goes down and Q goes down also If S shift right then P goes down and Q goes up IfS shift left then P goes up and Q goes down But when there is a combination of shocks on both demand and supply then the effects on P and Q will be ambiguous Example Qd28620p Qsl7840p60ph 1 Find the equilibrium price when Phl5 2 Find the new equilibrium price when phl75 3 What if we want to know equilibrium prices when ph2 2 l 25 4 And what about the equilibrium quantity Government intervention Trade policies trade ban and quota Insert graph 28 and 29 here 1 Japanese ban on rice import Result P goes up Q goes down 2 American quota on steel Result two cases If quota is bigger than QP then no effect on equilibrium If quota is less than Q then P goes up and Q goes down Price ceiling and Price floor A price oor sets a minimum price and it creates excess supply in the market A price oor only works when it is set above equilibrium price Example A minimum wage leads to unemployment A price ceiling sets a maximum price in the market An effective ceiling should be below equilibrium price and it will create excess demand shortage in the market So the result is some people cannot get what they want even they would like to pay higher price to get it Producer will not produce enough since the price ceiling prevent for an incentive to do so Then illegal market could emerge Chapter 3 Applying the SupplyandDemand Model Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman Inc All Rights Resened Figure 30151 How the Effect of a Supply Shook Depends on the Shape ofthe Demand Curve a pyperk9 D1 6 355 2 33930 52 e1 81 o 176 215220 Q Million kg of pork per year Jeffrey M Pe off M croeconom cs 2001 Add son Wes ey Longman 3910 AH R ghts Reserved Figure 301b How the Effect of a Supply Shock Depends on the Shape ofthe Demand Curve b A per kg 3675 330 0 D2 92 32 e1 81 176 220 Q Million kg of pork per year Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Figure 3010 How the Effect of a Supply Shock Depends on the Shape ofthe Demand Curve c pperkg 92 330 03 e 1 52 81 o 176 205 220 Q Million kg of pork per year Jeffrey M Per off M croeconom cs 2001 Add son Wes ey Longman 3910 AH R ghts Reserved Figure 302 Elasticity Along the Pork Demand Curve A per kg Perfectly elastic 6 14301 1144 astic1s lt 1 aZb 73915 Unitary g 1 Inelastic 0 gt E gt 1 330 enectly inelastic O 65 572 62 143 220 a 286 Q Million kg of pork per year Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Figure 303a Vertical and Horizontal Demand Curves a Perfectly Elastic Demand p Price per unit p Q Units per time period Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Figure 303b Vertical and Horizontal Demand Curves b Perfectly Inelastic Demand p Price per unit 0 Q Units per time period Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Figure 3030 Vertical and Horizontal Demand Curves c lndividual s Demand for Insulin p Price of insulin dose p 0 Q Insulin doses per day Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Figure 304 Elasticity Along the Pork Supply Curve 7 per kg S 530 n an 430 n 066 220 260 Q Million kg of pork per year Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Figure 305 Effect of a 105 Specific Tax on the Pork Market Collected from Producers p Per kg 32 l r 105 Si T 2163 million 176 Q2 206 Q1 220 Q Million kg of pork per year Jeffrey M Perloff Microeconomics 2001 Addison Wesley Longman inc All Rights Reserved Solved Problem 31 p Price per unit 62 p2 91 1 82 1 e1 1 D1 81 D Q2 Q1 Q Quantity per time period Jeffrey M Per off M croeconom cs 2001 Add son Wes ey Longman nc AH R ghts Reserved Figure 306 Effect of a 105 Specific Tax on Pork Collected from Consumers pperkg a Wd 1 105 pz400 z eger 5 1 p133 p2 1295 t1 05 l D1 D2 0 176 Q2206 Q1220 Q Million kg of pork per year Jeffrey M Perxom chroeconomwcs 2001Addwson Wes ey Longman me AH nghta Reserved Figure 307 A Comparison of an Ad Valorem and a Specific Tax on Pork p per kg S 0 176 Q2 206 Q1 220 Q MiHion kg of pork per year Jeffrey M Pe off M croeconom cs 2001 Add son Wes ey Longman 3910 AH R ghts Reserved Solved Problem 32 p Price per unit p D1 DZ 1 lt1Pquot 1w Qquot Q Quantity per time period Jeffrey M Per off M croeconom cs 2001 Add son Wes ey Longman nc AH R gms Reserved In class Practice questions for Perfect Competitive Market 0 Assume that a very large number of rms in an industry all have access to the same production technology The total cost function associated with this technology is TCq 40q 7 24q2 4q3 If the demand function for the industry s product is Q l9 7 P find numbers of rms when the market is at its LR competitive equilibrium PMC Pro t0gt TRTC gtPAC ThusPMCAC 1 Poland wants to privatize its farming industry and will therefore allow 10000 farms to produce wheat under competitive circumstances Assume that entry into the wheat growing segment of the industry will be easy Also assume that each wheat farm will have a total cost function of the following type TC qz 2 7 4q 200 where q is the farm s output At the present the government planners are setting a price of P 20 per bushel for wheat a How much wheat will each farm produce At the longrun perfectly competitive equilibrium for the wheatgrowing segment of the farming industry will the price be lower or higher than the present administered price Hint remember the longrun conditions These conditions will help you nd the competitive price At the shortrun equilibrium P MC whereas the LR equilibrium TR TC which implies P AC why is that that is production is at the point of minimum average cost When we set the average cost so that is equal to the MC we obtain q274200qq74 q27200q0 12740070 gtq20 Therefore the LR equilibrium output will be 20 bushels of wheat per farm The LR equilibrium P AC MC P q 7 4 20 7 4 16 This price is lower than the present administered price of P 20 b If each wheat farm had ten acres before privatization and produced a yield of four bushels per acre should the size of these farms be increased or decreased after the market becomes competitive In other words will it be cheaper to grow wheat on larger or smaller farms when the market is competitive Because each farm will produce 20 bushels of wheat at the LR equilibrium and it takes 1 acre to produce 4 bushels the optimum size for a wheat farm after the industry becomes competitive will be only 5 acres compared to 10 acres before privatization 2 Assume that the taXi industry in the town of New City is perfectly competitive Also assume that the constant marginal cost of a taXi ride is 5 per trip and that each taXi is capable of making 20 trips a day We will let the demand function for taXi rides each day be Dp 1100 7 20p a What is the perfectly competitive price of a taXi ride At the perfectly competitive equilibrium P MC Therefore the competitive price of a taXi ride is 5 b How many ride will the citizens of New City make every day Substituting the P into the demand function we find that the equilibrium numbers of taXi rides every day is 1100 7 205 1000 c How many taxis will operate in New City Given that each taXi is capable of making 20 trips a day the number of taxis needed in New City is 100020 50 Assume that every taXi that operates in New City has a special license Therefore the number of such licenses is the same as the number of taxis that you calculated in Part c of this problem Further assume that the demand for taXi rides has increased and is now Dp 1200 7 20p The cost of operating a taXi is still 5 per ride and the number of taxis has not changed d Calculate the price that will equate demand with supply The number of taXi licenses in New City is 50 the same as the number of taxis we calculated in Part c which means that the supply of taXi rides every day is 1000 Equating demand to supply we find that 1200 7 20p 1000 or p 10 Thus each taXi ride costs 10 e Calculate the pro t that each taXi will earn per day each taXi operates at its full capacity Given the cost of each taXi ride is 5 and the fare is 10 the profit each taXi earns on a ride is 5 The pro t per day is 205 100 3 Suppose that there is an economy with two rms whose products are completely independent By independent we mean that when one rm changes its price the other rm s demand is totally unaffected The only possibilities for employment in this economy are a career running rm 1 or rm 2 or a career as an economics professor who earns 20000 a year There are no barriers to entry in these careers and anyone currently employed in one occupation can costlessly change to another The only input that either rm needs to make its product is seaweed which costs 2 a pound Each rm requires one pound of seaweed to produce one unit of its product The cost of the input seaweed does not include the cost of an entrepreneur s time There are no costs involved in being an economics professor The demand for the product of rm 1 is P1 2002 7 4Q1 and the demand for the product of rm 2 is P2 4004 7 5Q2 a If anyone can become an economics professor what will the longrun equilibrium prices be for rm 1 and 2 As we know that at the LR equilibrium a competitive rms economic pro t is driven down to zero But in this case the de nition of economic profit must include an entrepreneur s opportunity cost of not being an economics professor which is 20000 Therefore the LR pro t of each rm will be driven down to 20000 We can express the two rms total cost function as C1 2Q1 and C2 2Q2 When we set the pro t so that it is equal to 20000 for rm 1 we nd that 20000 P1Q17 2Q1 7 2002Q1 7 4le 7 2Q1 7 2000Q1 7 4le Solvmg for P we have P 42 83 or 1961 63 but atpnce 42 83 rm 1 produees Q 489 8 at the 1ower average cost Solvmg for rm 21h a h 2 W111 produee 22795 4 at aphee 8 7 sxmxlar ma her we nd that rm b Is the phee ofeach rm39s product formed down to the level ofthe margrha1 cost of the seaweed7 No see the answerto Part a still have to eohsrder the opportunity cost ofbemg a professor 4 Cohsrder ah eeohorhy thh the supply of soeeerbaus qs soeeerbans grveh by of 270 7 5p p and the demandfor a Calculate the equrhbhurh phee and quantity 1quot 11 c 27075 47cgt73lt1lt1 w 1211 b Graph the supply and derhahdfuhehohs Fxrstwe wme both supply and demand havmg prree on the lefthand srde r 47en251r 70757c357270711 gt 7 4711211quot c Calculate both the consumer and producer surplus 4 l2 Hm 7428 i 1N in rll 2H7 1m Lhe govemmmt each erne they buy a soccer ball d calculale the new equlllbnum prlce and quanmy p u anl mm r l Lhere fore new demand curve ls r 270751p5lgt ll 270752725 a llquot 44575 lrrrrrlr h umhmmk lp 47 Lllllrmlw ruu lllrn unl null Mlmlh r lll cgt 245 757 4 e w 245 a 7 2722 c l lr mm x 6 Draw a graph marklng Lhe aller Lax consumer surplus and producer surplus as nu well as the tax rev 6 ltmuH mun mm mm S Rccnnul m Mna vcchmu B and 1 ls m Nwmm s s NmH hmng q D Mum m PS Nitrw 134737quot 1 185371153 J Sin 1 1088 7 Hsl a g Calculate the deadrwexghtloss imposed by the tax 1W ilH 2 Llurmxxxsrm a Ql If Fred s MRS of salad for pizza equals to 5 then which ofthe following is true A He would give up 5 pizzas to get the next salad B He would give up 5 salads to get the next pizza C He will eat 5 times as much pizza as salad D He will eat 5 times as much salad as pizza A B Notes MRS dx fm d y X 1s always on the top wh11e y on the bottom MRS is always negative MRSSfmp 5 3 ds 5dp dp The above equation says to get one more unit of pizza this consumer has to give up 5 units of salad So B is the correct answer Q2 Steven feels that colTee and tea are perfect substitutes Due to caffeine levels his MRS of tea for coffee equals 72 If coffee and tea sell for the same prices how much tea and coffee Steven will consume Solution Step 1 Let s do the budget constraint first Let pt denote price of tea p the price of coffee and Y the income of Steven Then the budget constraint BC is ptt p50 Y Ifwe put tea on the yaXis coffee on XaXis then MRT ie the slope of BC is MRT amp l since p5ptp P2 te C1 Budget constraint slopel ffee 1C0 Step 2Perfect substitute implies that the indifference curve for Steven is a straight line To be able to draw this IC we have to know the slope of IC ie MRS But we know MRSt m 2 so we can draw any IC in the above diagram Step 3 Now let s move the IC It is easy to see 1C1 gives the best utility Since the intersection of BC and IC is at the intercept of XaXis we know the optimal bundle will be 1 0 And it is a corner solution a Tax Incidence Questions 1 What are the effects that a sale tax has on equilibrium price and equilibrium quantity 2 Who is paying for the entire tax 3 Do the equilibrium price and quantity depend on whether the tax is assessed on consumers or on producers Two types of sales tax 1 Sales tax ad valorem tax a rate on the sales price ie government collect tax for every dollar you spent we use 04 Example a tax rate 008 on a 50 purchase is 4 alpha 008 We call 50 50 008 54 as the market price This is different from what we see in the market In stores they only mark the price as 77what they receive but when you actually purchase the good you are paying the marked price plus the tax In our example consumers are paying 54 while producers are receiving 50 and 4 is collected by government 2 Unit taxspeci c tax a dollar amount on each unit sold we use 739 Example Government charges 184 cents for each gallon of gas So when the gas station charges you 149 dollars per gallon the market price is 149 149 has includes the tax already Who is paying more of the tax Judge it by demand elasticity and supply elasticity Formula dp 65 1739 6576 where e is the demand elasticity 65 is the supply elasticity Facts 1 If lel larger then price increase less Tax incidence falls less on consumers more on producers 2 If 65 larger7 then price increase more Tax incidence falls more on consumers less on producers Do the equilibrium price and quantity depend on whether the tax is assessed on consumers or on producers Two cases Government collects tax from producers and Government collects tax from consumers 1 Collect tax from producers This basically says that producers pay tax after he receives money from consumers So if p0 is the price that consumers pay7 p0 is the price that producers receive before the tax is collected After the tax is collected7 what producers acutally get is p0 7 739 And producers are going to decide how much he is going to supply by this price that he acutally receives So7 instead of 29197 the new supply curve is Q5p 7 7397 if we denote p as pc the market price Example Q9 88 40197 Qd 286 7 20p What is the new supply curve Q5 88 40p 7 7 88 40p 7105 46 40p Then we solve out the new equilibrium Qs Q1 46 4019 286 7 2019 29 4 This is the equilibrium market price7 what the consumers pay Producers receive p7747105295 So consumers pay 4 producers receive 295 and government gets 105 And consumers pay 70 cents of the tax while producers pay 35 cents for the tax Consumers bear more of the tax burden 2 Collect tax from consumers This says that after consumers pay price to rmsproducers consumers still have to pay tax to government So what consumers actually spend is p 739 where p is the market price And producers receive p Using the same example above now the change in supply and demand curve only hap pens with demand curve Consumers are paying p 739 now so they will decide how much they are going to buy based on price p 739 What is the new demand curve Qd 286 7 20p T 286 7 20p 105 265 7 20p So the new equilibrium is 88 4019 265 7 20p 19 295 This is what consumers pay to producers So consumers pay 295 105 4 to get a good Producers receive 295 while govern ment takes away 105 Summary We can see from the above example that collecting tax either from consumers or from producers give the same result Tax revenue also stays the same 105 206 2163 which is the rectangle area in the graph Figure 306 How about the ad valorem tax 1 How does the ad valorem tax change the demand curve Before tax7 consumer pays p to buy a good Now after the tax7 consumers have to payp ap to buy it ap is the tax paid to government Figure 32 The new demand curve is Qd 286 7 201 04 0 The slope of demand curve changes from 20 to 201 a ie7 the demand curve shrink to the left The equlibrium price and quantity change in the same way as before when there is a sale tax But how much exactly might be different In class Practice questions for Perfect Competitive Market 0 Assume that a very large number of rms in an industry all have access to the same production technology The total cost function associated with this technology is TCq 40q 7 24q2 4q3 If the demand function for the industry s product is Q l9 7 P find numbers of rms when the market is at its LR competitive equilibrium 1 Poland wants to privatize its farming industry and will therefore allow 10000 farms to produce wheat under competitive circumstances Assume that entry into the wheat growing segment of the industry will be easy Also assume that each wheat farm will have a total cost function of the following type TC qz 2 7 4q 200 where q is the farm s output At the present the government planners are setting a price of P 20 per bushel for wheat a How much wheat will each farm produce At the longrun perfectly competitive equilibrium for the wheatgrowing segment of the farming industry will the price be lower or higher than the present administered price Hint remember the longrun conditions These conditions will help you nd the competitive price b If each wheat farm had ten acres before privatization and produced a yield of four bushels per acre should the size of these farms be increased or decreased after the market becomes competitive In other words will it be cheaper to grow wheat on larger or smaller farms when the market is competitive 2 Assume that the taXi industry in the town of New City is perfectly competitive Also assume that the constant marginal cost of a taXi ride is 5 per trip and that each taXi is capable of making 20 trips a day We will let the demand function for taXi rides each day be Dp 1100 7 20p a What is the perfectly competitive price of a taXi ride b How many ride will the citizens of New City make every day c How many taxis will operate in New City Assume that every taXi that operates in New City has a special license Therefore the number of such licenses is the same as the number of taxis that you calculated in Part c of this problem Further assume that the demand for taXi rides has increased and is now Dp 1200 7 20p The cost of operating a taXi is still 5 per ride and the number of taxis has not changed d Calculate the price that will equate demand with supply e Calculate the pro t that each taXi will earn per day each taXi operates at its full capacity 3 Suppose that there is an economy with two rms whose products are completely independent By independent we mean that when one rm changes its price the other rm s demand is totally unaffected The only possibilities for employment in this economy are a career running rm 1 or rm 2 or a career as an economics professor who earns 20000 a year There are no barriers to entry in these careers and anyone currently employed in one occupation can costlessly change to another The only input that either rm needs to make its product is seaweed which costs 2 a pound Each rm requires one pound of seaweed to produce one unit of its product The cost of the input seaweed does not include the cost of an entrepreneur s time There are no costs involved in being an economics professor The demand for the product of rm l is P1 2002 7 4Q1 and the demand for the product of rm 2 is P2 4004 7 5Q2 a If anyone can become an economics professor what will the longrun equilibrium prices be for rm 1 and 2 b Is the price of each rm s product forced down to the level of the marginal cost of the seaweed 4Consider an economy with the supply of soccer balls qs 4p and the demand for soccer balls given by qS 270 7 5p a Calculate the equilibrium price and quantity b Graph the supply and demand functions c Calculate both the consumer and producer surplus Now suppose the government imposes a sales tax such that consumers much pay 5 to the government each time they buy a soccer ball d calculate the new equilibrium price and quantity e Draw a graph marking the after taX consumer surplus and producer surplus as well as the taX revenue f Calculate the consumer surplus the producer surplus and the deadweight loss g Calculate the deadweight loss imposed by the taX Chapter 9 Applying the Cnmpetitive Mndel quanth But how does th5 affect eonsumers and producers7 How mueh do they lose or galn7 And what about the soerety7 Frrst to what extentrs eonsumer affected7 We need some measure for that Utrlrty ean lrua v 2 hardto compare So we measure eonsumerwelfare m terms of dollars I n are Consumer welfare from agoodls the bene t a eonsumergets from consumlng that good mlnus what the eonsumerpardto buy thatgood you wantto buy rt Thls ls called willingness to payquot a amoney measure ofsatrsfaetron orwelfare We are asklng a eonsumerto evaluate a falr exchangequot between agood and money Thus the money amount ls of the same value as the good 1 The pnee on the demand eurye shows eonsumers39 wllllngness to payquot Flgure 9 1 lal Dams Cunsumax Surplus a w Mammea pa week Flgure 9 l If you buy 3 magazlnes rn the market ean we know your wllllngness to pay for them together and for eaeh unrtv e The rnformaudn ls m the demand eurye Why7 buy th Flr Mlle at apnee gt 35 oryou wlll not buy rt at 35 At pnee 34 you buy two unrts The second or would not buy rt at 4 2 The surplus Take Flgure 9 l a the transaetron ls 3 unrts at 33 F rm Flr Vule l are wllllng to pay 35 buy only pard 33 so the surplus ls 2 and 1 forthe second unrt and so for the thrrd unrt What ls the total value a eonsumergets from thrs transaeuon Total Wllllngness to pay Area under demand eurye And Payment reetangle under pnee We deflne the welfare measur s consumers surplus the total value Wllllngness to pay 7 payment gt consumer surplus c5 en D eurye and prree F 9 l b b Steven39s Cnnsumersulplus E 8 5 E a r as i ounsumer surplust D1 apendilursj 39 Demarm t Matglnul wslllngness m pay luv lhe lasl mm a 0mm q Tmmng cams per year Flgure 9 l b 2 How does consumer surplus ehange wth prree Flgure 9 27 b is my mluion 116 125 a Human mse scans pcrycm Flgure 9 2 As P goes up quanth deereases me mangle area c5 reducedto A from ABC P up gt cs down How does elastlclty affect ACS Problem 9 07 Problem 9 1 Suppose thattwo llnear demand eurves go through me rmnal equlllbnum 2 one at 2 e a a rnerease eause are larger eonsumer surplus 10557 Answer 1 less elasne steeper demand eume 2 Ithe pnee mereases cs falls by only ec wlnle eceD forless rnelasne demand eume p spcrum Relallvew lnelasnc demard 1al e Halallvcly clam demand at or 0 Units perweek Problem 9 l z1rndueerwelare H1 The surplus ls the s amountyou get exceedlng what you pa ro ueer surplus evenu eTolal v Y anable cost We do not countflxed cost beeause ltls sunk cost cannoth avorded already spent Frrrus39 welfare wlll notbe affected by it A V ls exactly he s eurve Total cost sum the cost ofeach umts area uuderMc Flgure 9 312 panel 1a A rm Fvuduwr surplus p 5 91 unit a 4 umvs pa 1ng Fxgure 93a m m n v V quot1 A Markuw Pluducur Sury u Mam anan Curve n ma Del mm x pmqwmm p5 0 o um peryear Figure 9 3b Note that PS ls not pro t the ddfference ls the xed eost 2 How does PS ehange wrth pnee Problem 9 27 E n gt l f E as mlllion W q t a 30 0 n c D3ln44 milltan 11 b F D I 15 I 5 0 Simon ruse sems pet year Problem 9 2 As pnee deereases PS reduees to F from DEF P down gt PS down 3 Campeu39u39nn mam39mheswelrare 1 Soclal welfare m amarket ls the sum of surplus ofboth Butlater on we wll faee dfferent govemm nt mvolved e th l re ls alssue ofgove olleles Andw th n the ls government re hen government ls mmentrevenuesxpendlture And we should add venueexpendture mto soclal welfare PS and cs the soclety7 Ifwe want to maxlmlze soclal welfare what ls the best arrangement7 D eonsumers39 valuatron of an extra umt ofgood s produeers39 eostm produemg extra umt We ean see that when D ls hlghe than sthe good shouldbe produeed D ls lower than 5 rt shouldnot The best ls to stop atD and s eross gt equlllbnum quanatv another group from an aeu oh that alters a market equlllbnum 2 Underrproductlon e To th soclal welfare at Q1 ls Flgure 9 4 cs ABC and PS DE E a a u a A Suwly pa 1 5 c e W Pr 5 Demand D M03 1 2 I n um plvye r Flgure 9 4 Ifwe regulate proolueers to prooluee at Q2 auolregulatrhg phee to be P2 gt Pl the welfare ls cs A and PS BD A 57B7CandAPSBrE The mangle AW 7cE ls mlsslng Note that eohsurhers lose Bc butproolueers gam B andlose E The partB slmply changes handsquot 3 Overrproductlo The consequence ofproduclng over the equlllbnum ls also DW39L Flgure 9 5 Supmy two 9 H W r39 n as E C Bernard F s H 1 z 12 um pEVyEEr Frgure 9 5 Ifwe regu1ate the frrrns to produee at Q2 gt Q1 and pnee to be P2 lt P1 so that eonsurners W111 buvt1ne unrts above Q1 nave va1ues1owert1nantnerr eost Tne soera1 Welfare 15 redueed Produee at Q1 cs A and PS c1 Produee at Q2 cs ACDE and PS FGHrBrDrEeGe 7 ACS cDE and APS BrCrDrE The new mangle AW 7 B15 a negatrve arnount eonsurn ers 4 Why study Welfare measure7 e rnarketequr1rbnurnrt enanges eonsurners39 and produeers39 welfare In the next seetron we wr11ana1vze a few poueres 417nlicies and welfare m ntn 1t bad and we can vote to m uence 1t 1Polxmesthatsh1 supply eurve Two common types hmrts on the nurrber of rms rn a market errts on the amount of output that rm can produce Three ways to hmrt the number offm Restnct the number of rms Bar some member of socrety Rarse the entry cost or ent cost only apphed w rrms not to the one renarns Let s consrder the rst wayiResmchg the number of rms whrch whm the restnctron rs rmposed bene t omhrgher pro t Applrcatron Regulatron oftaxrcab rmposed a Cat th 1b Mark 2 an Act m 52 A r a t t t C 5 Fr r E u a 1392 near 44 0 2r ct was per monh 0 aces cc momh 1 Thewelfare ofcompeutwe equrhbnum When there rs no ctron on number of rms rn the longrrun rm wru produce atthe mrnrrnum ofayerage cost and supply curve rs horrzontal lme S he market equrhbrrum rs at pornt E and equrhbnum prrce rs p equrhbnum quantrty rs Q Thee are n rms rn themarket We know rn the longrrun producers have a zero pro t therefore 1930 And cs rs the areabetween Denand curve and p up to Q ABC 21the restnctron rs rmposed let s say n1 rms rn the market and n1 ltn Then each rm is producing ql at price p1 So when price is equal to pl the market supply equals to 71qu If the market needs more production more cab rms price has to rise ie follow the MC When Q gt n2 qz the supply curve is the sum of all n2 rms supply curve The new supply curve is S 2 And the new equilibrium is at point E2 New market price is p2 quantity is Q 3 Compare 1 CSABC Ps0 WABC 2 csA PSB WAB u CSBC u PSB u w CDWL Interpretation By preventing other cab firms from entering the market economic pro t is created the area 7239 So the rms that are in the market bene t from the restriction but consumers lose because of higher price In most cities permits can be rented or sold So the owners of permits can charge this 7239 and we call this Rent The rent for the permit causes the cab driver s average cost to rise to AC 2 Then for new rms they don t have positive pro ts anymore because market price is equal to the minimum of AC Producer surplus B go to original owner rather than to the current owner 2 Policies that create a wedge between Supply and Demand Most common policies are sale taxes or subsidy and price controls These policies create a wedge between MC and price and either too little or too much is produced 1 Welfare effects ofa sale taX Figure 97 If we assume that government will impose this tax on producers supply curve will shift to left and price will increase Sunnlv E e uz 2 e an n rll D 5 Demand zl F a l l a l 25 a HlHInn ma vlrms pal yam Flgure 9 7 Ongl al eqmllbnum ls atpomt 2 wlule the new equlllbnum ls atpomt 22 Pnee Lhatproducer enarges ls 32 cents but produeers ean only recelve 324121 cents m n d only 1 market No tax csABc PSDEF WABCDEF With tax CkA P Tax renen r w BDl Assysec APSYLHE AW 5 E lost area cE DW39L The extra 2 cents per stem that buyers pay eauses eonsurner surplus to fall by 932 And olue to 9 cents olrop m the pnee that rms reeerne they lose PS ofDE108 45 The govemmentgams tax revenue ofBD127 o revenue so welfare olrops beeause ofunder produeuon 2 Welfare effects of a subsldy Subsld tax 50 lnstead oftaklng sornellung away gov39twlll subsldlze eonsurnersproolueers m buylng selllng goods A peraunll subsldy to eonsurners wlll eause the olernanol curve to shlftnght and Let p pf Dpnce produeers reeelves than 1 p pt a pm stem Supply 119 E E Demand l5 LS4 a slum al was Emma pe39 ycal gure 9 8 PSDG ABDG BDE PsBcDG r CDEF Interpretatloh Consumers galh beeause they ear pay less and getrhore goods Produeers reeewe ahlgherprlee and sell more output galhs for eohsurhers and produeers are less than the s aD from two rhueh produetloh where produeuoh eost ls hlgher than value 3 Welfare of a phee H or In some market gov39t sets aprlee oor whleh ls the lowest phee a eohsurher ear pay legally for the good In ehapter 3 we leamed that an effectlve phee oor rhustbe set above the equlllbrlurh prlee Let39s see how thls polley affects the Applleau oh Soybean market gure 9 9 Government pledges to buy as rhueh output as farmers wahtto sell E 3 Supury 5 5 A Puee suapnn u E c at 39 Dewand s F 3 5 MG 1 u a 9 0 0 sum nusuets nt myhmns peryeer Frgure 9 9 ofgoods So eonsurners wru on1y purehase Q However when pnee rs hrgher farmers wru produee more and wants to sell Q arnount of soybeans m the rnarket Beeause ofthe pnee support pohey farmers wr11seuQto eonsurners and sell Q 79 unrts of soybeans to goyernrnent at pnee 5 per unrt No pnee oor csABc PSEF wABcE1 P ee oor PsBcDEF gov39texpenduurerCDFG BErG Am 37c APSBCD AWYCeFemDWL Interpretatron Pnee oor pnce support mcurs a dutcmon m the rnarket xcess produeuon rnore outputrs produeedthan rs eonsurned 50 extra output rs stored or d Lnef ereney m eonsurnpuon At 9 eonsurners are wuhng to pay 5 for the last good whreh rs more than the rnargrna1 eost 3 on of produerng thrs last one 4 Welfare effects of apnee eerhng below the pnce equurbnum r 1 n n uu ea uryru becau nr du r recewe a lowerprrce and sell fewer umts would hkeddeadwexght loss E E a E be 1 A Supply 5 c p D gt I 7 Pnce cemng F Demand On a 1 d 9 Funds per year Frgure 9 10 No resmcuon csABcP DEF WABCDEF Pnce ceumg c BD P F w ABDF Ass D7 c APS DrE AW7CrE ons ers gam because ofa lower prrce gam area D buLLhey cannotbuy more outputbecause suppbers now produce less lose area c producers lose DE because they sell less and recewe a lower pnce Deadwergm loss occurs because ofundeproducuon Solutions Qd 300 15p4 4gtlt3512 l 300 15p4 1412 302 15p Q5M Qsd st 6p 20 7w4p 40 10p 60 7x4 10p 88 2 300 15 6 4gtlt712 3 when pb6 Q p 302 15p de d 17 the demand curve shifts to right 1 gt 0 By LAW OF DEMAND when price of bus goes up the quantity demanded for bus ticket will decrease but we see that quantity demanded for car goes up So quantity demanded for bus ticket and car change in opposite direction which implies that these two goods are substitutes Q 300 15p6 4gtlt512 when pt 5 298 15 the demand curve shifts to left P g 4 lt 0 dpz By similar reasoning tire and car are complements 4 Has been answered in question 2 5 when wage increases to 7 QM Q st 6p 20 7w4p 40 10p 60 7 X 7 lOp 109 Market supply curve shifts to left because the cost of producing a car has been increased 8 Last step QSM Q st 0 9 QSM Qd 3lOp 88302 l5p 325p390 6 Before all the shocks 390 3p l56 25 3Q QSM 10gtlt156 8868 QSM Qd 310p 109 298 15p 3 25p407 After all the shocks 3 p l628 25 3 Qquot QSM 10gtlt1628 88 748 7 When there is a ban policy QSM Qd 36p 69298 l5p QSM QS st f 321p367 Q 0 6p 690 367175 6p 69 21 quot 3 Q QSM 6x175 69359 When there is a quota policy lst step Under what condition that the imports from Japan st gt 40 Q gt40 4p 40gt 40 3 4p gt 80 3 p gt 20 2quotd step st 0 4p 40 when 10ltpS20 40 when p gt 20 3rdstep Qsd6p 690 when pSll5 6p69 when p gt 1 15 when p S 10 when p S 10 4p40 when 10 lt p S l 15 10p109 when ll5ltpS20 6p29 when p gt 20 Before the shocks equilibrium price pl56 and Q68 When price ceiling sets price at 10 the actual price in the market is 10 and the actual amount of cars sold in the market QSM 10 X p 88 100 88 12 and there is shortage 10 When price oor sets the minimum price at 20 the actual price in the market is 20 and the actual amount of cars sold in the market Q 302 15p 302 300 2 and there is excess supply Chapter 7 Costs Shorterun cos ts Long run costs Lowering costs in the long run 0 Economic cost and accounting cost Opportunity cost the highest value of other alternative activities forgone To determine the opportunity of a resource you need to compare the other uses of it Although this cost may not show up on the balance sheet Opportunity cost is important for rms to make decisions among several choices For example a person has two choices run his own business or work for other rms If he run his own business the explicit cost is 40000 which includes wage paid to labors rent for of ce etc By running his own business this person can earn 60000 pro ts So in total he will have 20000 in hand If he just considers this pro t he will make the decision to operate his own rm However if he thinks about the other choice working for other rms the decision will be different If what he earned by working from other rms is larger than 20000 he will run his own business Otherwise he will earn more to work for other rms 1 Short run Costs 1 C cost F xed V variable A average M marginal Fixed cost vs variable cost changing with output Fixed cost includes things rms cannot change for example capital costs and rent for land Other costs than can be changed with output are variable Another way to see it the cost you have to pay when you produce nothing but still in business C FC VC Marginal cost MC ACAq Note that FC will not change so marginal cost also means marginal variable cost Average costs AC Cq There are average total cost average xed cost and average variable cost AC AFC AVC Let39s see ahurheheal example Table 71 ml 7 Vannun nf SimRun Cuslwml Dulpm hml vahh 1m MW tumor rml lump Vlzmlhh Mm Outputs Casi Curr chquot chug m CMI Co a b u r t M re W m Ur u n m u l w 25 4s 1 7 1 4x as 14 1 4 lo 4 4s 2quot l2 5 Al luv v o s as ml 5 7 4h 14 l M In a as m lu 45 Du I I 439 u I As Next let39s see the eurves Flgure 7 l P l Panel eost average eost average xed eost and average vanable eost Properues ofthese eurves leed eostvvrll hot ehahge ahorrzohtal llne Total eos parallel shlft p from varlable eost erehee between total eost eurve and varlable eost eurve ls equal to t l tp ls 0 4 Total eost ls the verueal surh ofvarlable eost and flxed eost 3 1 Average eost at apartreular l ls the slope of ahhe from ohgrh to the conespondlng porht oh the eost eurve 2 Marglnal eost at aparueular l ls the slope oferther total eost eurve or vanable eost eurve at that porht beeause Tc vc are parallel 3 Average vanable eost at a parueular qls the slope ofallne from ongln to the conespondlng porht oh vanable eost eurve 4 When the hue from ongln ls tahgehtto total eost atporht a then Average eost ls equal to Marglnal eost at that porht a Also th5 equalrtv oeeurs at e conespondlng porhtrh panel b vvhere the Marglnal eurve rhterseets the Average c lt Ac gt Ac oleereases u Mc gt Ac gt Ac r ur Mc Ac ero Avc at the rhrrurh 5 Alc oleelrhes as output goes up 6 AcAvc AFc rt39s relauohshrp vvrth MCls the same as u 4 hereases 55mg porht gt Ac at rhrrurhurh 1e McrhterseetAc and um 2 Cost and produet euwes 2 1 1n the shonrrun eaprtal ls xed then the unable eost lsjust the eost oflabor And unable eost eurve are the same thng Flgure 7 2l the m l t p ths Wage rate w By dolng so the labor axls ls ehangeolrnto unable eost However yr axls ls not ehangeol 50 see that the total output eurve and unable eost eurve overlaps eaeh other But we have to notaee thatnorrnally when we olraw the unable eost graph ls the opposrte ease i Tm Dmde m abon a rauabteeost 5 s E o a 5 20 4 4 77 25 mu m 2 a 3 3 L Hoursn abor aemay VCml almmenns1 2 2 Margrha1 eost ear be denved from margrha1 produet as well For outputto rherease by Aq vve needAL uhrts oflabor 1t vvru eost us WAL ahdthrs rs a ehahge rh vc Mc ACAq AVCAq wALAq Moreover the relataohshrp betvveeh Aq and AL are desehbed by Mn AqAL The rhverse rs lMPL ALAq Mc vv Mm Let39s eorhpare the eurves r Speerahzatroh at the begrhhrhg stage ofproducuon MP rhereases Mc deereases h Drmrhrshrhg margrha1 retums MP deereases MCmcreases 2 3 The average varrable eost rs the rhverse of average produet Lq APL Inverserelataohshrp t a t ofLabor Beeause APL tends to me and fall ACtehds to fall and then me 3 How do eost changes shx the eost curves7 A A We vvru 1 A speerfre tax evanable eost 395 supply m the market Whathappehs to the eost eurves when a speerfre tax rs xmposed7 Ifwe treat tax as part ofthe eost rtbelohgs to the vanable eategory Suppose there rs a 10 speer e tax ther for every produetthatthrs rm produees he has to pay an extra eost tax Tc Td 1oq But be careful of the xed eost xed eostrs the eostthat rm p 39 then the tax thrs rm pays rs 0 so the xed eostrs the same as before c and AFC wru hot ehahge vcmoyes up by 10d AVC moves up by 10 exactly 7 3 but they 39 mlmmum and quahtrty produeed at the mrmmum rs 511118 E M mutant 3 8 37 27 a 5 to 5 q mm per day 2 A lumprsum fee 7 xed eost A lumprsum that a rm pays for the hght to operate a busmess Thrs rs a xed amouhtper year ande part ofthe xed eost FC moves up by the fee amouht Fc Fcquot ee AFC moves up by sfeeq vc Avc Mc wru hot ehahge ACmoves up by sfeeq but sfeeqrs deereasmg when qmerease whreh rmphes the 0 Practice Questinn What is the effect at a lumprsllm ree an the quantity at which a rm s afterrtax aver age east curve reaches its minimum Answer Lnnk at the g1th heluw Quantity increases by qt units km net uml s Inquot maxim nu ql r llm s pnrdny 2 Loni11m cast Longrrun 15 when rms can change all then tnputs quot Plant me and maehtneny can be vaned So there 15 n d eost Fxxed eosttn the longrrun 15 equal to 0 We will talk about only c AC and Mc no dunncnon between FC and VC tnth n Jun tneuns the mlmmum eost 0mm mm cnnbimtiun m bun es 0 go 5quot budget constxamt rms choose eombtnattons ofmputsquot to mlmmlze eostgtven a output level Fume wtu detenntne the projected output and then detenntne the tnputs For consumers we have mdAfference eu as For rms we havetsoquants and isncn l linesquot Note here an tsoquantts the teehnology constxamt for afn39m teehnology eonstmnt tsoquants Comparedto a onsumer s ehotee Preferences maxtnntze uuhty cost mtnnntze eost Budg nstxam Consumers and rms are all maxuntztng mtnnntztng under eonstmnts Ique wage rate is w andthe capital rentls r the east is cwLrK m aTCT crank V h that cost you the same amount ofmoney xsocost form a 5mm lme Fxgure 7 4 For a speeme amount E the xsocost lme ls K EIrr wrL Sa 4 m w5r1on rhur slope7wrAK 7 v2 and mt Cepts K 1001 10 and L IOUW ZO outer lmes mean hxgher costs The a o gt a E 5 I a 5 a 2 5 I x a a 2 50 isucusl smo sucas1 150 isuuost a 2 7 a 7 150 7 55 1o 55 2o 750 L Unils DI labor per year 2 Now lem s see a m makmg Lhe opumal choxce ofxnputs 100 along ths 1007xsoquant gt nwm choose the lowest xsocost on the xsoquant Flgure 7 5 We have three rules to decxde Lhe opumal mputs y touches the xsoquant mputs gmphmauy 2 MP1 MP1 Wr 3 Laspdouar rule MP1 m MPKr a e 09 lanuanl K u Asnlc dulzlpm yeal u g an le L Unl39sa ahalperyear Fxgme 75 are are two cases comer soluuon nothappemng andlntenor solutlon For lntenor solun on as m Flgure 7 5 gt lsocosttangentto lsoquant Wu H w m comblnatlon the same Slope on lsoquant MRTSWL emp mm Slop on lsocost rWr Slopes are negative here Thls means MRTleml 39MPL MI K And also my w WKr Thls ls the rms39 costrmlmmlzmg condluon We can vlew the consumer39s optlmal ellolee atthe same nmeBrvemca1 slope on 1c mass M MU zMU p slope on EC MRTWZ epz P p Tangency means MIRSElhrZPzPE MU MUz z P a This means yeu weuld want D gain higher utility frem ene unit ef eeeds that are mere expensive than the ether e have a censumers39 utility maximizing cenditien fer an interier selutien innP MU F The last dellar brings the same utility increment frem bath eeeds Effect at z factnr price change all of39 leg labons eheapenelatlve to eapltal Figure 7 6 g q mo lscquar l a omginal m ismasl E can Kr E E g New lsocosl 1m kr y u 77 L Workers per year for abudget constraint What is the optimal choice now7 Using the newlsocost curves we can ndthe optimal combination y Example Problem 7 2 Both w andr doubles and the projected outputlevel is the same optimal gt Slope does not change same eomblnatlpn But epst doubles Lnngenln can curves can plot the optimal combination for every q andrecord the epst spent on these inputs Figure 7 7 Note that each post corresponds to a epmblnatlpn pr andL gt The curve m Flgure 7 7 may uotbe a sualghtlme depends on retum to scale mymmnm mm M nannymu z mu u my l Rum m u m m 2 eunuuetw Figure 7 7 Panel level of output eombmatlou oflabor and eapltal for each output level Practice unit nf nutput Describe the lnngrnln east curve Snlutinn 7le q i L 7 11K 7 q Sn C WLVKZ wkq Practice What is the lnngrnln can curve if qLK Most eornrnonly the LRAC and LRMC curves have the sarne shape as the shonrmn curves Urshaped thure 7 8 at castcuwe 6 c 8 n39 n Quanmy parday b Natgtnat and Averaae U05 Curves Ccsl nemme a a warm veruav What rs the rneantng ofthe shape of LRAC7 Dependmg of the slope ofthe LRAC we ean eaeh pomon 1 Downward stoprng LRAc emeetent to produce more gt Ecnnnmies at scale 2 Flat LRAC sarne emeteney gt Nn ecnnnmies at scale 3 Note that thrs rs scale eeonornresquot whteh addressed the retattonshrp between AC and q Returns to sea1equot addresses the retattonshrp between q andrnputs ehanged proportionally For constant return to scale the AC and MC will be constant and equals to each other For increasing return to scale AC is decreasing For Decreasing return to scale we have an increasing return to scale In Chp 6 we have learned that most productions have IRS when Q is small CRS for a moderate Q and DRS when q is large and the cost curve in Panel a is the one for this kind of production when return to scale could vary with rm s size Corresponding to this cost curve we have a Ushaped Another common type is the Lshaped AC curves p208 Application Let s compare the two shapes There is a ef cient range of scales on the Ushaped curves since the cost to produce each unit is the lowest On the Lshaped AC curves any large scale is ef cient 7 Lshaped AC favors bigger rms Examples are water electricity Practice A firm has Cobb Douglas production function Q AL IK I3 where a lt 1 On the basis of this information what properties does its cost function have Solution This information tells us that this production is decreasing return to scale For a decreasing return to scale we know that AC curve will be increasing when output q is increasing 3 Lowing cost in the longrun Beside the isoquant picture we have used we can also nd the LR cost curves by investigating the SR curves We can see a rm s optimal combination by letting it choose capital rst than labor This is correct since rms do choose capital rst in the shortrun Let s put the isoquant picture on the side for comparison Suppose a rm can choose three capital levels low median and large plant sizes We can draw three shortrun AC curves Figure 79 Note that each point on a SRAC corresponds to a level of labor input Putting three horizontal lines in the isoquant picture we can see the corresponding short run product and then we know the shortrun cost by calculating the money amount Now suppose the rm wants to produce ql it can choose among three levels of K One of them gives the lowest cost and the other two are the wrong plant size What will rm do if it has the wrong plant size In the shortrun it can do nothing But it can adjust given suf cient time Average cast 5 SUN q q Dulpul per any Figure 79 Inch I nwnln 39 level lnlieie are many possible plant sizes LRAC is smooth and Ushaped A rm chooses clie lowest SRAC foi a given level ofq 9 The union ofthe lowest SRACs constitutes the LRAC When clie linn can change capital input continuously clie LRAC is clie envelope ofall the SRACs We can see clie LRAC is always less than oi equal to clie SRAC projected q imie linn is at clie right plant size th ent level choice d c Inli This is because for any eeun 39 a an lie cost cannotbe lower So SRA LRAC ofcapim i in ofcapital is clie opuin e linnis at awrong plant In his case IRAC lt SRAC Longrrun Expansion Path vs snoiunn Expansion Path 1n clie shortrun capital is xed Finns can only change clie inputs oflabor So clie slion 39 39 39 quot 39 mum Imam But be 4515 rather n i hum man 4kr which is lower man d1 cost for shortrun K Can 1 391 year amok mum emammn pam Shonrnm 2m Imam um saquanl L Wolkevs my year Inclass problem Consumer Theory 1 If Fred s MRS of salad for pizza equals to 5 then which of the following is true A He would give up 5 pizzas to get the next salad B He would give up 5 salads to get the next pizza C He will eat 5 times as much pizza as salad D He will eat 5 times as much salad as pizza The answer is B Notes MRS d xfmy 67 X 1s always on the top wh11e y on the bottom MRS is always negative MRSSfmp 5 3 ds 5dp dp The above equation says to get one more unit of pizza this consumer has to give up 5 units of salad So B is the correct answer 2 Steven feels that coffee and tea are perfect substitutes Due to caffeine levels his MRS of tea for coffee equals 2 If coffee and tea sell for the same prices how much tea and coffee Steven will consume Solution Step 1 Let s do the budget constraint first Let pt denote price of tea p the price of coffee and Y the income of Steven Then the budget constraint BC is pit p50 Y Ifwe put tea on the yaXis coffee on XaXis then MRT ie the slope of BC is MRT amp l since p5ptp P2 te C1 Budget constraint slopel ffee Step 2 Perfect substitute implies that the indifference curve for Steven is a straight line To be able to draw this IC we have to know the slope of IC ie MRS But we know MRStfm 2 so we can draw any IC in the above diagram Step 3 Now let s move the IC It is easy to see 1C1 gives the best utility Since the intersection of BC and IC is at the intercept of XaXis we know the optimal bundle will be 1 0 And it is a comer solution a Chapter 5 Applying Consumer Theory Deriving demand curves H ow changes in income shift demand curves E ects of a price change Deriving labor supply curves 1 Deriving Demand Curves 0 Knowledge about consumer choice allows us to construct the Demand curves so now we know where the demand curve comes from 0 Trace out the Demand curves by varying the price holding income taste and other prices constant 2 How Changes in Income Shift Demand Curves 0 Effects of a change in income holding other things constant 0 Income Elasticities C A in guantity demanded m A income AYY ifC 105 gt income goes up 1 then the quantity demanded goes up by 105 ifC 105 gt income goes up 1 then the quantity demanded goes down by 105 0 Normal Good 7 positive income elasticities o Inferior Good 7 negative income elasticities o IncomeConsumption Curves and Income Elasticities My inferior good can be your normal good 0 0 Some goods must be inferior if all goods are inferior then when we have more money want less of all goods gt doesn t make sense 0 Some good can be normal when I have low income and becomes inferior when I have higher income e g hamburger I prefer steak when I have more money 3 Effects if A Price Change 0 Has two effects 0 Substitution effect 7 hold utility constant as the price increase consumers substitute their consumption to another good Income effect 7 an increase in price reduces a consumer s buying power effectively reducing the consumer s income and causing the consumer to buy less of at least some goods 0 0 Income and substitution with a Normal Good 0 Income and substitution with a Inferior Good 4 Deriving Labor Supply Curves o LaborLeisure Choice 0 Leisure Demand amp Leisure Supply 0 Income and Substitution Effects 0 Problem Emily receives a nostringsattached scholarship that pays him an extra Y per day How does this scholarship affect the number of hours he wants to work Does his utility increase 0 Shape of the labor supply curve Chapter 6 Firms and Production 1 Firms and production 1 Why study rms US national production GDP Firms 84 Government 11 Nonpro t organizations 4 Private households lt 02 What is a rm A unit or organization that convert inputs raw material workers machine into outputs Let s see rm as a black box 3 types of rms sole proprietorship partnership and cooperation Sole Proprietorship rms owned and run by a single individual Partnership rms jointly owned and controlled by two or more people The owners operate under a partnership agreement Corporations rms owned by shareholders in proportion to the numbers of shares of stock they hold The shareholders elect a board of directors who run the rm In turn the board of directors usually hires managers who make shortterm decisions and longterm plans 2 The owner will make decisions for a rm His objective is to maximize pro t 11 11 Revenue 7 Cost Revenue pq A necessary condition for maximizing pro t is to have an ef cient production process An ef cient production process is de ned that the rm cannot produce more output with the existing knowledge or that the rm cannot produce same output by using less inputs If a rm is produced ef ciently then it cannot be maximizing its pro t There are three major categories of inputs Capital K building machine equipments etc Labor L managers skilled workers or unskilled workers Material M oil water steel iron etc For simplicity we study rms using L and K as inputs The function of a rm is summarized in its production function q fL K Where q is the maximum amount of output produced by using L units of labor services and K units of labor Note Maximum has implied that production function is an ef cient process 3 Time and rms ability to vary inputs Roughly we divide a rm s time frame into two time periods longrun and shortrun Long run all inputs can be changed 7 both labor and capital Shon I39un some inputs are not changeable 7 capital is xed labor can change plant srz es Equrprhehtrs xed butyou ear always hrre an extra hand 2 Shortrun wnduction 1 Let39s see a shonrmn production fuhe q Produetroh fund on wrth ohe varrable rhput L A fe w defrhrhohs rst Margrha1 produet oflabor e the value of one extra Worker fL K L q Average produet oflabor e the value of team efforts APL qL See the de muoh m Table 61 horrlteaprta1rs xed hill 54 anal Pnldu Malglna mam and lung mum at nah wmt Fm atqu Chem t I rm m1 I39mnl mm 392 rt mm Minimal P m mm a 11mm m Note that eaprtal rs xed at 8 whrle labor can be vaned looklrke duVMrw nrduV an mm mmquot nl I m w shnhk E 5 w z 911 s e m t m L 1mm an a Frgure o 1 Faets TP 1 Lnruany TP mcreases faster and faster as L mcreases Thrs 15 beeause speerahzauon ean mcrease producmm 2 Atter the bene t of speerahzatron 15 fully unhzed the mcrease m T W111 s1ow down unta1 an extra worker eontrrbutes negatwe1y MP by de nmon rt 15 the s1ope ofTP 1 MP rnere 2 MP deereases butts sun posrtwe 3 Wxsneganve As produetron rnereases rt wr11 enter the range of d1m1mshmg rnargrna1 returnsquot Thrs 15 ea11eo1the 1aw of dAm1mshmg rnargrna1 returnsquot Thrs rneans the extra bene tfrorn an extra worker deereases as the number of workers mcreases Aprs the s1ope othe hne from the ongm to 1 q Its re1ataonshrp wrth MP 1 MP gt AP gtAP mcreases 2 MP lt AP gtAP deereases 3 MP AP crossmg pornt gt AP at mammum 4 whreh rneans that m average eaeh Worker ean produee1 unrts of output Ifwe mcrease 1 rnore unrt oflaborth15 extra1abor W111 generate 19 unrts of output Ifhe ean only generate 14 unrts of output then AP W111 not be ehanged But now 9gt14 so thrs extra unrt bras up the average produet 7 L154wehv AP 3 ngrnln prndllctinn 7 1 We have seen the shortrrun produetron funeuon wrth a xed eaprta1 K Now 1et39s vary E t n s g E a a 5 x a g c q35 124 qM a LWurkcm pnrday gure 52 We ean see the number 24 q24 appears m dAfferent eornbrnatrons oflabor and eaprta1 you the sarne output1eve1 We ean draw xsoquantquot eurves ofproducuon Frgure o 2 Eaeh curve rneans an output1eve1 urut It one Y before Properties same reasons as ICs 1 Farther is better 2 No crossing 3 Downward sloping We can see the shortrun TP curve for a xed capital i the picture of isoquants Another way to understand the ICs an isoquants trail m s There are isoheight curves on the map They trace out locations with the same altitude Think utility levels and nmpm 39 Ir 39 39 I 39 quot 39 n I n comer is the highest place in the picture 2 Shapes of isoquants the same as the case for indifference curves The shape of isoquants shows whether the two inputs are substitutes or complements al m m Ewe per day 8 y x WWMW cmwm t whim Figure 6 Note the straight lines means perfect substitution The dashed line in panel b says that it is not efficient to produce for combinations of input on that line Firm can produce the same amount of output by using less input Those three solid points are efficient production The last panel is for imperfect substitutes Marginal rate of technical substitution in producti MRTS K or L 3 The trade off between capital and labor when maintaining production level on Same as ICs the steeper the isoquant is the more productive labor horizontal axis is K Ums arcamal perm u 2 a A 39 a L Warksls par day n FigureSA Ifwe are given two point a and b then we know that the change in Lls l and change in 18 Butwhatlfwe are askedto denve MIRTS for a given K is 718 so MRR 7 EIL point say a7 Then we have to apply the next formula 4 Substitution between inputs MIRTS and MP L AqAL MPn AqAK on an lsoquant we Want to decrease capital andlncrease labor while xing the output Sn Less Aq MP AK Gain Aq MAL They are equal So Mm AKMPLAL0 And MP1 Mlgtn e AKAL MRTS technical substitution This is because when the inn employs more labor themar returns nflzhnr is diminishing eThe lsoquants are cnnvzxto the ongm Ifwe go back to Figure 54 we can seen112mm e7 M12711 74 and Mm 72 And by at labor 4 Returns to scale The eoneept of retums to sea1equot rs formeasunng whether a rm can produce more merenuy by expandmg the produetron sea1e propomonally For example xfa rm expands produeuon to 3 tunes the ongmal srze wru the outputbe 3 tunes hrgher as well7 Thrs rs to say EL 3K gt lt 3fL K where there are three rdentrea1 plants In genera1 rfafrrrn expands produeuon to t urnes the ongmal sea1e Increasin retuxns ftL tK gt t L K Cnnstant returns tn scale ftL tK t fL K Decreasing returns tn scale ftL tK lt t L K lawman Mt an name unmanthan sn ureteneraetear ht awn EMA 19d stun unmnc quotamen sea awn aemu ntrnttn te yer 0 at m u I AM M Ma AW Mu an t w warmquot Film 5 Returns to scale relates to rms competitiveness 1 When there is increasing returns scale it is more ef cient to produce with a larger plant A rm will increase production scale one large plant to provide cheaper goods This will drive smaller rms out of business 2 When there is decreasing returns to scale it is more ef cient to produce with a small plant A rm will reduce production scale to have more plants to provide cheaper goods 3 When there is constant returns to scale plant size does not matter Example 1 qfXy Xy This is a constant returns to scale production function 3x 3y 3q Example 2 q fL K aLaK This is a very important type of production function which is called the CobbDouglas function Let s see ftL tK a tL tK W a L K g tW fL K gt lt t fL K Depending on the value of oc 1 CR8 lt1 DRS Example 3 Figure 66 Returns to scale may vary for a rm K Unlls or capital per year CA El Dscvoasing mums m scale q 6 a a c Conslam volume a scale a a lnaeasmg relums lo scale 0 l 2 4 a L Wuvk hours peryeal gum 66 Fromatoh andth outputls 3gt1Z remms to scale From b to c when rm doubles lts SlZe agam the output now becomes 6 Rut th rm moves from c to d the output 15 less the double ofprevlous output whlch lmphes a decreaslng returns to scale amount of output l o m H m mm m Ithe th rm th ue suffers from decreasmg remms to scale Chapter 4 Consumer Choice Preferences Utility Budget constraint Constrained consumer choice In the previous chapter we have been using the demandsupply model So how is the individual demand curve decided How does each individual decide the amount of goods he is going to buy To analyze this kind of question supplydemand model is not useful here We have to learn how consumers choices are made All consumers must choose which goods to buy how much to buy because limits on wealth prevent them from buying everything that catches their attention Therefore consumers buy the goods that give them the most pleasure subject to the constraint that they cannot spend more money than they have 1 Preference 0 Three properties of consumer preferences 0 Completeness the ability to rank all bundles o Transitivity to ensure the consistency in the preference 0 More is better also known as nonsatiation Indi erence Curve 1C 7 the set of all bundles of goods that a consumer views as being equally desirable Indifference map preference map 7 a complete set of IC that summarize a consumer s tastes shown below 0 Bundles on IC farther from the origin are preferred to those on IC closer to the origin 0 There is an IC through every possible bundle IC cannot cross IC slope downward 00 Good Y o Marginal Rate ofSubstitution 7 Slope ofthe IC We can notice that if we move along the IC consumers are getting more of one good while less of the other good This means that consumers are willing to make trades between goods How do we measure this willingness to trade We use marginal rate of substitution MRS is the maximum amount of one good a consumer will sacri ce to obtain one more unit of another good MRS dY dX For example suppose point a is 38 point b is 45 then move from a to b causes good Y to drop 3 units and good X to increase 1 unit MRS 3 l 3 o Curvature of IC 0 Diminishing marginal rate of substitution 7 the willingness to trade fewer of good B for one more unit of good Z as we move to the right of the IC 0 Extreme cases perfect substitutes perfect complements 2 Utility Numerical values that re ect the relative rankings of various bundles of goods Examples of utility function 0 XY 0 UlnXlnY 0 U min X Y 0 U X 1n Y Ordinal rather than Cardinal 7 only ranks matter Utility and IC Marginal Utility MU 7 the extra utility getting from consuming the last unit of a good Marginal Rate of Substitution MRS or the slope of IC 7 can also be expressed in terms of MU 3 Bud get Constraint BC PXX PyY M o Opportunity set 0 Linear relationship the easiest way to draw BC is to nd the intercept on X and Y axis 0 Marginal Rate of Transformation MRT or Slope of BC 7 the tradeoff the market imposes on the consumer in terms of the amount of one good the consumer must give up to obtain more of the other good 0 Change in price increasedecrease 7 consumers can be worse offbetter off depends of the IC 0 Change in income 7 if income increases consumers will be better off and if income decreases consumers will be worse off 4 Constrained Consumer Choice 0 Two types of solutions 0 Interior solution 0 Corner solution 0 Concave and Nonconvex IC 0 Application Food Stamps Mathematical knowledge 1 Functions of a single variable a Function y a The rst derivative of f With respect to at is df 7 x 7 dac lt gives7 at each value at the slope or instantaneous rate of change in a The second derivative of f With respect to at is d2f W39 f It gives the rate at Which the slope of f changes It is thus related to the curvature of the function f Rules of differentiation 7 For constants7 a 7 For sums 1 EWng 7 f i9 7 7 Power rule wan naxnil 7 Product rule 7 Quotient rule iamp f 9 7 f9 dx 91 9avl2 7 7 Chain rule d l Ewan f9x9 Examples Calculate the derivatives in each of the following cases y 535 2 101 2ac2 3x4 91 3x 7 1 53919gtWMH Concavity and rst and second derivatives If f is tWice diflerentiable7 the following statements 1 to 3 are equivalent 1 f is concave 2 f x S 0 Vac 3 If A E 07 l7 Vac and V350 fW 1 7 W0 2 Mac 1 7 WM For all 10 S fac0 f acoac 7 350 Vac Moreover 4 If f ac lt 0 Vac then f is strictly concave Examples Are the following functions concave 1 fx31272x5 2 gx75139x3 3 hac3ac73 Functions of several variables n22 Function y facl x2 Partial derivatives 8 f forz39 12 96239 Total differential dy of the function y facl7 x2 7 3f 3f dy 7 8x1d118x2d12 Where dam and 112 are small changes in 1 and 12 Example facl x2 at 31112 7 7 What are the partial derivatives Optimization Function y is differentiable The function achieves a local maximum respectively global maxi mum at 35 if 2 for all at in some neighborhood of 30 re spectively for all 1 The function achieves a local lobal at E if 2 for all at in some neighborhood of E respectively for a Necessary conditions for local interior optima in a singleevariable case is twice continuously differentiable lt reaches a local interior 1 maximum at 1 3 f ac 0 F00 gt f ac S 0 SOC 1 maximum at E 3 f a 0 F00 7 WW 2 0 300 4 Constrained optimization Consider the following problem lm Max 1352 subject to 90017352 0 a ash 2 objective function or maximand7 x1 and 12 are Choice variables7 905112 constraint Let solve this problem by substitution 7 suppose we can rewrite the constraint 911 x2 0 as 2 7 We can substitute this directly into the objective function the 2 variable constrained maximization problem can be rephrased as the single variable problem with no constraints A tlm flymh 7 11 is de ned by 8fx1 x1 3f17 11 1 811 3952 d951 7 and as by I Example Cost minimizing rm C wL TK With CobbeDouglas pro duction functions MinwL TK KL subject to Q LO K 7 The constraint Q LO K becomes L QiK fT 7 Unconstrained minimization A aniK g 7K 7FOC d0 7 5 421 7 a WQ 3 0 7800 120 l E 2 1 3 K r gt0 dK2 04 wQ a 7 7 Solve FOO gives K Q r a 7 Substitute Kquot in L Q K g gives t L eTx EH Practice for Chapter 2 Solution Qd300 15p4 4gtlt3512 1 300 15p4 l412 302 15p Q5M Qf st 2 6p 20 7w4p 40 10p 60 7x4 10p 88 Qd300 15p6 4gtlt712 3 when p17 6 302 15 the demand curve sh1fts to r1ght P g 1 gt 0 dpb By LAW OF DEMAND when price of bus goes up the quantity demanded for bus ticket will decrease but we see that quantity demanded for car goes up So quantity demanded for bus ticket and car change in opposite direction which implies that these two goods are substitutes Q 300 15p6 4gtlt512 when pt 5 the demand curve shifts to left 298 15p dQ 4 lt 0 61p By similar reasoning tire and car are complements 4 Has been answered in question 2 5 when wage increases to 7 Q5M Q st 6p 20 7w4p 40 10p 60 7x 7 10p 109 Market supply curve shifts to left because the cost of producing a car has been increased QSM Qd 310p 88302 15p 3 25p 390 6 Before all the shocks 390 3 p E 156 sq QSM 10gtlt156 8868 QSM Qd 310p 109298 15p 3 25p 407 After all the shocks 3 p 1628 3 Q QSM 10 x1628 88 748 7 When there is a ban policy QSM Qd 36p 69298 15p QSM QS st f0 321p367 Q 6p 690 367175 6p 69 21 quot 3 Q QSM 6gtlt175 69359 8 When there is a quota policy lst step Under what condition that the imports from Japan st gt 40 Q gt40 4p 40gt40 3 4p gt 80 3 p gt 20 If the price is greater than 20 the quantity import will be more than 40 However due to the import quota the quantity import cannot exceed 40 Hence if the dprice is higher than 20 the total supply equals the domestic supply plus 40 ie Q5m QS 40 part C 2 d step To see foreign supply curve at different prices st0 when pSlO 4p 40 when10ltpS20 40 when p gt 20 3rd step To see foreign supply curve at different prices Q 6p 69 0 6p69 when p 115 when p gt 115 Last step QSM Q1 st 0 when p S 10 4p40 when 10 lt p S 115 Part A 10p109 when 115 lt p S 20 Part B 6p29 when p gt 20 Part C Foreign Domestic Total P P P 20 Q Q yr 4H4 A R C Note if you are using different W you will have the intercept on the P aXis 8 but the analysis will be similar 9 Before the shocks equilibrium price p156 and Q68 When price ceiling sets price at 10 the actual price in the market is 10 and the actual amount of cars sold in the market QSM 10 X p 88 100 88 12 and there is shortage 10 When price oor sets the minimum price at 20 the actual price in the market is 20 and the actual amount of cars sold in the market Qd 302 15p 302 300 2 and there is excess supply Inclass problem Applying Consumer Choice 1 Jane consumes gs and berries Her current consumption bundle of gs and berries exhausts her income The last package of gs she eats costs her 2 and gives her 8 utils her measurement of utility The last carton of berries she eats costs her 1 and gives her 5 utils Show how Jane can afford to be happier Hint use the ratio MUxPx which tells us the additional utility that 1 can buy if Jane allocate this 1 to buying good X and compare it with the case where she allocate this 1 instead to buying the other good 2 Consider the utility of the right shoe and the left shoe let the left shoe on the yaXis and the right shoe on the XaXis show graphically the income and substitution effects if any when the price of the right shoe increase holding the price of the left shoe constant 3 Ian consumes only two goods potato denoted by X and beef denoted by Y in his life To him potato is an inferior good a Can beef also be an inferior good to him Why b If Ian s income goes up while everything else stays the same draw a graph showing his old and new budget constraints and mark his old and new optimal consumption points How does your graph show that potato is an inferior good to him c If the price of potato goes up while everything else stays the same draw a graph showing Ian s old and new budget constraints and mark his old and new optimal consumption points Show on the same graph the substitute effect and income effect of this price change Do they work in the same direction How is the fact that potato is an inferior good embodied in your graph 4 Ms A has utility function de ned by Umb mcbd where m and n are her demands for two commodities mangoes and bananas Denote I as income p the price of mangoes and q the price of banana Assume I p q are positive a show that the demand for mangoes is given by m gtllt ll 1 c cd b Now if the demand becomes Umb c lnm d lnb show that the demand for mangoes can also be written as above Why Inclass problems Production 1 A good recipe for a French dish called ceViche requires 16 ounces of filler of red snapper 3 ounces of lime juice 1 ounce of coriander and 8 ounces of Bermuda onion This combination of inputs is expressed in the following production function y min 2 2 Z3 LA 16 3 8 In this production function 21 is filler of red snapper 22 is lime juice Z3 is coriander and Z4 is Bermuda onion The unit of measure for each input is the ounce and the unit of measure for ceViche the output is the quantity produced by the recipe If a restaurant has on hand 32 ounces of snapper 9 ounces of lime juice 5 ounces of coriander and 48 ounces of onion how many units of ceViche can it produce 2 Construct a total product curve for a function that exhibits diminishing marginal production throughout Construct a total product curve for a function that exhibits initially constant and subsequently diminishing marginal product 3 Are the following production function CRTS DRTS or IRTS a q KL4 b q K L c q min K6 L3

### BOOM! Enjoy Your Free Notes!

We've added these Notes to your profile, click here to view them now.

### You're already Subscribed!

Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'

## Why people love StudySoup

#### "There's no way I would have passed my Organic Chemistry class this semester without the notes and study guides I got from StudySoup."

#### "I bought an awesome study guide, which helped me get an A in my Math 34B class this quarter!"

#### "I was shooting for a perfect 4.0 GPA this semester. Having StudySoup as a study aid was critical to helping me achieve my goal...and I nailed it!"

#### "It's a great way for students to improve their educational experience and it seemed like a product that everybody wants, so all the people participating are winning."

### Refund Policy

#### STUDYSOUP CANCELLATION POLICY

All subscriptions to StudySoup are paid in full at the time of subscribing. To change your credit card information or to cancel your subscription, go to "Edit Settings". All credit card information will be available there. If you should decide to cancel your subscription, it will continue to be valid until the next payment period, as all payments for the current period were made in advance. For special circumstances, please email support@studysoup.com

#### STUDYSOUP REFUND POLICY

StudySoup has more than 1 million course-specific study resources to help students study smarter. If you’re having trouble finding what you’re looking for, our customer support team can help you find what you need! Feel free to contact them here: support@studysoup.com

Recurring Subscriptions: If you have canceled your recurring subscription on the day of renewal and have not downloaded any documents, you may request a refund by submitting an email to support@studysoup.com

Satisfaction Guarantee: If you’re not satisfied with your subscription, you can contact us for further help. Contact must be made within 3 business days of your subscription purchase and your refund request will be subject for review.

Please Note: Refunds can never be provided more than 30 days after the initial purchase date regardless of your activity on the site.