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Econ Week 8

by: Emma Norden

Econ Week 8 Econ 1101

Emma Norden
U of M
Principles of Microeconomics
Thomas Holmes

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Principles of Microeconomics
Thomas Holmes
Class Notes
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This 9 page Class Notes was uploaded by Emma Norden on Friday October 30, 2015. The Class Notes belongs to Econ 1101 at University of Minnesota taught by Thomas Holmes in Fall 2015. Since its upload, it has received 34 views. For similar materials see Principles of Microeconomics in Economcs at University of Minnesota.


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Date Created: 10/30/15
Week 8 102615103015 0 Private Goods Rival in Consumption One person consuming affects someone else s ability to consume it EX 1 eat it so you can t Excludable People can be prevented from consuming it 0 Public Goods Nonrival in consumption one person consuming doesn t take away from another person s ability to consume it EX Watching TV hearing a siren Nonexcludable You can t prevent people from consuming the good EX Sirenscan t set siren up so only those paying for it can hear it 0 Efficient provision of Private Goods Make a unit of output and give it to a person if that person s marginal willingness to pay exceeds marginal cost 0 Efficient provision of Public Goods Ex Building an artificial sun to light Econland would cost 20 Add all the willingness to pay of each person together Dl would pay 9 D2 8 D3 7 D4 6 D5 5 D6 4 D7 3 D8 2 D9 1 D10 0 Total 45 Therefore the social benefit would be more than the cost to build the sun so it would be socially efficient to build the sun Public good is a kind of externality Free Rider Problem Beneficial for society as a whole but no one is willing to pay the entire amount to do it themselves 0 Common Resources Nonexcludable Rival in consumption 0 Club Goods Excludable Nonrival in consumption Consumer Theory Pizza 4 per slice Beer 2 per bottle Goldy s income 24 With 24 he could get 12 beer or 6 pizza or something in between original bc curve bcbudget constraint Slope4 pizza2 beer 2 When price of pizza falls to 2 per slice slope 1 new bc curve Plot grader Constraint L I it A N 5 39 12 I r W 1r at H F3 s r 35 r 3c I quot I i 2 3 4 5 Er Qi i ii iE iB ii r r 323 Horizontal intercept Ierm nVertical intercesth i Finger quot Z P izza pbeer Z Z TEQW39 quot G1 Suppose Goldy only cares about calories he gets utility from calories therefore the more calories the better If pizza and beer both have 200 calories he Will get 12 beers because that is the optimal consumption bundle Optimal consumption bundle ocb highest indifference curve that is still on the budget constraint Indiffereme ouwe through Ginger api a 0 Utility 2 ZDEIIEWE Z l beer Get 2001 eaelh so trad Mr 1 rormet I mg quotalums m 2 at 515 3 Bt lt HE BM 13 haze rial 0 Diminishing marginal rate of substitution As Goldy eats more pizza his Willingness to give up beer to get pizza goes down therefore indifference curves have a bowed shape quot g it 39ngguammu m Optimal consumption bundle is 3 pizzas and 6 beers because it meets 2 requirements 1 It s on the budget constraint curve 2 Marginal rate of substitution mrs PpizzaPbeer or slope of indifference curve slope of budget constraint Public goods and common resources are not excludable meaning people cannot be prevented from using them This is closely related to externalities No price attached to it If one person provided public good everyone would benefit positive extemality If person catches a fish common resource people are worse off because there are fewer fish negative externality Chapter 11 Public Goods and Common Resources Goods can be thought of as having two characteristics Excludable Can people be prevented from using the good Rival in consumption One person s use of good reduces another person s ability to use it These two characteristics divide goods into 4 categories Rival lif39l eons umptinm quotH es Ne Private Glue3 C ut Gentle 15235 I leecream came I Put pioieetnen F Clothing I Cable TU i Cengeeted mil made I Llnmngeetecl tuli reeds Emiudahle emmun fesnweee FF39LIbIIe Seeds a 6 Fee in the mega391 li Turneduemien I The E z39 ltTDI39imEf39llt I Netienei elenee a Eenge ed merited release I Urieneeeied neutral reeds Free rider Person who receives bene t of a good but doesn t pay for it When people have incentive to be a free rider rather than paying for good market would fail to provide efficient outcome Govemment can pay for public goods with taX revenue to make everyone better off 0 Most Important Public Goods National Defense Basic Research General knowledge not technological knowledge which can be patented and thus excludable Fighting Poverty Cost and benefit analysis Study to estimate costs and benefits of a project to the society as a whole Quantifying benefits is hard to do because people have little incentive to tell the truth if given a questionnaire Efficient provision of public goods is more di icult than the efficient provision of private goods Value of a private good can be determined because when buyers enter market they show how much they value good by prices they are willing to pay Sellers reveal their costs with prices they re willing to accept Cost and benefit analysists do not have any price signals to indicate whether a public good should be provided and how much they estimate costs and benefits of a public project Example on page 222 Common Resources Not excludable but are rival in consumption thus one person s use of a common resources reduces another s ability to use it Policy makers need to be concerned with how much of the common resource is used a problem best understood through the parable called the Tragedy of the Commons Tragedy of the Commons arises because of an externality Due to extemality common resources are often used excessively Govemment can solve this problem by using regulation or taxes to reduce consumption of the common resource or turn it into a private good Tragedy of the Commons story on page 223 0 Common Resources Clean air and water Congested roads Fish whales and other wildlife Chapter 21 The Theory of Consumer Choice Theory of Consumer Choice examines how consumers facing tradeoffs make decisions and how they respond to changes in their environment 0 Budget Constraint What people can afford Majority of people would like to consume more than they do but they are constrained by their income Ex Suppose a consumer has an income of 1000 per month and she can buy pizza for 10 and a liter of Pepsi for 2 Line shown on graph is called the budget constraint as it shows all the combinations that the consumer can afford Mum be Liters Smud lng Spa dll Total Quantity er Firms n Pepsi an Pizza en Pepsi Spending lull Pepsi 1933 El 53000 5 i3 El i 90 EC EDD ICICI l 2 ED lCICI SUE EDIE l Eff 15E WEE SIZE 1351133 ED 213E ECIUZI IJEJEI 1 3313 5C ESE EDD EDD 1 1133 HE EDD 1 DD EDD 1 39 in so 3 5 see run was EC UCI EGG SUD 14133 in i 10 450 100 QUIZ 11133 M D EDD CI 1 CI 1 333 Quanliw hf Fi El Slope 5 liters per pizza Opportunity cost of pizza is 5 liters of Pepsi this is the trade off Page 437 0 Preferences What the consumer wants Consumer chooses bundle of pizza and Pepsi depending on her preferences If two different bundles meet her tastes equally well the consumer is indifferent Indifference curve Shows the various bundles of consumption that make the consumer equally happy Ex If consumption of pizza is reduced consumption of Pepsi must increase to make consumer equally satisfied Marginal rate of substitution rate at which consumer is willing to trade one good for the other Because indifference curve isn t a straight line marginal rate of substitution is not the same at all points Consumer is equally happy at all points given on an indifference curve Consumer prefers higher indifference curves to lower ones because she wants to consume more rather than less Four Properties of Indifference Curves 1 Higher indifference curves are preferred to lower ones Higher indifference curves represent larger quantities of goods 2 Indifference curves slope downward 3 Indifference curves don t cross 4 Indifference curves are bowed inward The marginal rate of substitution slope of an indifference curve which shows rate at which consumer is willing to trade one good for the other depends on the amount consumer is currently consuming Curve bowed inward because people are more willing to trade away goods they have a lot of Indifference curves are less bowed if goods are more easily substituted if the goods are harder to substitute the indifference curves are very bowed Page 439 Perfect Substitutes The indifference curves are Straight if the goods are perfect substitutes EX If someone offered you bundles of nickels and bundles of dimes you would only care about the total monetary value in each Thus you would be willing to trade 2 nickels for l dime Marginal rate of substitution would always be 2 Perfect complements The indifference curves are right angles if the goods are perfect complements EX If someone offered you bundles of shoes you would only care about how many pairs there are A bundle of 5 left shoes and 7 right shoes would only be 5 pairs thus the right shoes are no use These are two extremes usually it is something in between 0 The Consumer s Optimal Choices A consumer wants to end up with the best combination of Pepsi and pizza This is the point at which the indifference curve and budget constraint touch called the optimum Anything above the budget constraint she can t afford Anything below the budget constraint would yield less satisfaction At the optimum the slopes of the indi erence curve and budget constraint are the same The consumer chooses the consumption where marginal rate of substitution relative price Marginal rate of substitution rate at which consumer is willing to trade one good for the other Relative price rate at which the market is willing to trade 0 How Changes in Income Affect Consumer s Choices Increase in income leads to parallel shift in budget constraint consumer can afford more of both goods so curve shifts outward and slope of budget constraint stays the same Now consumer can choose optimum on higher indifference curve Graph where pizza and Pepsi are normal goods Qua min f Peps XiJanquot mm rt 11 Qin m an i i l l 3941 gr 1 I m nil jd hh U w w r b F 1t h n Ini inful f39 bulge eruatmurr If Quantity M Pia Graph where pizza is a normal good and Pepsi is an inferior good uaimiw QEP EFSJ V X ewhudgeizms a nit lrutial y WWW minim ilr39tual if budge L runsang m Ev rr Quantity luff Final Page 444 o How Changes in Prices Affect the Consumer s Choices Fall in price of goods shifts budget constraint outward and changes its slope Impact on consumption with change in price of a good has two effects Income effect Because Pepsi is cheaper you re better off and income has more purchasing power so you can buy both more pizza and Pepsi Substitution effect Because price of Pepsi has fallen you get more liters of Pepsi for every pizza Now that pizza is relatively more expensive you should buy more Pepsi and less pizza If the two effects work at the same time consumer will buy more Pepsi because both effects increase the purchasing of Pepsi but it is ambiguous whether or not consumer buys more pizza Income e ect shifts consumption to higher indifference curve Substitution e ect is a movement along indifference curve 0 Deriving the Demand Curve A consumer s demand curve is a summary of the optimal decision that arise form budget constraints and indifference curves Giffen Good a good that violate the law of demand Usually when the price of a good rises people buy less but if people buy more good is considered a Gi en good Giffen goods are inferior goods where income e ect dominates substitution e ect causing demand curves to slope upward Giffen goods are very rare Ex Carrie has 100 hours a week to divide her time between working and leisure She gets 50 an hour If she spends all her time relaxing she has no consumption If she works for all 100 hours she makes 5000 but no leisure If she works 40 hours a week she makes 2000 and enjoys 60 hours of leisure If her pay increases to 60 she can work less or more Substitution e ect would say Carrie works more because the tradeoff between leisure and consumption becomes more costly Curve slopes upward Income e ect would say Carrie works less because she wants to enjoy both higher consumption and more leisure Curve slopes backward Page 451 o How Do Interest Rates Affect Household Saving Ex If the interest rate is 10 and Saul makes 100000 when he s young and working before he s old and retired then for every dollar saved he can consume 110 when he s retired At the optimal combination of consumption based on his preferences Saul consumes 50000 when he s young and 55000 when he s old If interest rate increases to 20 two things are possible Substitution e ect Because consumption when old becomes less costly relative to consumption when young Saul saves more Income e ect Because of the higher interest rate Saul is better off than he was As long as both goods are normal goods Saul will want to enjoy an increase in consumption both when he s young and old so he saves less Page 455


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