Second Midterm - Class Notes Flashcards
Cross Price Elasticity
Measures the responsiveness of demand of good A to a change in the price of good B
ηab = % change in Q of good A / % change in P of good B
IF ηab > 0, then good A and B are SUBSTITUTES
IF, ηab
Elasticity of Supply
Measures the responsiveness of quantity supplied to a change in price
ηs = % change in Q supplied / % change in PRICE
When…
ηs > 1 supply is ELASTIC
ηs
Application : Product Specific Tax
Imposition of a sales tax suppose the government places a per unit tax upon some commodity
1) What impact does the tax have upon the equilibrium price and quantity?
2) Who pays the tax?
LOOK AT GRAPH EXAMPLE IN BOOK
The Theory of Consumer Behaviour
Theory underlying the demand curve
ASSUMPTIONS ON PREFERNCES
1) COMPLETENESS (Pick one)
When facing a choice between any two bundles of goods, a consumer can rank them so that one and only one of the following relationships is true: The consumer prefers the firs bundle to the second, prefers the second to the first, or is indifferent between them.
2) TRANSITIVITY
If consumer prefers bundle X to bundle Y, and prefers bundle Y to bundle Z, then the consumer bust prefer bundle X to bundle Z
3) NONSATIATION
Ceteris paribus, more of a commodity is preferred than less of it.
Utility
The satisfaction, happiness or need fulfillment that consumers receive from the goods and services they consume
Marginal Utility
The change in utility that results from an incremental change in consumption of a good or service
The Law of Diminishing Marginal Utility
(The more you have something, the less happiness next time)
The greater is the amount consumer of a good or service, the smaller the increase in utility from an incremental increase in the consumption of that good.
Or, the MORE consumed of a good, the smaller is the marginal utility.
The less of the good consumed, the GREATER the marginal utility.
The Consumer Objective
Is to maximize his utility given his level of income
Consumer Equilibrium
The consumer equilibrium is defined as those levels of the quantities such that the consumers utility is maximized.
A consumer equal is achieved when the consumer has NO INCENTIVE to reallocate his budget or to buy a different bundle of goods.
What are the two conditions that consumer equilibrium must satisfy
1) THE CONSUMER MUST SPEND ALL OF HIS INCOME
In our model, there is no saving and borrowing. We can include savings and borrowing into our model but that requires that we introduce time and present value calculations.
2) MU1 / P1 = MU2 / P2 = … = MUn / Pn
(Equimarginal in consumption)
Where MU1 / P1 is the extra satisfaction from an additional dollar spent on good 1
And MU2 / P2 is the extra satisfaction from an additional dollar spent on good 2.
Consumer equilibrium must be equal, if not, it isn’t.
Market Demand
Deriving the market demand from individual demand curves is relatively easy for private goods, simply horizontally sum the individual demands
That is, SUM AT EACH PRICE, the quantities demanded at the price.
Example.
Price = 1, Ind A=5, Ind B=3, Ind C=4, MARKET = 12
Private Goods
Goods that are rival and exclusive
A good is RIVAL if one persons consumption significantly decreases another persons consumption
A good is EXCLUSIVE if someone can be prevented from consuming it
The Demand Curve Shows us Two Things
1) Shows what quantity consumers are willing to buy at a given price
2) Shows what consumers are WILLING TO PAY for a given quantity (for the last unit)
Consumer Surplus
Is the amount the consumer is willing to pay MINUS the amount the consumer has to pay
Is a measure of the benefits the consumer gets by buying a commodity in the market and paying any one price
CALCULATING CONSUMER SURPLUS
(Depends on the type of good)
1) DISCRETE GOOD (You can’t buy a 1/4 of a car)
CS= (WTP1 - P) + (WTP2 - P) + … + (WTPn - Pn)
2) CONTINOUS GOOD (Divisible)
CS= area of the triangle below the demand curve and above the price line.
CS = 1/2 BH
