ECN 100A

Indifference Curves Between Food and Clothing

As consumption increases, goods change from being complements to substitutes

Industrial Organization

The study of imperfectly competitive markets. How do firms behave when they have a monopoly? What about when they have market power but have a couple rivals? Strategic behavior.

Solutions to constrained choice

What if Lisa really likes Burritos and never gets sick of them u = 5B + Z MRS = 1/5 Where does MRS = MRT? nowhere! This tells you that she is at a corner solution Consumer buys all one good

Game Theory

What will consumers/firms/etc do in strategic settings where what you want to do might depend on what I do?

More Is Better

all else being the same, more of a commodity is better than less of it (always wanting more is known as nonsatiation).

"More" is Better (free disposal)

all else equal more of a good is better than less of it (can always throw it away)

opportunity set

all the bundles a consumer can buy, including all the bundles inside the budget constraint and on the budget constraint

MRS

along an Indifference curve MRSzb = MUz/MUb Calculate this for our utility function. Notice how it simplifies. What is the interpretation? Draw an indifference curve going through the bundles (Z,B) = (4,16) and (Z,B) = (8,8) with Z on the xaxis. Do both bundles in fact provide the same value of utility? At the point (4,16), how many Burritos would you be willing to give up to get 4 more pizzas?

Budget Constraint

budget line (or budget constraint) the bundles of goods that can be bought if the entire budget is spent on those goods at given prices.

Completeness

can always rank preferences between two bundles (even if they tie)

Engel curve

the relationship between the quantity demanded of a single good and income, holding prices constan

Indifference curve

the set of all bundles of goods that a consumer views as being equally desirable. Indifference map a complete set of indifference curves that summarize a consumer's tastes or preferences

Predicting behavior

(with econ. Models) What firms will do, what stuff people buy, what prices will be, evaluating economic policy (e.g. should the government provide free daycare?)

Solutions to poverty

1.Government provides goods they likely need 2.Government provides "vouchers" for classes of goods they likely need 3.Give them cash What is an example of each of these 3 options? For low income workers, main policy response chosen is intervention in labor market directly (eg. minimum wage). Will discuss later in the course

The Economic Method

1.Who are the economic agents? Consumers and producers 2.What is their "objective function"? Utility/Happiness? Profits? 3.What is the equilibrium? What do we expect to happen? 4.What happens to the equilibrium in response to a shock? We call this "comparative statics" 5.Who gets what, how happy are they, is the equilibrium efficient? We call this welfare analysis

Intervention in Budget Sets

A government rations water, setting a quota on how much a consumer can purchase. If a consumer can afford to buy 12 thousand gallons a month but the government restricts purchases to no more than 10 thousand gallons a month, how does the consumer's opportunity set change?

Curvature of Indifference Curves

Casual observation suggests that most people's indifference curves are convex. Special cases (which are still convex)

Examples of Goods

Cigarettes/tobacco Bottled (Fiji) water Spam Bus tickets Uber rides

Income and Substitution Effects

Consider two goods, x and y. Consumer's utility is U = x^0.5 + y^0.5 Original prices: Px = 4, Py=1 Income: $8 New prices: Px = 4, Py=4 Suppose "compensated" with $10 so total income now $18 1.What was original amount of y consumed? 2.What was amount of y consumed after the price increase? 3.What about after the price increase and income compensation? 4.Therefore... what was the total effect, the substitution effect, and the income effect as a result of Py increasing from 1 to 4?

Allocating Resources

Consumers choosing how (or if) to spend their money; Firms figuring out what products to make and how

Energy Economics

How do we allocate scarce energy resources? If we worry about the environment, how might we want to intervene in energy markets where firms often have market power?

Models and Predictions

How equilibrium will change in response to shocks, demand and supply is highly predictive and useful, provide a mental framework for thinking carefully about how equilibria in various markets will change in response to shocks, especially government interventions

Budget Constraint

If Lisa spends all her budget, Y, on pizza and burritos, then pBB + pZZ = Y where pBB is the amount she spends on burritos and pZZ is the amount she spends on pizzas. This equation is her budget constraint. It shows that her expenditures on burritos and pizza use up her entire budget.

Deadweight loss

If there is deadweight loss in equilibrium, why exactly is the equilibrium inefficient?

Impossible Indifference Curves

Lisa is indifferent between e and a, and also between e and b...so by transitivity she should also be indifferent between a and b...but this is impossible, since b must be preferred to a given it has more of both goods. B, Burritos per semester, Z, Pizzas per semester

Lisa's Food

Lisa's utility for food u= B0.5Z0.5Derive the expression for Lisa's MRS Price of Burritos is $2, Pizza is $1 each. What is MRT? Lisa's income is $60 What is Lisa's optimal consumption of Pizza and Burritos?

Regulatory Economics

Market power is typically bad for welfare. How or how should we not regulate firms with market power?

Indifference Curves and Consumption Levels

Should Indifference Curves look the same no matter what the level of consumption? Example: Clothing and Food

Diminishing marginal rate of substitution

The marginal rate of substitution approaches zero as we move down and to the right along an indifference curve. Will be less and less willing to sacrifice a burrito for another pizza if we've already eaten a lot of pizza Where this property holds, (which is in practice pretty much all the time) indifference curves are always convex. The first bite of pizza always tastes better than the last! For goods with diminishing marginal rates of substitution, the consumer wants as much balance as possible (provided prices do not differ too much we will come to that next!)

Calculating the Optimal Bundle

The twostep process, Use the formula to derive a general relationship between the elements of the bundles For example the ratio of B to Z in an optimal bundle Use the budget constraint to solve for the specific quantities Substituting in the ratio of optimal goods from part 1.

Utility

Utility a set of numerical values that reflect the relative rankings of various bundles of goods. utility function the relationship between utility values and every possible bundle of goods. The level (value) of the utility function doesn't really matter, What matters is how utility changes with respect to the goods that enter into it Utility functions are defined by these tradeoffs

Economic method

Who are the agents? Consumers and Producers 2. What is their objective function? For consumers, it's utility, for producers, it's profits 3. What is equilibrium? A price level where there is neither excess demand nor excess supply Inherently stable. Any point aside from equilibrium is unstable. Why? 4. What if the price of a substitute product rises? Falls? Suddenly there is excess demand or excess supply, and either consumers or producers will change their behavior until there is no incentive for either group to change. That's what equilibrium is. 5. Who benefits from the price of a substitute product falling? Intuitively consumers couldn't be worse off could they?

Welfare Analysis

Who wins and loses from certain shocks? Welfare Analysis: Is equilibrium (Pareto) "efficient" (we will discuss this term later)?

Good

a commodity for which more is preferred to less, at least at some levels of consumption

Individual preferences

determine the amount of pleasure people derive from the goods and services they consume. Consumers face constraints or limits on their choices. Recall that economics is about the allocation of scarce resources Consumers maximize their wellbeing or pleasure from consumption, subject to the constraints they face. As prices change, consumption also changes as consumers reoptimize their purchases These problems are known in mathematical terms as constrained optimization problems and where your calculus comes in handy

Economists often criticized

for their use of models because assumptions are either unrealistic portray humans as either selfish or "utility maximizing"

Deriving demand curves

from consumer optimization problem Consider two goods, x and y. Consumer's utility is U = [x^?][y^(1?)] where 0<?<1 Original prices: Px, PyIncome: Z 1.What is the consumer's demand function for x? Note that it is a function of both prices and total income. 2.What about for y? 3.How does demand for x depend on each variable?

Perfect substitutes

goods that a consumer is completely indifferent as to which to consume.

Perfect complements

goods that a consumer is interested in consuming only in fixed proportions

transivity

if A better than B and B better than C, then A is better than C

Consumer Theory and Income Elasticities

income elasticity of demand, Normal goods, those goods that we buy more of when our income increases, have a positive income elasticity. Luxury goods are normal goods with an income elasticity greater than 1. Necessity goods are normal goods with an income elasticity between 0 and 1. Inferior goods, those goods that we buy less of when our income increases, have a negative income elasticity.

model

is a simplified representation of reality; by definition it makes unrealistic assumptions

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 slope downward. Unless one of the goods is a "bad" 4.Indifference curves cannot cross.

Demand and Supply Predicts

prices and quantities

Changing price of beer

rotates the budget constraint Optimal Consumption changes This traces out a demand curve

Bad

something for which less is preferred to more, such as pollution

Effects of a Price Change

substitution effect the change in the quantity of a good that a consumer demands when the good's price changes, holding other prices and the consumer's utility constant.

income effect

the change in the quantity of a good a consumer demands because of a change in income, holding prices constant.

The Demand curve

the demand curve for coffee and one for Tea We know the price of Tea shifts the demand curve for coffee Do people in this classroom benefit from the price of Tea falling? Forget about areas under the demand curve and let's think about it Three natural cases 1.You bought coffee before and you bought coffee after the price of Tea fell 2.You did not buy coffee before and still don't buy coffee 3.You bought coffee before but now you buy Tea instead Is it possible you buy more coffee? Why/why not? The total effect is not obvious without a mode