3150 Test 2

(4) Things that cause higher elasticity for a product

1. There are many subsitutes for the product 2. The product is a large portion of one's budget 3. The product is a normal rather than inferior good 4. The time period considered is long rather than short

One thousand dollars given to you a year from now is worth _____ to you today if the relevant discount rate is 10%.

$909

Measures of Elasticity

= -1: both price and quantity change in the same proportion <-1: inelastic; quantity is unresponsive to price change >-1: elastic; quantity is highly responsive to price change

Two Principles of Believable Information

1. Cannot be easily counterfeited 2. Will elicit information from others who cannot afford to withhold similar information lest they appear less adequate than their competitors

(4) Ways to Calculate Elasticity

1. Point Slope Method 2. Total Expenditure Method 3. Segment Ratio Method

Two Problems with CPI

1. Uses a fixed basket so it eliminates the possibility that the consumer can fight off inflation by substituting non-inflated goods; overestimates the true effect of inflation 2. Product quality increases make it difficult for the CPI to measure true cost of living changes

If the marginal rate of substitution between future and current consumption is less than one, then this consumer exhibits..

A negative time preference

Positive Time Preference

A pessimist about the future

Aggregating Individual Consumer Demand Curves into Market Demand Curves

Adding each consumer's demand at all possible prices (horizontal summation) Solve demand curves for Q and then add (don't leave them as P=...)

Positive Engel Curve

Amount demanded of a good increases with income - good is normal

Impatient vs Patient Indifference Curves

An patient person will have a flat indifference curve with respect to present consumption Impatient person will have a steep curve with respect to present consumption

Way for businesses to reduce consumer surplus

Charging a flat up-front access fee for the product or service in addition to a per unit charge

If an educational voucher system were adopted where parents could spend their share of education tax dollars at any school of their choice, then we could expect families to...

Choose more education because they do not need to pay double for private education

Price Consumption Curve (PCC)

Connects all optimal market basket points that result from a series of price changes while nominal income is held constant Shows what is happening to the amount of money the consumer is spending on the good

Price of good x rises and demand for good y falls

Cross-price elasticity is negative Good x and good y are complements

Income Elasticity vs Price Elasticity

Denominator is percentage change in income and percentage change in price, respectively

Tax on Gasoline: Purpose & Effects

Designed to conserve fuel without making the consumer worse off Substitution Effect - people use things other than fuel Income Effect - increased spending on fuel because of the tax Substitution Effect is LARGER than Income Effect (goal is achieved)

Indifference Curves & Time

Diminishing Marginal Utility, more is better than less, and transitivity impact a consumer's time preferences Shows the trade-offs a consumer is willing to make between present and future options

Income Effect

Economize by buying even less of the item in question because you feel poorer

What is the plot of the income and quantity information shown in the income-consumption curve?

Engel Curve

An increase in the interest rate will cause...

Future consumption to rise and present consumption to fall

Negative Engel Curve

Good is inferior

Present Value of Lifetime Income

Horizontal intercept of the intertemporal budget constraint

When given an opportunity to deposit 10% of income to the retirement saving account with an equal employer matching contribution, many employees decline the offer. However, when given the same opportunity in the form of future commitment, i.e., the employee's and the employer's contributions would start next years, many of the employees who declined the first would accept. This illustrates the concept of...

Hyperbolic discounting

School Vouchers: what would parents do?

If parents could use (public) school tax to pay for private school (higher quality education) they would buy more education Would have a more highly educated population

Permanent Income Hypothesis

Illuminated by rational choice models which show that increases in present income will be used only partially in the present

Giffen Goods (Income and Substitution Effect)

Income Effect is larger than Substitution Effect Positively sloped demand curve

What relates quantity and consumed to changes in income while prices are held constant?

Income-consumption curve

Say a study reveals that price elasticity of demand for teenage smoking was -0.5. If they government imposed a tax on cigarettes the total expenditure teenagers spend on buying cigarettes would...

Increase

Precautionary saving theory implies that...

Individuals save more when they are uncertain about their future income

What causes economic principles to apply to the generation and allocation of information?

Information is not free

What helps analyze behavior over time?

Intertemporal Choice Models

There has been much discussion over whether marijuana should be legalized. We know that legalizing would lower the price of marijuana. Assume that if it becomes legal the price will be cut in half. Given your text estimate of -1.0 price elasticity for marijuana, what would you expect to be the change in marijuana usage?

It will increase by 50%

PCC Rises...

Less money is being spent

Elasticity for Luxuries vs. Necessities

Luxuries - goods with income elasticity greater than 1 Necessities - between 0 and 1

In a model of present vs future consumption, a decrease in the interest rate will

PRoduce a change in consumption/saving that is theoretically ambiguous, i.e., depends on the particular consumer's preferences

What results from horizontally summing up individual demand curves?

Market demand curve

Cross-Price Elasticity

Measured by the putting the price of another good into the denominator of the elasticity equation

The consumer price index overestimates inflation because it...

Measures the cost of a market basket in the second year that has too many units of the most inflated items (i.e., consumers switched to relatively less expensive goods)

Which of the following goods is likely to have the lowest elasticity of demand? Milk, diamonds, furniture, automobile

Milk

Consumer Surplus

More utility is gained from a purchase than was given up = area under the demand curve of the items bought - amount the consumer paid for the goods

Substitution and Income Effect for Normal and Inferior Goods

Normal Goods - income and subsitution effect work in the same direction Inferior Goods - income and substitution effect work in opposite directions

Ordinary vs. Income-Compensated Demand Curve

Ordinary takes into account both substitution and income effects, while Income-Compensated only takes into account substitution effect

Lifetime Income Hypothesis

People who have irregular income tend to allocate income over time in ways that keep consumption fairly stable from one time period to the next Saving occurs in high income years and borrowing occurs in low income years

Elasticity

Percentage change in quantity divided by the percentage change in price

What documents the quantity consumed for various prices of a good when nominal income is held constant?

Price-consumption curve of the indifference curve model

Two-Part Pricing

Pricing scheme that consists of a fixed fee and a marginal charge for each unit purchased Reduces consumer surplus

Substitution Effect

Purchase less of an item and use something else in its place

A gasoline tax with a rebate...

Reduces oil consumption

"Keeping Up with the Joneses" is the metaphor for....

Relative Income Hypothesis

Taking advantage of housing price changes

Substituting between income and housing in ways that make them better off

Engel Curve

Results from the quantity of a good being analyzed and plotted with the absolute level of income

Negative Time Preference

Saving the best for last A unit of pleasure in the future is worth more than a unit of pleasure now Someone who is optimistic that enormous opportunities are coming

Income Consumption Curve

Shows what nominal income changes alone do to the consumption of a good

Income-Compensated Demand Curve is useful for...

Situations where sales taxation and subsidy programs are related because taxes affect price and subsidies affect income Income-Compensated Demand Distinction is not very important unless the income effect is large

Unit-free Property of Elasticity

Slope of demand curves is sensitive to units used to measure price and quantity while elasticity is not

PCC is Horizontal...

The amount of money spent on the good does not change

PCC Slopes Downward...

The consumer is spending more money overall on the good even though the price fell

Price of good x rises and demand for good y rises

The elasticity is positive Good x and good y are substitutes

Why is the alcohol more elastic than once thought?

The income effect of alcohol price is significant because alcoholics don't have big incomes

A concept derived from the full disclosure principle is....

The lemon principle

The horizontal intercept of the intertemporal budget constraint is referred to as...

The present value of lifetime income

(2) Impacts of Purchasing Habits

The price of a good and your income

What is shown by rotating the budget line around the original indifference curve?

The substitution effect of a price decrease Keeps real income constant but allows the consumer to buy more of the lower-priced good than was originally planned

Full Disclosure Principle explains what about used vs new products?

Used are going to be cheaper because there's a higher chance of them being defective People will sell defective things and keep the non-defective things

What influences the location of an intertemporal budget constraint?

Variations in the time when income is received and the interest rate paid on the income

(3) Influences on Time Preference

Varying estimations of the uncertainty of the world Varying estimations of the good or bad anticipatory value of upcoming events The degree to which our sense are directly affected

MARTA Fare increase

Was wise from a profits maximizing point of view

Intertemporal budget constraint shows

What consumption options are availble between the present and future

When does optimal intertemporal allocation occur?

When the intertemporal indifference curve and intertemporal budget constraint are tangent

Suppose you receive Y1 of your income this period and Y2 of your income next period. If you can either borrow or lend at an interest rate r, what is the most you can consume in the current period?

Y2 / (1+r)+Y1

Based on the economic theory of rational choice, if you buy food when it is put on special at half price just after you paid (hint: recall the example of changing prices of houses from class):

You will be better off because you will go back to get some more food at bargain prices

What is the most likely cross-price elasticity between beef and vegetables for a strict vegan when the price of vegetables increases?

Zero

When prices change from one year to the next...

consumers adjust their market basket and their overall welfare will be impacted.

According to the Life-Cycle Hypothesis, if a person received a payment roughly equal to her current income, her consumption would...

increase, but not by as much as the increase in income

When a product depicted on the horizontal axis of a typical indifference curve model behavior is taxed...

the budget line becomes steeper