101 Class 05 W2008 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Section 400 Class 5 Coarse wool (bales) 1.75 m Joint PPF Slope = rise/run = 1/2 Slope = rise/run = 3/2 0.75 m Fine wool (bales) 2 m 1/23/2007 Class 5 2.5 m 2 The Supply Curve (when Pcoarse = $500/bale) Pfine ($/bale) $750 Supply $250 2m 1/23/2007 Class 5 2.5m Qfine (bales) 3 Producers' Motivation Producers are motivated to maximize profits: Profits = revenue costs E.g. Australian wool growers produce fine wool when the value of the fine wool produced (revenue) exceeds the value of coarse wool they could produce instead (opportunity cost) Profit from any productive enterprise depends on i.e. positive profits the relative productivity of resources in production of each good the relative prices of the two goods 1/23/2007 Class 5 4 Measuring Benefits to Producers Measure the value of output in dollars Compare this to the dollar value of the opportunity cost Value of the marginal unit is simply the price Marginal unit of the good confers benefit equal to the difference between these two measures Class 5 5 Read this from the supply curve 1/23/2007 Producer Surplus Pfine ($/bale) $750 P =$520 $250 Producer Surplus = 2m * $270 = $540 m Supply 2m 1/23/2007 Class 5 2.5m Qfine (bales) 6 Producer Surplus P P* Producer Surplus Q* 1/23/2007 Class 5 Q 7 Changes in Producer Surplus P P1 P0 Increase in Producer Surplus Q0 1/23/2007 Class 5 Q1 Q 8 Demand Decisions Previous discussion focused on supply decisions Expressed these in the "Supply Curve" Graphical method of expressing dependence of quantity supplied upon (relative) price We wish to do the same with respect to demand decisions What variables influence the quantity of a good demanded? Class 5 9 1/23/2007 Demand Decisions Supply decisions were made by referring to the opportunity cost of producing Demand decisions are made by referring to the opportunity cost of consumption What is the opportunity cost of consumption? The forgone consumption of other goods Consumer has limited resources (budget) The more of that budget that is allocated to consumption of good A, the less good B can be consumed 1/23/2007 Class 5 10 Consumer Valuation A consumer's value of a good is simply the greatest opportunity cost she would bear in order to consume the good i.e. How much consumption of "other goods" would she forgo to consume the good in question? In the market place, those "other goods" could be purchased for a dollar amount The value of a good can be expressed in a dollar amount by using market prices to evaluate the other goods the consumer would be prepared to forgo Class 5 11 1/23/2007 Consumer Valuation Your valuation of an item is The highest price you would ever pay to receive the good At a price higher than your valuation you would not buy the good At a price equal to your valuation, you must be indifferent between buying or not buying If you pay this price, you receive no net benefit from buying the good Marginal valuation Refers to the value of the marginal unit of a good Class 5 12 1/23/2007 Consumer Valuation: An Example Imagine you were presented with the chance to buy a chocolate cake... Two layers of rich chocolate cake Soft ganache frosting Layer of raspberry between the layers Raspberry sauce Whipped cream How much would you pay for such a cake? Class 5 13 1/23/2007 Chocolate Cake Auction Suppose we auctioned the chocolate cake in the class Everybody stands up (when asked) Price will increase Sit down when the price is too high for you Last person standing wins the cake Pays the last price quoted by the auctioneer 1/23/2007 Class 5 14 Marginal Value of Chocolate Cake Marginal Value ($) ??? ??? ??? ??? 100 1/23/2007 200 Class 5 300 Quantity (number of cakes) 15 Marginal Valuation and Demand $ P2 P1 Marginal Value Demand Curve Q2 1/23/2007 Q1 Class 5 Quantity 16 The Law of Demand As the price of a good rises, a consumer typically demands less of that good Marginal value of a good falls as consumption increases Really a reaction to a change in relative price Consumers choose how to allocate budget Relative price expresses tradeoff between alternative consumption goods Law of demand reflects tendency to substitute away from relatively expensive goods To buy relatively expensive goods means the consumer forgoes a lot of alternative goods 1/23/2007 Class 5 17 What variables change the quantity consumers demand? 1. Price of the good 2. 3. 4. Prices of other goods Income "Tastes" Class 5 Law of Demand Low price implies high quantity demanded 1/23/2007 18 Prices of other goods Typical case As good B becomes more expensive, good A becomes relatively cheaper Induces consumer to substitute toward consumption of good A If an increase in P leads to an increase in Q B A demanded, we say B is a substitute for A Examples: Pepsi is a substitute for Coke Cookies are a substitute for chocolate cake Water is a substitute for Miller Light Class 5 1/23/2007 19 Prices of other goods Other case Suppose consumers like to consume goods A and B together If PB rises, then buying a bundle of A and B together becomes more expensive Might lead to substitution away from both A and B (towards some alternative C) If an increase in PB leads to a decrease in QA demanded, we say B is a complement to A Examples: Left and right shoes are complements Whipped cream and chocolate cake are complements Textbooks and U of M tuition are complements 1/23/2007 Class 5 20 Income Typical Case: Increasing income increases the set of goods and services that can be consumed Buying the marginal unit of good A implies that more good B can be purchased when income is high than when income is low Consumer is usually willing to forego more good B to secure the marginal unit of good A, simply because higher incomes allow him to consume additional A and B If an increase in income leads to an increase in the quantity of good A demanded, we say that A is a "normal good" 1/23/2007 Class 5 21 Income Other case: Sometimes, increased income presents the consumer with alternatives that previously were not available Leads to significant substitution away from a cheap good (the only thing affordable at low income) towards expensive good (now affordable at the higher income If increasing income leads to a reduction in quantity of good A demanded, we say that A is an "inferior good" Examples: Ramen noodles Cassava root Taco Bell 1/23/2007 Class 5 22 Tastes Tastes may be variable for all sorts of reasons Consumers may be susceptible to advertising Consumer wants adapt to a changing environment Celebrity endorsements demonstrate the value of associating a product with a desirable image Marginal valuations for ice cream are likely to vary with the temperature Marginal valuations for Ephedra likely to fall when it is revealed that users have been dying Consumer wants adapt to changes in information 1/23/2007 Class 5 23 What shifts the Demand Curve Rightward? $ P1 Increase in the price of a substitute good Reduction in the price of a complemetary good Increase in income (if this is a normal good) Reduction in income (if this is an inferior good) Change in tastes, making this good more desirable Demand Q1 1/23/2007 Q2 Class 5 Quantity 24 What shifts the Demand Curve Leftward? $ P Reduction in the price of a substitute good Increase in the price of a complemetary good Reduction in income (if this is a normal good) Increase in income (if this is an inferior good) Change in tastes, making this good less desirable Demand Q2 1/23/2007 Q1 Class 5 Quantity 25 Measuring Benefits to Consumers Measure the value of goods consumed in dollars Compare this to the dollar amount paid Value of each marginal unit is given by the height of the demand curve This is simply the price Marginal unit of the good confers benefit equal to the difference between these two measures Consumer surplus 1/23/2007 Class 5 26 Consumer Surplus $ Consumer Surplus P1 Demand Q1 1/23/2007 Class 5 Quantity 27 Changes in Consumer Surplus $ P2 P1 Lost Consumer Surplus Demand Q2 1/23/2007 Q1 Class 5 Quantity 28 ...
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