101+Class+06+W2009 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Section 400 Class 6 Efficient Allocation of Goods A black forest cake is to be allocated to one person from a group of five Consumer Valuation ($) Alice 50 Bruce 40 Calvin 70 Doug 30 Emma 60 Who should get the cake? How is the cake most efficiently allocated? 1/28/2009 Class 6 2 Efficient Allocation of Goods Suppose Alice consumes the cake VAlice = $50 V Calvin = $70 If Calvin gives Alice $60 and Alice gives Calvin the cake, both are better off There exists a way to reallocate resources that makes some people better off and makes nobody worse off Class 6 3 1/28/2009 Efficient Allocation of Goods Goods are most efficiently allocated to the consumers with the highest valuation E.g. Allocate the cake to Calvin, whose valuation of the cake is highest What if there were 2 cakes? Or 3 cakes? Can we deduce the value of the marginal cake? Class 6 4 1/28/2009 Efficient Allocation of Goods Consumer Valuation ($) Marginal Value 70 60 50 40 30 1 2 3 4 5 Q (no. of cakes) Alice 50 Bruce 40 Calvin 70 Doug 30 Emma 60 1/28/2009 Class 6 5 Marginal Valuation and Demand 70 60 50 40 30 1 2 3 4 5 Demand Q (no. of cakes) 1/28/2009 Class 6 6 The Demand Curve The Demand Curve shows the quantity of a good consumers demand at every feasible price at which the good might sell Derived from the marginal valuation curve In fact, the inverse of the MV curve Similar to the way the supply curve is read as the inverse of the marginal opportunity cost curve 1/28/2009 Class 6 7 The Law of Demand As the price of a good rises, consumers demand less of that good i.e. Marginal value of a good falls as consumption increases Really a reaction to a change in relative price If goods 1 and 2 cost P1 and P2, then P1/P2 is the relative price of good 1 Class 6 8 1/28/2009 The Demand Curve $ P2 P1 Demand Q2 1/28/2009 Q1 Class 6 Quantity 9 What variables change the quantity consumers demand? Anything that changes the value of the marginal value of the good: Price of the good 1. 2. 3. 4. 1/28/2009 Prices of other goods Income "Tastes" Class 6 Law of Demand Low price implies high quantity demanded 10 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 6 1/28/2009 11 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 Class 6 1/28/2009 12 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" 1/28/2009 Class 6 13 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 1/28/2009 Class 6 14 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 1/28/2009 Class 6 15 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 1/28/2009 Q2 Class 6 Quantity 16 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 1/28/2009 Q1 Class 6 Quantity 17 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 Marginal surplus measure 1/28/2009 Class 6 18 Marginal Consumer Surplus $ Marginal Surplus P1 Demand Q1 Q1+1 1/28/2009 Class 6 Quantity 19 Consumer Surplus $ Consumer Surplus P1 Demand Q1 1/28/2009 Class 6 Quantity 20 Changes in Consumer Surplus $ P2 P1 Lost Consumer Surplus Demand Q2 1/28/2009 Q1 Class 6 Quantity 21 ...
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This note was uploaded on 05/16/2010 for the course ECON Section 40 taught by Professor Hogan during the Winter '09 term at University of Michigan.

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