511Notes - QE1 Economics Notes 1 Box 1 The Household and...

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QE1: Economics Notes 1 1 Box 1: The Household and Consumer Welfare The final basket of goods that is chosen are determined by three factors: a. Income b. Price c. Preferences Substitution Effect: change in consumption due to a change in price; whenever the price of a good increases, you purchase less of the good. The substitution effect is negative because an increase in price reduces your consumption. A reduction in price increases your consumption. Income Effect: the additional change in consumption of good 1 that is due to the fact that the price increase reduces the real income of the consumer. If income rises, then this a shift in the demand curve because a higher income is going to cause you to demand a higher quantity of all goods. Shifts in the Demand Curve: Changes in the prices of other goods Changes in tastes/preferences If there is a change in price, then it is a change along the demand curve NOT a shift in the curve. This is a change due to the income and substitutions effects Labor and Wages in Microeconomics Wage : the cost of labor. When you work, you forego leisure which is a normal good; the wage is your compensation for foregoing leisure. Substitution effect of an increase in wage : an increase in your wage is an increase in the cost of leisure. When wage increases, you work more because the cost of leisure has increased. Income effect of an increase in wage : when your wage increases, you feel richer and so you consume more of all goods, including leisure. Economic Efficiency and Policy For policy, we want to be able to answer the following questions: 1. What is the impact of the policy on government revenues? 2. What is the impact of the policy on the well-being of individuals? 3. Is the policy efficient? 4. Is the policy equitable? Relative Efficiency : benefits to those who gain exceed the losses to those who lose.
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