W12 MIC 12 Unit 1 Review

# W12 MIC 12 Unit 1 Review - UNIT 1 LEFTOVERS REVIEW Stuff A...

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1 Northwestern University ECON 310-1: Microeconomic Theory Profs Jim Hornsten & Ron Braeutigam Winter 2012 UNIT 1 LEFTOVERS & REVIEW Playtime Stuff IC’s BL’s A Quick Recap of CV & EV Applications Bias in the Consumer Price Index Backward-Bending Labor Supply Exam Details & Studying Tips Review of Unit 1 Notes for Lecture #12

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2 Northwestern University ECON 310-1: Microeconomic Theory Profs Jim Hornsten & Ron Braeutigam Winter 2012 TIPS: CV & EV require 2 IC’s and 4 BL’s New IC with utility U 2 Original IC with utility U 1 Original BL 1 for P x1 A B C D Bundle A: Original bundle on U 1 from BL 1 using P x1 Bundle B: Decomposition bundle from U 1 and P x2 (Substitution Effect) Bundle C: Final bundle from U 2 and P x2 (Income Effect) Bundle D: From U 2 and P x1 Decomposition BL d for P x2 New BL 2 for P x2 Parallel to BL 1 x, Quantity demanded of good x y, the composite good with P y =1 x A x D x B x C
3 Northwestern University ECON 310-1: Microeconomic Theory Profs Jim Hornsten & Ron Braeutigam Winter 2012 The Slutsky Decomposition: S- & I-Effects New IC with utility U 2 Original IC with utility U 1 Original BL 1 for P x1 A B C Bundle A: Original bundle on U 1 from BL 1 using P x1 Bundle B: Decomposition bundle from U 1 and P x2 (Substitution Effect) Bundle C: Final bundle from U 2 and P x2 (Income Effect) Decomposition BL d for P x2 New BL 2 for P x2 x, Quantity demanded of good x y, the composite good with P y =1 x A x B x C The Substitution Effect: SLIDE from A to B The Income Effect: SNAP from B to C

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4 Northwestern University ECON 310-1: Microeconomic Theory Profs Jim Hornsten & Ron Braeutigam Winter 2012 Compensating Variation After the change, what income gift wd fully compensate me for higher price? New IC with utility U 2 Original IC with utility U 1 Original BL 1 for P x1 A B C Decomposition BL d for P x2 New BL 2 for P x2 x, Quantity demanded of good x y x A x B x C “After the change” Start at new bundle C and use new price P x2 “fully compensate” Get me back to U 1 “what income gift” Shift BL outward CV THUS, CV is the size of the (outward) BL shift needed to return me from C to B. Compensation for the harm. “Make me whole again!”
5 Northwestern University ECON 310-1: Microeconomic Theory Profs Jim Hornsten & Ron Braeutigam Winter 2012 Equivalent Variation Before the change, what income sacrifice wd be equivalent to paying the higher price? New IC with utility U 2 Original IC with utility U 1 Original BL 1 for P x1 A C New BL 2 for P x2 x, Quantity demanded of good x y x A x C “Before the change” Start at original bundle A and use original price P x1 “equivalent to paying” Get me in to U 2 “what income sacrifice” Shift BL inward EV THUS, EV is the size of the (inward) BL shift needed to get me from A to D.

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W12 MIC 12 Unit 1 Review - UNIT 1 LEFTOVERS REVIEW Stuff A...

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