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Lecture Outline
Law of Demand – When the price goes up, the quantity demanded goes down.
(Negative correlation)
-Economists believe that the law of demand is nearly always true.
Law of Supply – When the price goes up, the quantity supplied goes up.
(Directly related)
Equilibrium
Sales tax – Causes the demand curve to shift downward parallel to itself by the amount
of the tax.
-Imposing a sales tax reduces the equilibrium quantity. A sales tax of 5 cents per
item causes the equilibrium price to fall by some amount less than 5 cents per item.
Excise tax – A tax on suppliers of goods. It causes the supply curve to ship upward
parallel to itself by the amount of the tax.
-It will affect the equilibrium by the price rising by an amount less than 5 cents.
Who bears the burden of the tax? – Supplier. If you are a demander, would
you choose to have an excise tax of 5 cents or a sales tax of 5 cents? The price to
demanders in both situations is equal.
Consumer choice
Wants – unlimited
Resources – scarce
Preferences
Assume:
At the moment of choice, there is a set of feasible alternatives
And
The chooser can rank his or her preferences over those alternatives
-People rank in an ordinal way (1st, 2nd, 3rd, 4th, etc.)
Preferences over two goods must satisfy two axioms and one assumption:
Axiom of Completeness
Slope of indifference curve – Marginal value is the slope of the indifference curve (the
marginal value that you place on good X is defined to be the number of Ys for which
you’d be just willing to trade one X)
Indifference map -
Special cases:
perfect substitutes
perfect complements
economic “bad”
Constraint: budget line shows a basket of what the consumer can afford
Equation = Px times x + Py times y = I
Px = the price of X in dollars
x = quantity of good x
Py = the price of Y in dollars
y = quantity of good y
I = Income
Slope of constraint
Consumer’s optimal choice - The basket the consumer chooses will always be
located where his budget line is tangent to one of his indifference curves.
MRSyx = Px / Py
Corner solutions – When the consumer’s optimum occurs in a corner of the diagram.
The consumer would spend all of his income on one good and none on the other.
-If a consumer has a nonconvex indifference curve he will end up with a corner
solution
Comparative statics
Own-price changes
Cross price elasticity of demand – Demand for X changes because the price of some
other good Y
-The percent change in consumption of X divided by the percent change in the
price of Y
-If demand for X with respect to Y is positive, X and Y are substitutes
-If negative, compliments
Income changes
normal good – When income rises, if X increases respectively it is normal.
inferior good – When income rises, if X decreases it is an inferior good.
Suggested study:
Review questions Ch 3 (p. 67): R1, R3, R5, R9
Review questions Ch 4 (pp. 103-104): R1, R2, R4, R6, R7, R8, R15