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Chikako Yamauchi
Assistant Professor, GRIPS
Lecture 1
Some Basic Microeconomics
Rosen & Gayer, Textbook Appendix
Demand
What factors affect the amount of goods people are willing
and able to consume in a given period of time?
1. price: increase P - decrease Q
2. income:
normal goods: increase income increase Q
inferior goods: increase income decrease Q
3. price of related goods
substitutes: coffee and tea
complements: coffee and cream
4. tastes: how much people like the good
Demand
Demand schedule:
Holding other factors
constant (income, price
of related goods, tastes)
it shows the relationship
between price and
quantity demanded.
A change in price causes
movement along the
demand curve
What if one of the other
factors changes?
Demand
If one of the other factors
changes, it causes a shift
in the demand curve.
For example, an increase
in the price of tea causes
people to consume more
coffee at each possible
price of coffee.
Remember: A change in
price does not shift the
curve
Supply
What factors affect the amount of goods people are willing
and able to produce in a given period of time?
1. price: increase P - increase Q
2. price of inputs: increased cost of production decrease
Q
3. conditions of production / state of technology: increased
tech. increase Q
Supply schedule: Holding other factors constant (price of
inputs, technology level) it shows the relationship
between price and quantity supplied.
Supply
Equilibrium
Price in which quantity supplied = quantity
demanded
What happens if there are extra supply (Qs >
Qd) or extra demand (Qd > Qs)?
What happens to the original equilibrium if
supply curve shifts towards left due to an
increase in the cost of production?
Equilibrium
Elasticity
Demand and supply curves can be flat or steep
Elasticity measures the shape of supply and
demand curves
Price elasticity of demand: the absolute value of
the percent change in quantity demanded %Q
divided by the percentage change in price
% P
Choice Theory
The fundamental problem in Economics is that resources
available to people are limited relative to their wants
Choice theory shows how people make sensible
decisions in the presence of scarcity
Assume that people derive satisfaction (utility) from
consuming commodities or goods and services
Assume more is always better
Assume people are never satiated: some utility is always
derived from more consumption
Lets consider 2 goods: marshmallows (M) and donuts
(D)
Choice Theory
b provides more utility
than a, while g
provides less utility.
Points in the white area
are unclear: more of
one good but less of the
other. Some points
provide more utility, and
othes provide less utility.
Each point has an
associated level of
utility
Choice Theory
Indifference curve shows all points producing
the same utility
Starting at (a), if I take one donut, how many
M are needed for the same utility?
Suppose 2 M are needed, then (i) is on same
curve
From (a), if I take one M, how
many D are needed? Suppose 2,
then (j).
U0 is an indifference curve
showing all the points with
the same level of utility.
MRS DM
M
D
Rate of trading one good for
another: how many M for 1 D?
Diminishing Marginal Rate of
Substitution: at (i), one has lots of M
and few D, so is willing to give up
more M for 1 D (big slope); but at (ii),
this person already has lots of D, so
not willing to give up as much M for
more D (small slope)
Indifference Map
The entire collection of
indifference curves
Shows everything about a
persons preferences
Moving upward and
rightward increases utility
Utility is maximized by
getting to the highest
possible indifference curve
Budget Constraint
Budget constraint shows rate at which
the market allows a person to substitute D
for M.
Suppose a persons income is 60, M
costs 3 each, and D costs 6 each.
Purchases must satisfy equation:
3M+6D <= 60
If D=0, M=20
If M=0, D=10
Slope=-20/10=-2
You can trade 2 M for 1 D
Budget Constraint
More generally:
P M M + PD D = I
y
PM PD
Slope
I
x
PM
PD
Falling Income
Decreasing income
causes a parallel shift
in the budget line
The slope is the same,
but different
intercepts
Changing Price
Causes the budget line to
pivot along the axis of the
good whose price
changes
Suppose PD increases
from 6 to 12
3M+12D=60
if M=0, then D=5
Now PD/PM=12/3=4
trade 4M for 1D
Consumer Equilibrium
Indifference Curves: show what consumer
wants to do
Budget constraint: show what consumer is
able to do
Goal of consumer: maximize utility given
the budget constraint
Consumer Equilibrium
What point does consumer
choose to maximize utility
given budget constraint?
(i) consumer cant afford
it, though it has higher
utility
Consumer Equilibrium
What point does consumer
choose to maximize utility
given budget constraint?
(ii) consumer is not
spending all of the income.
We are not considering
savings, so resources are
wasted
Consumer Equilibrium
What point does consumer
choose to maximize utility
given budget constraint?
(iii) feasible point, but
consumer can do better by
going to a higher
indifference curve. At (iii),
willing to give up many D
for another M, and this can
be done at an affordable
price
Consumer Equilibrium
What point does consumer
choose to maximize utility
given budget constraint?
(E) best possible point,
highest utility possible with
given budget constraint
U1 is tangent to budget
constraint
How can we characterize
the condition at E?
Consumer Equilibrium
MRS DM
PD
PM
Big change
No change
EC is hypothetical equilibrium
D1 to DC: income effect, decrease
D because of income decline
DC to D2: substitution effect
because of change in relative
prices while being compensated for
lower real income
Consumer Surplus
The demand curve
shows the maximum
amount that individuals
would be willing to pay
for the good
If the actual price is
lower than that, it
contributes to consumer
surplus
When the price
decreases, consumer
surplus increases
Producer Surplus
When we work, we want to be
paid at least a certain rate
(reservation wage), which
increases as we work longer
The wage exceeding our
reservation wage contributes
to producers surplus (note
that workers are the producer
of labor!)
When the wage rae
falls, it reduces
producer surplus