MA Micro Tutorial
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Transcript of MA Micro Tutorial
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App ly ing the Supply-and-Demand Model
Questions:
1. cigarettes taxes: how big a tax is needed to discourage a substantial numberof people from smoking?
2. health care: if Congress passes a law forcing firms to provide health care, willfirms pass on the full amount of these mandatory fees to consumers?
3. condoms: how much of a subsidy is necessary to encourage Frenchconsumers to use 70% more condoms?
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What-if questions
how do equilibrium price and quantity change when an underlying factorchanges? use graphs to predict qualitative effects of changes: The direction of change
need to know shape of demand and supply curves to determine quantitativechange:
> amount equilibrium quantity and price change
Shapes of demand and supply curves matter
supply shock (25 increase in price of hogs) effect on Canadian processedpork depends on shape of demand curve supply shock causes supply curve of pork to shift left from S1 to S2
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Elasticity of demand
Price elast ic i ty of demand:
summarize sensitivity of the quantity demanded to price in a single statistic:
Linear demand curve
linear demand: Q = a bp elasticity of demand:
pork demand curve: Q = 28620p
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Types of elasticities:
elastic: the quantity demanded changes more than in proportion to achange in price
inelast ic: the quantity demanded changes less than in proportion to achange in price elasticity of demand varies along most linear demand curves
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Income elasticity of demand- how quantity of one good changes as incomechanges
- positive indicates a normal good - negative indicates an inferior good
Cross-price elasticity of demand- how quantity of one good changes as priceof another good changes
- positive indicates goods are substitutes - negative indicates goods are complements
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Price elasticity of supplythe responsiveness of producers to changes inproduct price
supply curve is elastic if > 1 supply curve is inelastic if 0 < < 1
EX: pork supply curve is Q = 88 + 40p
so pork supply elasticity is
as price of pork increases by 1%, the quantity supplied rises by nearlytwo-thirds of a percent
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Two types of sales taxes
ad valorem tax(the sales tax): for every dollar the consumer spends, the
government keeps a fraction, speci f ic (un i t) tax: a specified amount, , is collected per unit of output
4 Questions about sales taxes
1. What effect does a specific sales tax have on equilibrium prices andquantity?
2. Are sales taxes assessed on producers "passed along" to consumers?(do consumers pay entire tax?)
3. Do equilibrium price and quantity depend on whether the consumers orproducers are taxed?
4. Do both types of sales taxes have the same effect on equilibrium?
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Price impact of tax
amount by which tax affects equilibrium price depends on elasticities ofsupply and demand
government raises tax by price consumers pay increases by
Effect of a $1.05 Specific Tax on the Pork Market Collected from Producers
Price increases by $.70paid by consumer
Producers pay the tax and are left with $.35lessamount paid by producers
Government receives the tax * amount sold
= $216.3 million
- dependent upon the elasticity ofsupply, elasticity of demand, and thesize of the price change
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Tax incidence: incidence of a tax on consumers is share of tax that consumerspay
Restaurant tax incidence estimated demand and supply for restaurant meals (Brown 1980):
constant elasticity demand curve: = -0.188 constant elasticity supply curve: = 6.47
original equilibrium: Q1 = 8.14 billion meals per year
p1 = $10.47 per meal ($1992)-- can you calculate the incidence from a $1 tax?
Incidence specific gasoline taxes specific taxes
federal range from nearly 11 and 20 per gallon state from 7 to 36 per gallon
incidence: federal tax every 1 increase retail price up wholesale price down
incidence: state tax every 1 increase retail price up 1 no wholesale price effect
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Consumer Behavior
Individual decision making
consumers face constraints on their choices
consumers maximize their pleasure from consumption subject to constraints
Consumers problem
consumer allocates money over goods: buys a bundle or market basket of goods
2 possible theories of consumer behavior
maximizing behavior random behavior
Assumptions about consumer preferences
1. completeness
2. transitivity3. more is better
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Indifference curve
identifies all the bundles that give the same amount of pleasure or utility
Indifference curve properties1. bundles on indifference curves farther from the origin are preferred to those on indifference
curves closer to the origin2. there is an indifference curve through every possible bundle3. indifference curves cannot cross4. indifference curves slope down
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Marginal Rate of Substitution-- Along an indifference curve a person trades one bundle on an for another by giving up some
burritos to gain more pizzathe rate of exchange is the marginal rate of substitution
-- indicates the
Budget constraint If a person spends all their income, Y, on pizza and burritos their budget constraint is
Y = pBB + pzZ orpBB = expenditure on B burritospzZ = expenditure on Z pizzas
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Change in Price
If one price rises price of pizza doubles:pZ=$2 (up from $1) with the price of burritos and income unchanged
slope of the new budget line causes the budget constraint to swing inward opportunity set shrinks
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Change in income if consumer's income, Y, increases from say $50 to $100parallel shift out of budget line
opportunity set grows consumer can buy more of all goods
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Budget line meets indifference curves
maximize utility subject to the budget constraint
Tangency property
at interior optimum, indifference curve is tangent to budget line:
last dollar spent on pizza gives as much extra utility as that spent on burrito
Point emaximum utilitythat can be achieved
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Food stamps
Are poor people necessarily better off receiving food stamps or acomparable amount of cash?
Answer
cash gives a greater choice whether that greater choice matters depends on the tastes of poor people
(how much food they eat)
Points of tangency belowand to the right of ebothare equivalent
Points of tangency aboveand to the left of ecash is
preferred
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Deriving Demand Curves
trace out the demand curve byholding income and the priceof one good (wine) constantand varying the price ofanother (beer)
example: estimated set of
indifference curves for thetypical American consumer arebowed away from origin
consumers' tastes (indifferencecurves) determine the shape
of the demand curve (elasticityof demand)
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Question
Congress must decide how to aid poor families
child-care program could provide an ad valorem or a specific subsidy (asmany states currently do under PRWORA)
alternatively, government could provide an unrestricted lump-sumpayment under the major welfare program that could be spent on daycare or on all other goods such as food and housing
for a given government expenditure, does the price subsidy or the lump-sum subsidy provide greater benefit to recipients?
which increases the demand for day care services by more?
which inflicts less cost on other consumers of day care?
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Solution
on initial budget constraint is Lo, poor family chooses the bundle e1
with a day-care price subsidy, budget line is LPS
; family consumes e2
measure the value of the subsidy to family: calculate how many othergoods the family could buy before and after the subsidy
(given price of other goods is $1 per unit, these other goods are
essentially income, Yo)
given family consumes Q2hours of day care, family could haveconsumed Yo other goods with the original budget constraint and Y2with LPS
thus, value to family of day-care price subsidy is Y2Yo
lump-sum payment of Y2Yo, budget constraint LLSgoes through e2,but
family chooses e3
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Firms- an organization that converts inputs (labor, materials, and capital) intooutputs (goodsand services)
Objectives conflicting objectives between owners, managers, and other employees
employees want to maximize their earnings or utility (most pay for least work)
owners want to maximize profit:
profit = TR - TC TR = revenue =pq = price x quantity TC = total cost = variable cost + fixed cost
Production
production process: transform inputs or factors of production into outputs common types of inputs:
capital (K): buildings and equipment labor services (L) materials (M): raw goods and processed products
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Variability of inputs over time
short run: a period of time so brief that at least one factor of production isfixed
fixed input: a factor that cannot be varied practically in the SR variable input: a factor whose quantity can be changed readily during the
relevant time period
long run: lengthy enough period of time that all inputs can be varied
firm can more easily adjust its inputs in the long run (LR) than in the shortrun (SR)
Law of diminishing marginal returns (product) - as a firm increases an input,holding all other inputs and technology constant,
the corresponding increases in output will become smaller eventually that is, the marginal product of that input will diminish eventually
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Long-run production: Two variable inputs
both capital and labor are variable many combinations of L and K produce a given level of output:
q = f (L, K)
Isoquant
curve that shows efficient combinations of labor and capital that canproduce a single level of output (quantity)
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3 major properties of isoquants-- follow from the assumption that productionis efficient:
1. further an isoquant is from the origin, the greater is the level of output2. isoquants do not cross3. isoquants slope down
Substituting inputs
-- slope of an isoquant shows the ability of a firm to substitute one input foranother while holding output constant
Marginal rate of technical substitution (MRTS)
tells how much a firm can increase one input and lower the other so as tostay on an isoquant
tells us how many units of K firm can replace with an extra unit of L,holding output constant
varies along a curved isoquant
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Two-step procedure to choose technology
1. pick all technologically efficient production processes2. from these technologically efficient production processes, pick the one
that is economically efficient (minimizes cost)
oppor tun i ty cost
value of best alternative use of the resource classic example: "There's no such thing as a free lunch" What have you given up to study opportunity costs
bus iness costs: only explicit costs (out of pocket)
econom ic costs: explicit cost + implicit cost
Short-run cost measures
fixed cost (FC): production expense that does not vary with output variable cost (VC): production expense that changes with quantity of
output produced total cost (TC): TC = VC + FC
Marginal cost (MC)
change in cost, C, when output changes by q MC = C/q
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Input choice-- choose from all technologically efficient combinations of inputs,the economically efficient combination of inputs
Costs of input bundles
isocost: all combinations of inputs that require the same expenditure (cost) with two production inputs: cost is C = wL + rK or
slope of each isocost line isthe same: K/L = -w/r
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Cost-minimizing rules-- to pick lowest-cost combination of inputs to produce a given level of
output:
pick bundle of inputs where lowest isocost line touches isoquant isoquant is tangent to isocost line: MRTS = |ratio of the input prices| = w/r
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Relative factor price changes
cause firm to change the mix of inputs used firm substitutes relatively less expensive inputs for more expensive ones
EX: original wage = 24 kr, so w/r = 3 kr = krone (Norways Currency) new wage = 8 kr, so w/r = 1
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