Short-Run Pain, Long-Run Gain - Initiative for Policy Dialogue
Short-Run Versus Long-Runyamamoto/files/Apr_25.pdf · Short-Run Versus Long-Run Elasticity (pp. 38...
Transcript of Short-Run Versus Long-Runyamamoto/files/Apr_25.pdf · Short-Run Versus Long-Run Elasticity (pp. 38...
Chapter 3 1©2005 Pearson Education, Inc.
Short-Run Versus Long-RunElasticity (pp. 38 - 46)
�Price elasticity varies with the amount oftime consumers have to respond to aprice
�Short-run demand and supply curvesoften look very different from their long-run counterparts
Chapter 3 2©2005 Pearson Education, Inc.
Short-Run vs. Long-RunElasticity – An Application (pp. 45 - 6)
�Why are coffee prices very volatile?�Most of the world’s coffee is produced in
Brazil
�Many changing weather conditions affect thecrop of coffee, thereby affecting price
�Price following bad weather conditions isusually short-lived
�In long run, prices come back to originallevels, all else equal
Chapter 3 3©2005 Pearson Education, Inc.
Price of Brazilian Coffee (pp. 45 - 6)
Chapter 3 4©2005 Pearson Education, Inc.
Short-Run vs. Long-RunElasticity – An Application (pp. 45 - 6)
�Demand and supply are more elastic inthe long run
� In the short run, supply is completelyinelastic�Weather may destroy part of the fixed supply,
decreasing supply
�Demand is relatively inelastic as well
�Price increases significantly
Chapter 3 5©2005 Pearson Education, Inc.
D
P0
S
Q0 Quantity
PriceA freeze or drought
decreases the supplyof coffee
S’
Q1
An Application - Coffee (pp. 45 - 6)
Price increasessignificantly due toinelastic supply and
demand
P1
Chapter 3 6©2005 Pearson Education, Inc.
S’
D
S
P0
Q0
P2
Q2
Intermediate-Run1) Supply and demand are more elastic2) Price falls back to P2.
An Application - Coffee (pp. 45 - 6)
Quantity
Price
Chapter 3 7©2005 Pearson Education, Inc.
SP0
Q0
Long-Run1) Supply is extremely elastic2) Price falls back to P0.3) Quantity back to Q0.
An Application - Coffee (pp. 45 - 6)
Quantity
Price
D
Chapter 3
Consumer Behavior
Chapter 3 9©2005 Pearson Education, Inc.
Introduction (pp. 64 - 5)
�How are consumer preferences used todetermine demand?
It is very likely that your consumption pattern isdifferent from any of your friends with more or lesssame income.
�How do consumers allocate income tothe purchase of different goods?
Do you spend your income only on phone bills?
Chapter 3 10©2005 Pearson Education, Inc.
Introduction (pp. 64 - 5)
�How do consumers with limited incomedecide what to buy?
Do you think a family with no babies spend theirincome for baby’s items?
�How can cost of living indexes measurethe well-being of consumers?
Chapter 3 11©2005 Pearson Education, Inc.
Consumer Behavior (pp. 64 - 5)
� The theory of consumer behavior can beused to help answer these and manymore questions
� Theory of consumer behavior�The explanation of how consumers allocate
income to the purchase of different goodsand services, or theories behinds consumerdemand curves, QD=QD(P, …)
Chapter 3 12©2005 Pearson Education, Inc.
Consumer Behavior (pp. 64 - 5)
�Example: Consumption patterns ofJapanese Households (See the figureson my handouts. The figures are takenfrom Kakei Chosa (Family Income andExpenditure Survey, Ministry of InternalAffairs and Communications))
http://www.stat.go.jp/english/data/kakei/index.htm
Chapter 3 13©2005 Pearson Education, Inc.
Consumer Behavior (pp. 64 - 5)
� There are three steps involved in thestudy of consumer behavior
1. Consumer Preferences� To describe how and why people prefer
one good to another (You havepreferences)
2. Budget Constraints� People have limited incomes (Opportunities
are limited)
Chapter 3 14©2005 Pearson Education, Inc.
Consumer Behavior (pp. 64 - 5)
3. Given preferences and limited incomes,what amount and type of goods will bepurchased?� What combination of goods will consumers
buy to maximize their satisfaction? (Make arational or optimal choice)
Chapter 3 15©2005 Pearson Education, Inc.
Consumer Preferences (pp. 65 - 79)
�How might a consumer compare differentgroups of items available for purchase?
�A market basket is a collection of one ormore commodities
� Individuals can choose between marketbaskets containing different goods
Chapter 3 16©2005 Pearson Education, Inc.
Consumer Preferences – BasicAssumptions (pp. 65 - 79)
1. Preferences are complete� Consumers can rank market baskets
2. Preferences are transitive� If they prefer A to B, and B to C, they must
prefer A to C
3. Consumers always prefer more of anygood to less� The more, the better
Chapter 3 17©2005 Pearson Education, Inc.
Consumer Preferences (pp. 65 - 79)
�Consumer preferences can berepresented graphically usingindifference curves (for the case of 2goods)
� Indifference curves represent allcombinations of market baskets that theperson is indifferent to�A person will be equally satisfied with either
choice
Chapter 3 18©2005 Pearson Education, Inc.
Indifference Curves:An Example (pp. 65 - 79)
4010H
2010G
4030E
2040D
5010B
3020A
Units of ClothingUnits of FoodMarket Basket
Chapter 3 19©2005 Pearson Education, Inc.
Indifference Curves:An Example (pp. 65 - 79)
�Graph the points with one good on the x-axis and one good on the y-axis
�Plotting the points, we can make someimmediate observations aboutpreferences�The more, the better
Chapter 3 20©2005 Pearson Education, Inc.
The consumer prefersA to all combinations
in the yellow box, whileall those in the pink
box are preferred to A.
Indifference Curves:An Example (pp. 65 - 79)
Food
10
20
30
40
10 20 30 40
Clothing 50
G
A
EH
B
D
Chapter 3 21©2005 Pearson Education, Inc.
Indifference Curves:An Example (pp. 65 - 79)
�Points such as B & D have more of onegood but less of another compared to A�Need more information about consumer
ranking
�Consumer may decide they areindifferent between B, A and D�We can then connect those points with an
indifference curve
Chapter 3 22©2005 Pearson Education, Inc.
•Indifferentbetween points B,A, & D•E is preferred toany points on theindifference curveU1•Points on U1 arepreferred to H & G
Indifference Curves:An Example (pp. 65 - 79)
Food
10
20
30
40
10 20 30 40
Clothing50
U1GD
A
EH
B
Chapter 3 23©2005 Pearson Education, Inc.
Indifference Curves (pp. 65 - 79)
�Any market basket lying northeast of anindifference curve is preferred to anymarket basket that lies on theindifference curve
�Points on the curve are preferred topoints southwest of the curve
Chapter 3 24©2005 Pearson Education, Inc.
Indifference Curves (pp. 65 - 79)
� Indifference curves slope downward tothe right�If they sloped upward, they would violate the
assumption that more is preferred to less� Some points that had more of both goods would
be indifferent to a basket with less of both goods
Chapter 3 25©2005 Pearson Education, Inc.
Indifference Curves (pp. 65 - 79)
� To describe preferences for allcombinations of goods/services, we havea set of indifference curves – anindifference map�Each indifference curve in the map shows
the market baskets among which the personis indifferent
Chapter 3 26©2005 Pearson Education, Inc.
U2
U3
Indifference Map (pp. 65 - 79)
Food
Clothing
U1
ABD
Market basket Ais preferred to B.Market basket B ispreferred to D.
Chapter 3 27©2005 Pearson Education, Inc.
Indifference Maps (pp. 65 - 79)
� Indifference maps give more informationabout shapes of indifference curves�Indifference curves cannot cross
� Violates assumption that more is better
�Why? What if we assume they can cross?
Chapter 3 28©2005 Pearson Education, Inc.
Indifference Maps (pp. 65 - 79)
Food
Clothing
•B is preferred to D•A is indifferent to B & D•B must be indifferent toD but that can’t be if B ispreferred to D. Acontradiction
U1
U1
U2
U2
A
B
D
Chapter 3 29©2005 Pearson Education, Inc.
Indifference Curves (pp. 65 - 79)
� The shapes of indifference curvesdescribe how a consumer is willing tosubstitute one good for another�A to B, give up 6 clothing to get 1 food
�D to E, give up 2 clothing to get 1 food
� The more clothing and less food a personhas, the more clothing they will give up toget more food
Chapter 3 30©2005 Pearson Education, Inc.
A
B
D
EG
-1
-6
1
1
-4
-21
1
Observation: The amountof clothing given up for 1 unit of food decreasesfrom 6 to 1
Indifference Curves (pp. 65 - 79)
Food
Clothing
2 3 4 51
2
4
6
8
10
12
14
16
Chapter 3 31©2005 Pearson Education, Inc.
Indifference Curves (pp. 65 - 79)
�We measure how a person trades onegood for another using the marginal rateof substitution (MRS)�It quantifies the amount of one good a
consumer will give up to obtain more ofanother good, or the individual terms of trade
�It is measured by the slope of theindifference curve