Download - MEM Lecture 7 2014
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MEM Lecture 7
Biresh Sahoo, Ph.DProfessor , XIM, Bhubaneswar
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Application: Welfare effects of changes inhousing prices
Consider the following two scenarios:1. A builder has purchased a house for Rs.20,00000.
The very next day, the prices of all houses, includingthe one the builder just bought, double.
2. The builder has purchased a house for Rs.20,00000.The very next day, the prices of all houses, includingthe one the builder just bought, fall by half.
In each case, how does the price change affect thebuilders welfare? (Can the builder be better offbefore the price change or after?) Assume that m =
Rs.40,000009/2/2014 2
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20,00000
40,00000
60,00000
1 21.5H2 Qty. of housing (x)
Other goods (y)
u 0
u 1
0
O 2
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A
B
B2B1
Scenario I
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1 2 3
40,00000
20,00000
30,00000
H3
O3
B1
B2
A
B
u 0
u 1
Scenario II
0
Qty. of housing (x)
Other goods (y)
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Application of demand analysis While at a discount shoe store, a customer asked a clerk, I see
that your shoes are buy one, get one free - limit one free pair percustomer. Will you sell me one pair for half -price? The clerkanswered, I cant do that. When the customer started to leavethe store, the clerk hastily offered, However, I am authorized togive you a 40 percent discount on any pair in the store.
Assuming the consumer has $200 to spend on shoes (X) or allother goods (Y), and that shoes cost $100 per pair, answer thefollowing questions:a) Illustrate the consumers opportunity set under the buy
one, get one free deal and under a 40 percent discount. b) Why was the 40 percent discount offered only after the
consumer rejected the buy one, get one free deal andstarted to leave the store?
c) Why was the clerk willing to offer a buy one, get one free
deal, but unwilling to sell a pair of shoes for half-price?2 September 2014 5
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o1 2 3 4
100
200
Pairs ofshoes (x)
Income on othergoods (y)
ICB
A
D
J
N
F
H M K
G
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Application of demand analysis
A common marketing tactic among many liquorstores is to offer their clientele quantity (or volume)discounts. For instance, the second-leading brand of
wine exported from Chile sells in the US for $8 perbottle if the consumer purchases up to eight bottles.The price of each additional bottle is only $4. If aconsumer has $100 to divide between purchasing thisbrand of wine and other goods, graphically illustratehow this marketing tactic affects the consumersbudget set if the price of other goods $1. Will aconsumer ever purchase exactly eight bottles of wine?Explain.
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4 8 12 16
17
1020
30405060
708090
100
12.5
36
Bottles ofWine
OtherGoods
0
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4 8 12 16
17
1020
30405060
708090
100
12.5
36
Bottles ofWine
OtherGoods
0
uo
u1
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4 8 12 16
17
1020
30405060
708090
100
12.5
36
Bottles ofWine
OtherGoods
0
uo u1
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Market demand: How to arrive at?Summing individual demand curves to derive market demand forsandwiches
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0 2 4 6
P r i c e
2
4
6
d Y
(a) You
0 2 4
2
4
6
d B
(b) Brian
0 2
2
4
6
d C
(c) Chris
0 2 6 12
2
4
6
d Y +d B+d C =D
(d) Market demandfor sandwiches
Sandwiches per month
Market demand curve is the horizontal sum of individual demand curves
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Determinants of demand
IncomePrices of substitutes
Prices of complements AdvertisingPopulation
Consumer expectations
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Change in quantity demandedPrice of pizza (p)
Pizzas (x)
D0
4 7
10
6
A
A to B: Increase in quantity demanded ( x)
B
0
p
x
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Price of pizza (p)
Pizzas (x)
D0
D1
6
7
D0 to D1: Increase in demand ( x)
Change in demand
12 0
x
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Application: Consumer surplus (CS)
The value consumers get from a good but do nothave to pay for it.
That is, the amount a buyer is willing to pay for agood minus the amount the same buyer actuallypays for it.
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An illustrative example:Imagine that you have a digital camera, and because now you badly
need money, you decide to sell it. One way to do so is to holdan auction. Assume that four persons show up for your auction.
Buyer Willingness to Pay JohnPaulGeorgePeter
Rs.1000Rs. 800Rs. 700Rs. 500
To sell your camera, you begin bidding at a low price, say Rs.100.Because all four buyers are willing to pay much more, the price
rises quickly. The bidding stops when John bids Rs.800 (orslightly more). Note that camera will go to that buyer who valuesit most highly.
Johns CS = Rs.1000 Rs.800 = Rs.200
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Example continued
Therefore, price rises until two buyers are left. In this case,John and Paul bid Rs.700 (or slightly higher). At this price,both John and Paul each receive CS of Rs.300 and Rs.100.
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Now consider a somewhat different example. Supposethat you have two identical cameras to sell. Again, youauction them off to the four possible buyers.
To keep things simple, we assume that both cameras areto be sold for the same price and that no buyer isinterested in buying more than one camera.
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Using DD curve to measure CSPrice Buyers Quantity
1000 < p800 < p < 1000700 < p < 800500 < p < 700
p < 500
None John John, Paul John, Paul, George John, Paul, George, Peter
01234
1 2 3 4
1000
500
800700
0
P r i c e
Camera
Johns CS = 500
Pauls CS = 300
Georges CS = 200
Peters CS = 0
DemandcurveTotal CS = 1000
CS: Discrete
demand curve
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CS: Continuous DD curve
Price (p)
Quantity (x)
D
10
8
6
4
2
1 2 3 4 5
Total willingness to pay for 4
units = Rs.24CS = 16
Actual amount paid for 4
units = Rs.8
0
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Learning and applying CS
Assume that Johns dd. curve for court time is: p = 50 - (1/4)x,where x is measured in hours per year. What is the maximumannual membership fees John would be willing to pay for the
right to buy court time for Rs.25/hr?
Court time (hr/yr)
Price(Rs./hr)
50
25
100 2000
A
CB
CS = (1/2)*100*25= Rs.1250
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Why do some tennis clubs have an annual membershipcharge in addition to their hourly court fees?
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