ma micro tutorial

8/13/2019 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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