Transcript Slide 1

1. Budget Constraint
PA = $12 PB = $2.40 Income = $72
A
0
1
2
3
4
5
6
B
__
__
__
__
__
__
__
7
6
5
4
3
2
1
0
5
10 15 20 25 30 35 40 45 50
MUB
MUN
MUA
=
=
... = P
PB
PA
N
Choices are based on
Comparisons of MU per $
spent on each good
Would a person maximize
satisfaction by buying a
$15 product that adds
twice as much
satisfaction as a $5
product?
Item
Pants
Price
$60
Utility
125
Shirt
$40
100
Wallet
$20
50
Marginal Utility per $
Number
Bought
Domestic
$1
MU
Imported
$2
MU
1
10
24
Domestic
MU/$
____
2
8
20
____
____
3
7
18
____
____
4
6
16
____
____
5
5
12
____
____
6
4
6
____
____
7
3
4
____
____
With Constraint
Imported
MU/$
____
Without Income Constraint? With $12?
2. Budget Increase
PA = $12 PB = $2.40 Income = $72 $84
A
0
1
2
3
4
5
6
7
B
35
30
25
20
15
10
5
0
3. Price Change
PA = $12 PB = $2.40 $3 Income = $72
A
0
1
2
3
4
5
6
B
24
20
16
12
8
4
0
Why the Demand Curve slopes down
One Reason:
Substitution Effect
At a lower price consumers can
switch to the cheaper good,
substituting the cheaper for
the more expensive.
Why the Demand Curves slopes down
A Second Reason:
Income Effect
A lower price of a good will
increase purchasing power
of the consumer. They can
buy more than before.
Why the Demand Curves slopes down
A Third Reason:
Diminishing Utility
Consumers get less satisfaction
as they buy more of a good.
For the consumer to buy more
the price must be reduced.
The Pizza Demand Curve
• The demand for frozen pizzas
reflects the law of diminishing
marginal utility.
• Because marginal utility (MU)
falls with increased consumption,
so does a consumer’s maximum
willingness to pay -- marginal
benefit (MB).
John’s demand curve
for frozen pizza
MB1
$3.50
MB2
$3.00
MB3
Price =$2.50
$2.50
• A consumer will purchase until
MB = Price . . . so at $2.50
they would purchase 3 frozen
pizzas and receive a consumer
surplus shown by the shaded
area (above the price line and
below the demand curve).
MB4 < MB3 < MB2 < MB1
because
MU4 < MU3 < MU2 < MU1
MB4
$2.00
d = MB
1
2
3
4
Frozen pizzas
per week
Individual and Market Demand Curves
• Consider Jones’s demand for frozen pizza.At $3.50 Jones
demands 1 pizza …
and so on …
at $2.50 3 pizzas …
• Consider Smith’s demand for frozen pizza. At $3.50 Smith
demands 2 pizzas … at $2.50 3 pizzas …
and so on …
• The market demand curve is merely the horizontal sum of the
individual demand curves (here Jones and Smith).
• The market demand curve will slope downward to the right,
just as the individual demand curves do.
Jones
Smith
2-Person market
$3.50
$3.50
$3.50
$2.50
$2.50
$2.50
d
D
d
1 2 3 4 5 6 7 8
1 2 3 4 5 6 7 8
Weekly frozen pizza consumption
1 2 3 4 5 6 7 8
4. Labor-Leisure Budget Constraint
a. 70 hour week, $10 per hour wages b. $12 per hour wages
Work
Income
0
0
10
100
20
200
30
300
40
400
50
500 (550?)
60
600 (700?)
70
700 (850?)
5. Present versus Future Consumption
a. 6% annual rate of return
b. 9% annual rate of return.
5. Present versus Future Consumption
a. 6% annual rate of return
Present
Consumption
$1,000,000
Present
Savings
0
b. 9% annual rate of return.
Future Consumption Future Consumption
(6% annual return)
(9% annual return)
0
0
$900,000
$100,000
$574,000
$1,327,000
$800,000
$200,000
$1,148,000
$2,654,000
$700,000
$300,000
$1,722,000
$3,981,000
$600,000
$400,000
$2,296,000
$5,308,000
$400,000
$600,000
$3,444,000
$7,962,000
$200,000
$800,000
$4,592,000
$10,616,000
0
$1,000,000
$5,740,000
$13,270,000
Present Value
The interest rate connects the value of dollars
today with the value of dollars in the future.
The present value (PV) of a single ($100) payment
to be received one year from now is:
Receipts 1 year from now
PV =
interest rate + 1
where i = 6 %
$ 100
$ 100
PV = 1 + .06 =1.06 =$ 94.34
Present Value n Years in the Future
The present value (PV) of that single ($100)
payment to be received n years from now is:
PV =
Receipts n years from now
(interest rate + 1) n
where i = 6 % and n = 3
PV = $ 100 3 = $ 100 3 =$ 83.96
(1 + .06)
(1.06)
The present value of the future payment is
inversely related to:
the interest rate, and,
how far in the future the payment will be
received.
Present Value n Years in the Future
The present value (PV) of a stream of
payments (each of nominal magnitude R)
to be received each year for n years is:
R1
R2
R3
Rn
PV = (1 + i) + (1 + i)2 + (1 + i)3 + . . . . . + (1 + i) n
where i = 6 % and n = 3 and R = $100
$100
$100
$100
PV = (1.06) + (1.06)2 + (1.06)3 =$ 267.30
PV = $94.34
+
$89
+
$83.96 =$ 267.30
Investing in Human Capital
Earnings
w/ college
Annual
earnings
or costs
Earnings
w/o college
Co
$0
Cd
18
22
65
Age
Consider a somewhat simplified example of a humancapital investment decision confronting Juanita, an 18-year
old who just finished high-school.
We have graphed Juanita’s expected earnings both with …
and without college. Should Juanita attend college or not?
If Juanita chooses to attend college, she will incur both the
direct cost of a college education (tuition, books, etc) Cd …
and the opportunity cost of earnings forgone while in
college Co .
Investing in Human Capital
Earnings
w/ college
Annual
earnings
or costs
B
Earnings
w/o college
Co
$0
Cd
18
22
65
With a college education, though, Juanita can expect
higher future earnings (B) during her career (even though
they may begin lower, they end higher).
If the discounted present value of the additional future
earnings exceeds the discounted value of the direct and
indirect costs of a college education, then the college
degree will be a profitable investment for Juanita.
Age
Level of Education and Earnings
(and Discrimination)
The earnings of
both men and
women increase
with education.
Less than
9th grade
High
School
Some
college
Note, though,
Bachelor’s
that women’s
degree
earnings were only
about 2/3 those of
Master’s
similarly educated
degree
men.
Doctoral
degree
Men
24,595
Women
18,578
35,121
23,498
42,946
29,500
62,543
40,263
75,411
49,635
107,988
56% of men’s
69,085
Mean earnings ($) of
year-round-full-time workers (2000)
Level of Education and Earnings
Updated in 2001
Both still increase
with education.
Less than
high school
High
school
Some
college
Women’s earnings
still about 2/3
those of similarly Bachelor’s
degree
educated men.
Master’s
degree
Doctoral
degree
Men
27,190
Women
22,361
37,362
26,660
45,271
32,511
70,253
45,290
87,022
57,770
10% above 2000
71,608
14% above 2000
66% of men’s
Mean earnings ($) of
year-round-full-time workers (2001)
118,853
Level of Education and Earnings
Updated in 2005
Both still increase
with education.
Less than
high school
High
school
Some
college
Women’s earnings
still about 2/3
those of similarly Bachelor’s
educated men.
degree
Master’s
degree
Doctoral
degree
Mean earnings ($) of
year-round-full-time workers (2005)
Men
28,415
Women
20,508
40,112
28,657
49,537
35,521
75,130
49,326
95,794
59,569
14.9% from 2001
14.9% from 2001
47% of men’s
136,567
92,650
Level of Education and Earnings
Updated in 2007
The earnings of
both men &
women
increase with
education.
Less than
high school
High
school
Some
college
Women’s earnings Bachelor’s
degree
still only about
2/3
those of similarly
Master’s
degree
educated men.
Doctoral
degree
Men
Women
30,602
21,906
42,042
30,657
50,103
38,396
77,536
52,857
94,763
63,156
132,706
85,190
Comparison over time
2000
Bachelor’s Degree
2001
62,543
Men
40,263
Women
70,253
45,290
2005
75,130
49,326
2007
77,536
52,857
If Mr. Smith thinks the last dollar spent on shirts
satisfaction than the last dollar spent on cola, and
maximizing consumer, he should
a.decrease his spending on cola.
b.decrease his spending on cola and increase his
c. increase his spending on shirts.
d.increase his spending on cola and decrease his
yields less
Smith is a utilityspending on shirts.
spending on shirts.
Which of the following would be the best example of consumer surplus?
a.Jane does not get cell-phone service because she feels that it is
worth less than the $30 a month fee.
b.Sam pays $8 for a haircut that is worth $10 to him.
c. Ralph buys a house for $104,000, the maximum amount that he
would be willing to pay for it.
d.Sue purchases a book for $20 and uses a credit card to pay for
it.
“I like ice cream, but after eating homemade ice cream last night, I want to
have something else for dessert today.” This statement most clearly reflects
a. the budget constraint.
b. consumer irrationality.
c. the second law of demand: Price elasticity increases with time.
d. the law of diminishing marginal utility.
If Sarah’s income rises by 20 percent, and, as a result, she purchases 40
percent more designer clothing, her income elasticity for designer clothing is
a. 0.5.
b. 1.0.
c. 2.0.
d. seriously distorted.
Suppose the state of New York imposes a one dollar per pack tax on
cigarettes, which increases their price by 30 percent, and as a result, the
quantity sold declines by 20 percent. The price elasticity of demand for
cigarettes is equal to
a. –0.20.
b. –0.67.
c. –1.50.
d. –3.00.
Studies indicate that the demand for fresh tomatoes is much more elastic than
the demand for salt. These findings reflect that
a. tomatoes are a necessity while salt is a luxury.
b. it takes longer for consumers to adjust to a change in the price of salt
than to a change in the price of tomatoes.
c. salt will not spoil as easily as fresh tomatoes.
d. more good substitutes exist for fresh tomatoes than for salt.
If a Krispy Kreme doughnut shop near campus increases its prices by 5 %, but
revenues from its sales are unchanged, the price elasticity of demand for the
services offered by the doughnut shop must be
a. elastic.
b. of unitary elasticity.
c. inelastic.
d. equal to 0.5.
If the price of gasoline goes up, and Dan now buys fewer candy bars because
he has to spend more on gas, this would best be explained by
a. the substitution effect.
b. the income effect.
c. the highly elastic demand for gasoline.
d. weight watchers effect.
Which of the following is true for this demand
curve?
a. An increase in price from $2 to $3 will
reduce total expenditures on the product.
b. In the $2 to $3 range, the price
elasticity of the demand curve is
approximately unitary.
c. At a price of $2, the price elasticity of
the demand curve equals approximately –2.5.
d. In the $2 to $3 range, the demand curve
is inelastic.