1.Introduction and Supply & Demand
Economics that was raised earlier. People don’t always make decisions in the perfectly rational way we
model them as doing so This semester. Increasingly over the past several decades. economists have
started incorporating insights from psychology into our models. Economics at its core is all about how
the market knows best and that basically governments only mess things up. America is by far the most
unequal major nation in the world.. America was not a wealthy nation 100 years ago or 150 years ago..
led to tremendous growth, where we are now the most powerful. Rather than a capitalist economy. It’s
called a "command economy'' in this case, the government makes all the production and consumption
decisions. The bottom 99 % has less of our income corresponding with anywhere else in the world.. The
government decides how many shirts, cars, Tv, everything. And by and large, the government decided
who got it partly through corruption.
2.Preferences and Utility Functions
Happier marginal utility is always positive. You always get some benefit from the next unit. In
economics, we have to remember , you do n’t have to eat the 11 th cookie. You can give it away. If you
start with zero, and you get ½ a cookie based on this graph, it’s really hard to do it from zero. It ‘s sort of
much easier to start from one. Every fraction of a cookie makes you happier, but less and less happy
with each fraction. The marginal utility of the marginal utility – marginal utility is always diminishing.
When you have lots of pizza and not a lot of cookies, your marginal utility is small. Marginal utilities are
negative functions of quantity. The more you have of a thing, the less you want the next unit of it. MRS
is always diminishing. As you go along the indifference curve, that slope is always falling.
3. Budget Constraints and Constrained Choice
Food with food stamps and sell it. Food stamps, forcing people to spend about 15 % more on food than
they would like to unconstrained by the cash.. food stamps is making people, effectively, 15 % worse off.
We are making them spend 15% more food. So is it worth it. Well, actually, the evidence is starting to
pour in that it might not be worth it. In Uganda, a non-profit company randomly offered a group of
women $ 150,, which is huge relative to their income. After two months after 18 months. These women
had used that money to start businesses. And that actually raised their earnings. That actually doubled
their earnings. From that one injection of cash, it led them to actually double their annual earnings.
4.Demand Curves and
Income/Substitution Effects
Today, we are going to complete our discussion of consumer choice by actually coming back and
deriving the demand curve that we started the semester with. I’m going to spend the rest of lecture
then talking about the elasticity of demand, What determines the shape of that demand curve. I ‘ll talk
about how changes in income affect demand. And then, we’ll come back and talk about the effects of a
price change. The price of cookies rose to $ 9, and the budget constraint has steepened.. The slope of
the budget constraints has gone from minus ½ to minus ¾. So you have a steeper budget constraint.
Your opportunity Set is much larger because cookies are cheaper, and you can buy more cookies. The
slope of the price of cookies over pizza is now 1/3.. The only way to change the indifference curve would
be to change utility function.. Indifference curves purely come from this part of the budget constraint.
, But indifference curves you ca n’t really add up. But if we want to add up people, you would add up
demand curves..
What would drive a good to very, very elastic demand In general. Jonathon [UNK] nothing ‘s ever
perfectly elastic. But things which have very good substitutes. Typically this works well when we think
across brands. Offbrand medication, fast food burgers have pretty good substitutes with fast food pizza.
With a perfectly elastic demand, you have a horizontal demand curve. And therefore, price never
changes. In general, we end up with this range between perfectly elastic and perfectly inelastic. The
bottom line is here ‘s the intuition I want you to have what determines elasticity is substitutability. The
more substitutable goods are, the more elastically demanded they are. The engel curve is the
relationship between income and quantity demanded. The slope of the curve is what we call the income
elasticity of demand. As your income goes up, you ‘ll choose more of pizza and more cookies. The curve.
The curve is linear. That’s just because of the way we structured this utility function..
We’ll cheat a little bit and often draw a linear constant elasticity curves, which is technically wrong. But
if everything is really local, it ‘s not that bad a cheat. We call goods with a positive income elasticity
normal goods. Goods where the more money you have, the more of them. You want, we call normal
goods, but a number of goods in the world have gamma less than 0.. Jonathan [UNK] luxuries are going
to be good. Where gamma is greater than 1. Necessities are things like food, where rich people spend
more on food than poor people. Luxury watches are clearly not inferior. Fast food may be inferior. Rich
guys are much more likely to have two refrigerators than one. Jonathon [UNK]. How is the underlying
decision calculus changed by price changed when the price changes. We’ll decompose your response to
a price change into two effects. Effects, the substitution effect and the income effect. The substitution
effect is defined as the change in the quantity of a good when price changes holding utility constant at
some fixed level u bar..
The income effect is the change in quantity of a good as income changes. Change in quantity is
multiplied by the initial level of income.. income elasticity is the income elasticity. We talked about. And
you’ll come into a section about why that is. So let me start with graphically to understand it.
Substitution effect moves you from point a to point B. that is holding utility constant but at these new
prices, you would choose to have fewer cookies and less pizza. We call this notion compensated
demand. I ‘m saying price of change sucks for you. You ‘re worse off. Your opportunity set ‘s restricted.
But I’m going to compensate you by holding your utility constant. more cookies means lower Marg
utility of cookies. The more cookies you have, the less you care about the next cookie. So the
substitution effect is negative. The income effect is the change in quantity demanded as income changes
Economics that was raised earlier. People don’t always make decisions in the perfectly rational way we
model them as doing so This semester. Increasingly over the past several decades. economists have
started incorporating insights from psychology into our models. Economics at its core is all about how
the market knows best and that basically governments only mess things up. America is by far the most
unequal major nation in the world.. America was not a wealthy nation 100 years ago or 150 years ago..
led to tremendous growth, where we are now the most powerful. Rather than a capitalist economy. It’s
called a "command economy'' in this case, the government makes all the production and consumption
decisions. The bottom 99 % has less of our income corresponding with anywhere else in the world.. The
government decides how many shirts, cars, Tv, everything. And by and large, the government decided
who got it partly through corruption.
2.Preferences and Utility Functions
Happier marginal utility is always positive. You always get some benefit from the next unit. In
economics, we have to remember , you do n’t have to eat the 11 th cookie. You can give it away. If you
start with zero, and you get ½ a cookie based on this graph, it’s really hard to do it from zero. It ‘s sort of
much easier to start from one. Every fraction of a cookie makes you happier, but less and less happy
with each fraction. The marginal utility of the marginal utility – marginal utility is always diminishing.
When you have lots of pizza and not a lot of cookies, your marginal utility is small. Marginal utilities are
negative functions of quantity. The more you have of a thing, the less you want the next unit of it. MRS
is always diminishing. As you go along the indifference curve, that slope is always falling.
3. Budget Constraints and Constrained Choice
Food with food stamps and sell it. Food stamps, forcing people to spend about 15 % more on food than
they would like to unconstrained by the cash.. food stamps is making people, effectively, 15 % worse off.
We are making them spend 15% more food. So is it worth it. Well, actually, the evidence is starting to
pour in that it might not be worth it. In Uganda, a non-profit company randomly offered a group of
women $ 150,, which is huge relative to their income. After two months after 18 months. These women
had used that money to start businesses. And that actually raised their earnings. That actually doubled
their earnings. From that one injection of cash, it led them to actually double their annual earnings.
4.Demand Curves and
Income/Substitution Effects
Today, we are going to complete our discussion of consumer choice by actually coming back and
deriving the demand curve that we started the semester with. I’m going to spend the rest of lecture
then talking about the elasticity of demand, What determines the shape of that demand curve. I ‘ll talk
about how changes in income affect demand. And then, we’ll come back and talk about the effects of a
price change. The price of cookies rose to $ 9, and the budget constraint has steepened.. The slope of
the budget constraints has gone from minus ½ to minus ¾. So you have a steeper budget constraint.
Your opportunity Set is much larger because cookies are cheaper, and you can buy more cookies. The
slope of the price of cookies over pizza is now 1/3.. The only way to change the indifference curve would
be to change utility function.. Indifference curves purely come from this part of the budget constraint.
, But indifference curves you ca n’t really add up. But if we want to add up people, you would add up
demand curves..
What would drive a good to very, very elastic demand In general. Jonathon [UNK] nothing ‘s ever
perfectly elastic. But things which have very good substitutes. Typically this works well when we think
across brands. Offbrand medication, fast food burgers have pretty good substitutes with fast food pizza.
With a perfectly elastic demand, you have a horizontal demand curve. And therefore, price never
changes. In general, we end up with this range between perfectly elastic and perfectly inelastic. The
bottom line is here ‘s the intuition I want you to have what determines elasticity is substitutability. The
more substitutable goods are, the more elastically demanded they are. The engel curve is the
relationship between income and quantity demanded. The slope of the curve is what we call the income
elasticity of demand. As your income goes up, you ‘ll choose more of pizza and more cookies. The curve.
The curve is linear. That’s just because of the way we structured this utility function..
We’ll cheat a little bit and often draw a linear constant elasticity curves, which is technically wrong. But
if everything is really local, it ‘s not that bad a cheat. We call goods with a positive income elasticity
normal goods. Goods where the more money you have, the more of them. You want, we call normal
goods, but a number of goods in the world have gamma less than 0.. Jonathan [UNK] luxuries are going
to be good. Where gamma is greater than 1. Necessities are things like food, where rich people spend
more on food than poor people. Luxury watches are clearly not inferior. Fast food may be inferior. Rich
guys are much more likely to have two refrigerators than one. Jonathon [UNK]. How is the underlying
decision calculus changed by price changed when the price changes. We’ll decompose your response to
a price change into two effects. Effects, the substitution effect and the income effect. The substitution
effect is defined as the change in the quantity of a good when price changes holding utility constant at
some fixed level u bar..
The income effect is the change in quantity of a good as income changes. Change in quantity is
multiplied by the initial level of income.. income elasticity is the income elasticity. We talked about. And
you’ll come into a section about why that is. So let me start with graphically to understand it.
Substitution effect moves you from point a to point B. that is holding utility constant but at these new
prices, you would choose to have fewer cookies and less pizza. We call this notion compensated
demand. I ‘m saying price of change sucks for you. You ‘re worse off. Your opportunity set ‘s restricted.
But I’m going to compensate you by holding your utility constant. more cookies means lower Marg
utility of cookies. The more cookies you have, the less you care about the next cookie. So the
substitution effect is negative. The income effect is the change in quantity demanded as income changes
