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Your Suggestions

This article discusses various suggestions for improving lectures on market demand analysis, including providing sample problems, downloading recitation problems, and reorganizing the website. It also explores topics such as individual and market demand, price elasticity, income elasticity, and the Laffer curve.

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Your Suggestions

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  1. Your Suggestions • Sample problems and examples in lecture. • Download recitation problems before recitation. • Complete exercises in recitations. • Reorganize web site. • Have power point slides available earlier. • Overview class at the beginning.

  2. Your Suggestions • Board/slides. • Too fast/too slow. • Book does not have enough examples.

  3. Market Demand • From individual to market demand. • Price elasticity of demand. • Income elasticity of demand. • An example: the Laffer curve.

  4. From Individual to Market demand • Individual ‘s demand function for good 1: • Aggregate demand (market demand) function for good 1:

  5. Market Demand: Example • Consider 2 consumers of CDs: • Each consumer has the demand function: • Consumers have different incomes:

  6. Market Demand: Example • Individual demand functions: • Market demand: for for

  7. Inverse Market Demand: Example • Market demand: for for • Inverse demand: for for

  8. Individual demand curves: Market demand curve: Market Demand Curve

  9. Aggregation • Q:Is the sum of our demands (aggregate demand) for a good always equal to the demand of one individual whose income is given by the sum of our incomes? • In other words is aggregate demand equal to the demand of some representativeconsumer who has income equal to the sum of all individual incomes?

  10. Aggregation A: No, for two reasons: • Individuals have different preferences • Even if individuals had the same preferences, some goods are necessary goods, and others are luxury goods.

  11. 2 consumers with same preferences Equal income distribution: Unequal income distribution: Aggregation: Example with a Necessary Good

  12. Elasticity • Looking for a measure of how “responsive” individual and aggregate demands are to changes in price and income. • This measure is important to determine effects of taxes on prices.

  13. One Candidate • One candidate measure of how “responsive” demand is to price changes is the slope of the demand function (at a given point):

  14. Problem with Slope of Demand Function • Example: where represents gallons of gasoline and is the price of one gallon. • Change units and measure gasoline in quarts (1/4 of gallon). • Let represent quarts of gasoline. Demand is:

  15. Elasticity • Instead of using slope, use price elasticity of demand : • Advantage: independent of units

  16. Example Cont’d • Demand for gasoline: • Elasticity: • Demand for gasoline: • Elasticity:

  17. Elasticity changes with demand: Properties of Elasticity

  18. Properties of Elasticity • A demand function is elastic if: • A demand function is inelastic if: • A demand function is unit elastic if:

  19. Example: Cobb-Douglas • Demand function: • Slope: • Elasticity:

  20. Income Elasticity of Demand • Describes how responsive demand is to changes in individual or aggregate income. • Defined similarly to price elasticity:

  21. Income Elasticity of Demand • Normal goods: • Inferior goods: • Luxury goods:

  22. The Laffer Curve • How do government tax revenue change when the tax rate changes?

  23. If : zero revenues. If : zero revenues. There exists a tax rate that maximizes revenues. The Laffer Curve

  24. The Laffer Curve • Consider a population of identical workers • Each worker earns an hourly wage • Each worker has to pay a tax on his/her wage • Thus a worker’s net hourly wage is:

  25. The Laffer Curve • A worker decides how many hours to work according to the following labor supply function: • Tax revenue:

  26. The Laffer Curve • Tax revenue: • How do revenues change with the tax rate:

  27. The Laffer Curve • How do revenues change with the tax rate: • Compute:

  28. The Laffer Curve Compare with so that

  29. The Laffer Curve • We know that: • Then:

  30. The Laffer Curve • We want tax revenues to decrease with the tax rate: • This occurs when:

  31. The Laffer Curve • This occurs when: • Rearrange:

  32. The Laffer Curve • Condition: • Compute elasticity of labor supply:

  33. The Laffer Curve • Thus we have that tax revenues increase when government reduces tax rate if: • Elasticity of labor supply estimated to be at most 0.2 • Tax rate on labor income is at most 0.5

  34. The Laffer Curve • Elasticity of labor supply estimated to be at most 0.2 • Tax rate on labor income is at most 0.5 • Plug into our condition and check that it is not verified:

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