review for test 2 l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Review for Test 2 PowerPoint Presentation
Download Presentation
Review for Test 2

Loading in 2 Seconds...

play fullscreen
1 / 142

Review for Test 2 - PowerPoint PPT Presentation


  • 158 Views
  • Uploaded on

Review for Test 2. Some Key Concepts from Unit Two: Chapters 3-5. Supply and Demand. Supply and Demand determine prices in individual markets. Price is the mechanism that brings supply and demand together. The Demand Schedule. The demand schedule (demand curve)

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Review for Test 2' - uri


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
review for test 2

Review for Test 2

Some Key Concepts from Unit Two:

Chapters 3-5

supply and demand
Supply and Demand

Supply and Demand determine prices in

individual markets.

Price is the mechanism that brings supply

and demand together.

the demand schedule
The Demand Schedule

The demand schedule (demand curve)

shows the relationship between a commodity’s

market price and the quantity of that commodity

that consumers are willing and able to purchase,

other things held constant.

law of downward sloping demand
Law of Downward Sloping Demand

When the price of a commodity is raised

(and other things are held constant), buyers

tend to buy less of the commodity. Similarly,

when the price is lowered, other things being

constant, quantity demanded increases.

The downward slope in demand can be

explained by decreasing marginal utility.

substitution effect
Substitution Effect

When the price of a good rises, I will

substitute other similar goods for it.

For example, if the price of beef rises,

I will eat more chicken and pork.

income effect
Income Effect

As the price of a commodity rises, my income

will not stretch as far as it used to. I am

therefore “poorer” in a relative sense,

than before the price increase.

market demand curve
Market Demand Curve

The market demand curve “adds up”

all the quantities demanded by individual

consumers at a given price.

It shows the total amount of a quantity

consumers are willing and able to buy at

a given price.

moving along demand
Moving Along Demand

If the price of a product changes,

consumers move along the demand

curve to a new quantity. If price rises,

quantity demanded falls. If price falls,

quantity demanded rises. The curve

itself DOES NOT MOVE. The movement

is from one point to another ON THE

ORIGINAL CURVE,

demand for pretzels
Demand for Pretzels

P

At a price of $10, 3 pretzels

will be sold in this market.

Point A on the demand curve

shows this relationship.

A

$10

D

3

Q

total revenue
Total Revenue

Total Revenue is price times quantity.

In this case, total revenue would be

$30 ($10x3).

demand for pretzels12
Demand for Pretzels

P

At a price of $5, 9 pretzels

will be sold in this market.

Point B on the demand curve

shows this relationship.

B

$5

D

Q

9

moving from a to b
Moving from A to B

In moving from point A to point B, we have

gone down the original demand curve.

As the price of pretzels fell, the quantity

demanded increased.

Price and quantity move in opposite directions

on a demand curve.

total revenue at point b
Total Revenue at Point B

Total Revenue at point B is $45. ($5x9)

Total Revenue got larger as we moved

from point A to point B because the increase

in quantity was larger, in relative terms,

than the decrease in price.

Price fell by 1/2 ($10 to $5), but quantity

tripled (3 to 9). The increase in quantity more

than offset the decrease in price.

to find out what happens to tr
To find out what happens to TR

To find out what happens to TR as we

move along a demand curve we have to

know which change is proportionately bigger,

the change in quantity or the change in price.

TR will move in the same direction as the

change that is relatively bigger. So if

quantity changes by a larger percentage than

price, as it did in this example, TR will follow

quantity. If the percentage change in price

were bigger, TR would follow price.

elasticity of demand
Elasticity of Demand

The elasticity of demand tells us the

relationship between the percentage change

in quantity and the percentage change in

price as we move along a demand curve.

elastic demand
Elastic Demand

When demand is elastic, the percentage

change in quantity is GREATER than the

percentage change in price.

Total Revenue will therefore move in the

SAME direction as quantity as we move

along the demand curve.

inelastic demand
Inelastic Demand

When demand is inelastic, the

percentage change in quantity is LESS

than the percentage change in price.

Total Revenue will therefore move in

the SAME direction as price as we

move along the demand curve.

the demand curve19
The Demand Curve

P

Elasticity of demand refers to

movements along the curve.

D

Q

how do we move along the curve
How do we move along the curve?

If we own the sort of company or agency

that can control the price of its product, we

can move to a new point on the demand

curve by changing price. If we increase

price, we expect consumers to buy less of

the product. If we decrease price, we expect

consumers to buy more.

price and tr
Price and TR

If demand is elastic, I can boost total revenue

by dropping price because my increase in

quantity will more than make up for the lower

price.

If demand is inelastic, I can increase total

revenue by raising price because my

decrease in quantity will not be large

enough to undo the boost from a higher price.

elastic and inelastic demand
Elastic and Inelastic Demand

Changes in Price

If demand is elastic, TR moves the

opposite way from price. TR rises when

price falls, and TR falls when price rises.

If demand is inelastic, TR moves the

same way as price. TR rises when

price rises, and TR falls when price falls.

a company changes its price moving along a stable demand curve you observe
A company changes its price (moving along a stable demand curve). You observe:

TR rose after the price of a product

rose. You figure that demand is _________.

TR fell after the price of a product

rose. You figure that demand is _________.

TR rose after the price of a product

fell. You figure that demand is __________.

TR fell after the price of a product

fell. You figure that demand is __________.

inelastic

elastic

elastic

inelastic

another way to move along demand
Another Way to Move Along Demand

In markets, with a stable demand curve,

price will change when supply shifts.

When supply shifts, we move along the

original demand curve to a new

equilibrium point.

shifting supply
Shifting Supply

The shift in Supply

moves us from

one point to another

on the old Demand

P

S2

S1

p2

p1

D

Q

q2 q1

we know that
We know that

We know that when supply decreases,

price increases and quantity decreases.

We know that when supply increases,

price decreases and quantity increases.

supply shifts and tr
Supply shifts and TR

What happens to TR after a shift in

supply depends on the elasticity of demand.

When we shift supply, we are moving

along demand, so we use the same logic

as before. We look at the elasticity of

demand and see which is biggest, the

% change in quantity or the % change in price.

supply shift and tr
Supply Shift and TR

So, if demand is elastic, TR will increase

after an increase in supply because TR

moves in the same direction as quantity.

(Quantity increases after a supply increase.)

If demand is inelastic, TR will decrease

after an increase in supply because TR

moves in the same direction as price.

(Price decreases after a supply increase.)

by the same logic
By the same logic

Using the same logic, a decrease in

supply causes TR to decrease when

demand is elastic.

A decrease in supply causes TR to

increase when demand is inelastic.

you observe
You observe
  • TR decreases after a supply decrease. Demand is _____________
  • TR increases after a supply decrease. Demand is ______________
  • TR decreases after a supply increase. Demand is ______________
  • TR increases after a supply increase. Demand is ___________________

elastic

inelastic

inelastic

elastic

shifting curves

Shifting Curves

Moving the entire curve

the position of the demand curve
The position of the demand curve

The position of the demand curve (e.g.

where it sits in space on the graph) is

affected by a number of things. If one of

these factors changes, the entire

demand curve will move.

factors affecting demand
Factors Affecting Demand
  • Size of market, e.g. how many consumers.
  • Income levels of consumers.
  • Prices and availability of related goods.
  • Tastes and preferences.
  • Special influences, e.g. climate and conditions.
for demand to shift
For Demand to SHIFT

One of these factors must change.

shift versus movement along
Shift versus Movement Along

The demand curve does not shift when

price of the product itself changes.

Such a price change causes movement

ALONG the original demand curve.

change in demand
Change in Demand

Demand curves will shift, as income,

other prices, market size, or tastes or

preferences change.

"Shift" is another way of saying "change"

in this case.

movement along the demand curve
Movement along the demand curve

Movement along the demand curve occurs

as the good’s own price changes.

P

As price falls, a greater quantity

is demanded.

Q

shifts in demand
Shifts in Demand

Shifts in the demand curve take place if one

of the factors behind the demand curve

changes: income, prices of available goods,

tastes or preferences, or special influences.

for example
For Example

Demand may shift outward (increase) as income rises, market size increases, the price of a substitute increases, or some special factors in the market change.

P

Q

slide40
And

Demand may shift inward (decrease) as income falls, market size decreases, the price of a substitute falls, or some special factors in the market change.

P

Q

the supply schedule
The Supply Schedule

The supply schedule (or supply curve) for

a commodity shows the relationship between

the market price and the amount of that

commodity that producers are willing and able

to produce and sell, other things held

constant.

supply slopes up
Supply Slopes Up

Supply slopes up because of the “law of

diminishing returns.” To get extra output

usually requires proportionally more extra

input.

market supply
Market Supply

To get market supply, sum the

quantities supplied by all the

individual firms at each price level.

supply shifters
Supply Shifters
  • Changes in costs of inputs
  • Technological change
  • Government policy
  • Special factors (climate, culture)
these factors
These factors

Any of these factors can cause the firm

supply curve to shift.

movement along supply curve
Movement along supply curve

P

S

As price rises, all other

things held constant, the

quantity supplied increases.

Q

shift of supply curve
Shift of supply curve

P

If the price of an input falls,

the supply curve shifts out.

S

S’

Q

slide48

S

S'

D

A shift in Supply causes a movement

along the demand curve. Demand doesn't

change but quantity demanded changes

because of the price change.

slide49

S

D

D'

A shift in Demand causes a movement

along the supply curve. Supply doesn't

change but quantity supplied changes

because of the price change.

market equilibrium
Market Equilibrium

A market equilibrium comes at the place

where quantity demanded equals quantity

supplied.

Equilibrium takes place at the intersection

of the supply and demand curves.

graphical representation of equilibrium
Graphical Representation of Equilibrium

.

.

5

.

S

P

Surplus

.

.

.

4

.

Equilibrium

3

.

.

.

2

Shortage

.

.

1

D

.

.

.

.

Q

5

15

20

10

minimum wage
Minimum Wage

Wage is the price of labor. A minimum

wage increase is a price increases.

Employment is measured off the demand curve.

By looking at elasticity of demand we find

decrease in employment.

Unemployment is measured as the surplus

labor. It includes the people who lost jobs

(decrease in quantity demanded) AND the

new entrants to market (increase in quantity

supplied).

shifts in curves change equilibrium
Shifts in curves change equilibrium

Supply increases

P

S

S’

P

P'

D

Q

Q’

Q

shifts in curves change equilibrium54
Shifts in curves change equilibrium

Supply decreases

P

S’

S

P’

P

D

Q

Q

Q’

shifts in curves change equilibrium55
Shifts in curves change equilibrium

Demand Increases

P

S

(Note that TR

increases because

both P and Q

increase.)

P”

P’

D”

D’

Q

Q’

Q”

shifts in curves change equilibrium56
Shifts in curves change equilibrium

P

S

Demand Decreases

(Note that TR falls

because both P and

Q fall.)

P’

P”

D’

D”

Q

Q”

Q’

four possible outcomes
Four Possible Outcomes
  • Supply decrease: Price Up, Quantity Down
  • Supply increase: Price Down, Quantity Up
  • Demand increase: Price Up, Quantity Up
  • Demand decrease: Price Down, Quantity Down
elasticities
Elasticities

We may want to know how much

supply and demand respond

to changes in price.

Example: If the price of apples

increases by 10%, how many

fewer apples will consumers

buy?

price elasticity of demand
Price Elasticity of Demand

The price elasticity of demand

measures how much the quantity

demanded of a good changes when

its own price changes.

It is the percentage change in

quantity demanded divided by

the percentage change in price.

calculating elasticities
Calculating Elasticities

% Change in quantity demanded

_________________________

ED

=

% Change in price

If a 1% increase in price causes

a 5% decrease in quantity demanded,

what is the elasticity of demand?

calculating elasticities61
Calculating Elasticities

% Change in quantity demanded

_________________________

ED

=

% Change in price

5%

ED

____

=

= 5

1%

(By convention, the minus sign is

dropped on the ED.)

more examples
More Examples

A 10% decrease in price causes a

5% increase in quantity demanded.

10%

5%

_____

(1/2)

= 0.50

elastic and inelastic demand63
Elastic and Inelastic Demand

If demand is price elastic, ED is

greater than 1.0.

If demand is price inelastic, ED is

less than 1.0.

unit elastic demand
Unit-Elastic Demand

When percent change in price

equals percent change in quantity

demanded we have unit-elastic

demand.

ED = 1.0

calculating elasticity of demand an example
Calculating Elasticity of DemandAn Example.

As price falls from $12.00 to $8.00

per unit, the quantity demanded

increases from 95 to 105 units.

Calculate the elasticity of demand.

percent change in price
Percent Change in Price

change

$12 - $8

_________

* 100%

= 40%

($12 + $8)/2

midpoint

percent change in quantity demanded
Percent Change in Quantity Demanded

change

105 - 95

_______

* 100%

= 10%

(105+95)/2

midpoint

putting together the elasticity
Putting together the elasticity:

10%

_____

ED =

= 0.25

40%

caution
Caution!

If the demand curve is a straight

line, the elasticity of demand

does not stay constant along the

length of the line!

elasticity along a straight line
Elasticity along a straight line

P

Above the mid-point, ED >1

.

At the mid-point, ED = 1

Below the mid-point, ED < 1

Q

extremes of elasticity
Extremes of Elasticity

D

Perfectly Inelastic Demand

P

D

Perfectly elastic demand

Q

elasticity and revenue
Elasticity and Revenue

Total Revenue is QxP, price times

quantity sold.

slide73

If Demand increases, both P and Q

increase and TR must also increase.

If Demand decreases, both P and Q

decrease and TR must also decrease.

When Supply increases, P falls and

Q rises. What happens to TR?

When Supply decreases P rises and

Q falls. What happens to TR?

slide74

To figure out what happens when Supply

shifts, we have to know which effect

is biggest, the change in price or the

change in quantity.

The elasticity tells us which effect is

biggest.

slide75

If demand is elastic, which effect

is biggest, the percent change in

price or the percent change in quantity?

Ed =

% change in q

% change in p

____________

> 1 (elastic)

% change in q is biggest for elastic demand

slide76

If demand is inelastic, which effect

is biggest, the percent change in

price or the percent change in quantity?

Ed =

% change in q

% change in p

____________

< 1 (inelastic)

% change in p is biggest for inelastic demand

slide77

If demand is elastic, TR will move in

the same direction as quantity. (That means

TR for elastic demand moves in the

opposite direction of price, because Demand

slopes down.)

If demand is inelastic, TR will move in

the same direction as price. (That means

TR for inelastic demand will move in the

opposite direction of quantity.)

slide78

For elastic Demand, TR increases when

price falls or quantity increases.

For inelastic Demand, TR increases when

price rises or quantity falls.

when demand is elastic
When demand is elastic

Total revenue increases as the

price falls, when demand is

elastic.

Total revenue increases as supply

increases when demand is elastic.

Remember: Price falls when

supply increases!

slide80

Demand is elastic, TR increases as S increases

and price falls

P

Total Revenue = P’xQ’

S

S'

P1

P2

D

Q

Q1 Q2

when demand is inelastic
When demand is inelastic

Total revenue decreases as the

price decreases, when demand is

inelastic.

Total revenue decreases as supply

increases when demand is inelastic.

Remember: Price falls when Supply

increases.

slide82

Demand is inelastic. TR falls

as supply increases and price falls.

P

S

S'

TR”

TR”

TR’’’

Q

slide83

When you are drawing these

diagrams remember that

for a straight line demand curve

Demand is elastic above the

mid-point and inelastic below.

You will lose points if you

are working in the wrong part of

the curve.

the paradox of the bumper harvest
The Paradox of the Bumper Harvest

The demand for basic food stuffs tends

to be inelastic. The increase in supply

caused by a good harvest tends to lower

price relatively heavily. Hence the

percentage change in price is larger than

the percentage change in quantity, and

total revenue falls.

slide85

Supply increase caused by

good weather

S

S’

Total Revenue falls

because demand is

inelastic.

D

elasticity problems the basics
Elasticity Problems -- The Basics

If demand is elastic, total revenue moves

the same way as supply.

If demand is elastic total revenue moves

the opposite way as price.

Elastic demand is anything with an Ed >1

elasticity problems the basics87
Elasticity Problems -- the basics

If demand is inelastic, total revenue moves

the opposite way from supply.

If demand is inelastic, total revenue moves the

same way as price.

Inelastic demand is anything with Ed<1

special case when ed 1
Special case: When Ed = 1

When demand has unitary elasticity, an

increase or decrease in supply has no

effect on total revenue. (TR stays the same.)

questions
Questions

A decrease in supply is observed to increase

total revenue, you know that demand must be

__________________.

An increase in supply is observed to increase

total revenue, you know that demand must

be _________________.

inelastic

elastic

questions90
Questions

A decrease in supply is observed to decrease

total revenue, you know that demand must be

__________________.

An increase in supply is observed to decrease

total revenue, you know that demand must

be _________________.

elastic

inelastic

questions91
Questions

A decrease in supply is observed to have no

effect on total revenue, you know that demand

must have _________________.

unitary elasticity

elasticity of supply
Elasticity of Supply

% Change in quantity supplied

_________________________

Es

=

% Change in price

If % change in quantity supplied is

greater than % change in price, then

supply is elastic. ES > 1

special cases
Special cases

ES=1

ES = 0

ES = 

when supply is a straight line
When Supply is a Straight Line
  • Supply is inelastic if it crosses the horizontal axis.
  • Supply is elastic if it crosses the vertical axis.
  • It has unitary elasticity if it goes through the origin.
slide95

ES < 1

P

ES=1

ES > 1

Q

effect of a sales tax
Effect of a Sales Tax

Sometimes the government puts a

tax on specific commodities such

as gasoline, tobacco, and alcohol. Policy

analysts will want to know: How

will the tax affect the market price and

quantity? Who will end up “paying for”

the tax, the producers or the consumers?

slide97

Here’s how to work these problems.

  • If Supply and Demand are “normal”
  • (i.e. neither perfectly inelastic nor
  • perfectly elastic)
  • Supply shifts up by the amount of the tax.
  • Price rises by less than the tax.
  • The group with the lowest elasticity
  • (consumers or producers) pays the greater
  • share of the tax.
slide98

Special cases:

Perfectly inelastic demand: Price rises

by full amount of tax. Consumers pay all.

Perfectly elastic demand: Price doesn’t

rise at all. Producers pay all.

Perfectly elastic supply: Price rises

by full amount of tax. Consumers pay all.

Perfectly inelastic supply: Price doesn't

change. Producers pay all.

impact of a sales tax example
Impact of a Sales Tax, Example

In this market, with no tax,

1,000 items are sold at $2.00

each.

S

$2.00

D

1,000

impact of a sales tax example100
Impact of a Sales Tax, Example

The government now asks

the producers to pay a $1.00

tax on every item sold, which

will cause a decrease

in supply. For the

firm to sell the original

1,000 units, the price

would have to be $3.00

S’

S

3.00

$2.00

1,000

impact of a sales tax example101
Impact of a Sales Tax, Example

But consumers would not

be willing to buy 1,000

units at a price of $3.00.

The market will find

a new equilibrium price

somewhere between

$2.00 and $3.00, and

a new equilibrium

quantity less than

1,000.

S’

S

3.00

$2.00

D

1,000

the new equilibrium price
The new equilibrium price

In this case, let’s say that the new equilibrium

price is $2.80. Of this selling price, the

producers get $1.80 ($2.80 minus the $1.00

tax.) The $1.00 tax is the difference between

producer and consumer prices.

Thus $0.80 of the tax is paid by consumers in

higher consumer prices and $0.20 is paid by

producers in terms of lower producer prices.

general rules on tax shifting
General Rules on Tax Shifting

When demand is less elastic than supply,

the consumers pay the greater share of the

sales tax.

When demand is more elastic than supply,

producers pay the greater share of the

sales tax.

our example with a more elastic demand
Our Example with a more elastic demand

With this demand curve,

final price would be

$2.40.

Consumers pay $.40

of tax, producers pay

$.60.

S’

S

3.00

$2.00

D

1,000

perfectly inelastic demand
Perfectly Inelastic Demand

If demand is perfectly inelastic and supply has

some elasticity, consumers pay the entire tax.

Quantity doesn't

change.

D

S’

pn

S

p*

slide106

Perfectly Elastic Supply: Price goes up by

full amount of the tax. Consumers pay all.

In this case, quantity falls.

P

P*+t

S'

S

P*

D

Q

perfectly elastic demand
Perfectly Elastic Demand

If demand is perfectly elastic and supply has

some elasticity, producers pay the entire tax.

S’

price

doesn't

change.

quantity

falls

S

p*

D

q

last special case
Last special case.

Producers pay the entire tax if Supply

is perfectly inelastic and demand is downward

sloping. In this case, producers

supply the same amount, regardless of the

price. Price to consumers

doesn't change, nor does quantity.

price floors
Price Floors

S

P

A price floor is

a legally set minimum

price. Price floors

above market

equilibrium lead to

surpluses.

Pmin

D

Q

price ceilings
Price Ceilings

S

P

A price ceiling is

a legally set maximum

price. Price ceilings

above market

equilibrium lead to

shortages.

Pmax

D

Q

subsidies
Subsidies

Sometimes the government subsidizes

production of a product. A subsidy

given to producers shifts the supply curve

out.

the importance of e d
The Importance of ED

When demand is relatively elastic, more of

the subsidy goes to producers because

price does not fall as much.

When demand is relatively inelastic,

consumers receive most of the benefit

because price falls a lot.

chapter 5 concepts
Chapter 5 Concepts

Utility

Marginal Utility

Indifference Curves

Budget Constraints

what is utility
What is “utility”

Utility is a word economists use for

the satisfaction consumers derive from

goods and services.

Economists assume that consumers

are “rational,” that is that they choose

the items that give them the most

satisfaction.

marginal utility
Marginal Utility

When economists use the term “marginal,”

they mean “additional” or “extra.”

Hence, marginal utility denotes the

additional utility arising from consumption

of an additional unit of a commodity.

law of diminishing marginal utility
Law of Diminishing Marginal Utility

Total utility tends to increase as one

consumes more of a good. However,

the additional utility gained from

adding more units of the commodity

declines.

equimarginal principle
Equimarginal Principle

A consumer with a fixed income, facing

given market prices for goods, will

maximize utility when the marginal

utility of the last dollar spent on each

good is exactly the same as the marginal

utility from the last dollar spent on any

other good.

example
Example

good 1 costs $2.00 and good 2 costs $3.00.

If the last unit of good 1 consumed gives the

consumer 30 additional units of “utility,” then

for the consumer to have maximized total

utility the last unit of good 2 would give the

consumer ____ units of utility.

how to solve the problem
How to solve the problem

Divide the extra utility of the last unit

consumed by the price.

30 = MUgood2

2 3

30/2 = 15

45/3 = 15

___

_________

example120
Example

good 1 costs $2.00 and good 2 costs $3.00.

If the last unit of good 1 consumed gives the

consumer 30 additional units of “utility,” then

for the consumer to have maximized total

utility the last unit of good 2 would give the

consumer ________ units of utility.

45

other type of question
Other type of question

MU of the last unit of good 1 is 40 and its

price is $5. The MU of he last unit of good 2

is 30 and its price is $3.

These ratios are not equal.

(good 1: 40/5= 8; good 2: 30/3=10)

To get into equilibrium, consume more

good 2 (higher ratio) and less of good 1

(lower ratio).

slide122

Indifference Curve

An indifference curve shows the

combinations of two (or more) products

that would provide equal satisfaction to

a consumer. That means the consumer

would be equally satisfied with any

of the combinations of goods plotted

on that curve.

an indifference curve
An Indifference Curve

pizza

A

17

B

8

burgers

9 16

an indifference map
An Indifference Map

Good 1

Each curve represents a set of

choices that the consumer is

indifferent between. The consumer

prefers the sets furthest from the

origin.

U3

U2

U1

Good 2

the budget constraint
The Budget Constraint

The consumer is constrained by

a budget. The problem is to achieve

the highest level of satisfaction for

a given income. The higher the

indifference curve, the better.

slope of the budget constraint
Slope of the budget constraint

The slope of the budget constraint is

equal to the price ratio.

point of tangency
Point of Tangency

The consumer’s choice is the point

where the budget constraint is just

tangent (touching in one point) to the

highest attainable indifference curve.

putting things together
Putting things together

U3

Point B is the

consumer’s

choice

good 1

U2

U1

C

.

A

B

good 2

suppose income goes up
Suppose income goes up

If income rises, the budget

constraint shifts up.

increased income
Increased Income

good 1

good 2

slide131

What happens when income falls?

Answer: There is a parallel shift

inward (down) of the budget constraint.

price changes
Price Changes

If the price of one of the goods changes,

the budget constraint will pivot. The slope

of the line will change. There are four

possibilities:

price of good 1 increases

price of good 2 increases

price of good 1 decreases

price of good 2 decreases

slide135

Also, be able to show and recognize

the other two cases: the price of good 1

falls and the price of good 2 rises.

working with the budget constraint
Working with the budget constraint

If a consumer spends all her money for

snacks and buys 12 bottles of soda at $1.50

each and 9 bags of chips at $2.00 each, what

is the total amount spent on snacks?

12*$1.50 + 9*$2.00 = $36.00

graphing this budget constraint
Graphing this Budget Constraint

soda

24

slope = 24/18 = 1.33

slope = $2.00/$1.50 = 1.33

chips

18

slide138

The intercepts on the axes are found

by dividing the total budget by the

price of each snack.

$36/$1.50 = 24

$36/2 = 18

from individuals to markets
From individuals to markets

A market demand curve is the sum

of all the individual demand curves.

Example: A two-consumer market

P Person1 Person2 Market

6 5 11 16

4 10 20 30

2 25 46 71

consumer surplus
Consumer Surplus

P

The area above the price line

and below the demand curve

is called

“Consumer Surplus”

S

p

D

Q

slide141

Practice Problem

Price Units bought M.U.

pizza $6 5 18

chips $3 10

Fill in the missing MU, find how much

the consumer is spending on these items, graph

the budget constraint and find its slope.

slide142

Price Units bought M.U.

pizza $6 5 18

chips $3 10 9

a) Spends: $6*5 + $3*10 = $60

b) see above

c)

d) slope is 2

20

10 pizza