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ECON 201 - Midterm 1 Review

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ECON 201
Kathleen Rybczynski

Market Demand Demand: 1. Want it 2. Can afford it 3. Have made a definite plan to buy it Quantity Demanded: amount consumers plan to buy during a particular time period, at a particular price Complements and QD are positively related, substitutes and QD are inversely related. Law of Demand: other things remaining the same, the higher the price of a good, the smaller is the quantity demanded - Substitution effect: when OC rises, people seek substitutes, so QD decreases - Income effect: price rises relative to income, people canʼt afford, so QD decreases Rise in demand -> rise in price, BUT, QD varies inversely with P and not D Point Elasticity = ep= (∂q/∂p) * (p/q) Arc Elasticity (linear approximation) = e = (Δq/Δp) * ((p1+p2)/(q1+q2)) p More substitutes mean flatter slope and a lower price elasticity. Inelastic (decimal) < unit elastic (1) < elastic (1 to infinity) Price elasticity along a straight-line demand curve: e =pFDʼ/FD; Dʼ is bottom segment Demand is more elastic at higher prices since the consumers finds substitutes more affordable, and at lower prices there are fewer affordable substitutes. Income Elasticity of Demand (e) I eI= (δQ/δI) * (I/Q) < 0 is inferior good, > 0 is normal good, < 1 is necessity, > 1 is luxury good Engel Law: as income increases, % of income spent on certain foods declines. - Empirically observed that as income rises, some normal goods become inferior Cross Price Elasticity of Demand: e XY = (δQ X δP )Y* (P Y Q )X eXY > 0 then X and Y are substitutes, e XY < 0 then complements, e XY = 0 then unrelated Total Revenue = Price * Quantity Marginal Revenue (slope of TR) = TR / ∆Q Price Elasticity of Supply = e = (δQ/δP) * (P/Q) S Straight-line supply curve crossing +P axis is elastic, -P is inelastic, origin is unit elastic Govʼt Revenue (GR) = tax per unit ( ) * Q T After Tax Lecture 3 1. Method 1 - Price Elasticities ~ ∆P = (eS/(eS– e D) * ∆t 2. Method 2 - Algebraically coming with Q NEW Govʼt subsidies will help producers with price floors above the equilibrium. (surplus) Black marketers make huge profit with a price ceiling below the equilibrium. (shortage) To prevent a black market, the govʼt could buy all the Q supplied and sell at the ceiling. Cardinal Utility Theory Assumptions for Cardinal Utility Theory: 1. Rationality - maximizers of utility 2. Cardinality - TU is measurable in numerical terms 3. Function of all goods consumed 4. TU rises till some point satisfaction (max vertex) 5. Diminishing marginal utility 6. Marginal Utility of Money is constant - $1 for Bill Gates = $1 for a hobo Conditions for Total Utility Maximization 1. Consumer Equilibrium - TU is maximized when MUx = Px, decreases as MUx < Px 2. MUx/ Px = MUy/ Py (two good case; might want to compare vs. one good case later) Consumer Surplus: consumer gets a larger MU than paid for Criticisms of the Cardinal Approach to Demand Theory 1. Cardinality assumption is not realistic; utility cannot be measured objectively 2. Marginal utility of money not realistic with a single consumer, nor across consumers 3. Theory is limited to downward sloping curves (but economists have never found empirical evidence of an upward sloping demand curve) Indifference Curves Theory Some Assumptions: 1. Axioms of Consumer Behaviour: rationality, complete ordering, transitivity, non- satiation (consumer prefers “more” to “less”) 2. Definition and derivation: express the individualʼs pattern of preferences by connecting all bundles for which they have expressed indifference 3. Diminishing Marginal Rate of Substitution: falling slope thatʼs convex
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