business economics meco 6303 fall 2014 instructor: alejandro zentner
TRANSCRIPT
Business Economics MECO 6303
Fall 2014
Instructor: Alejandro Zentner
Business Economics
Lecture Notes
Demand, Supply, and Equilibrium. Engel Curves. Policy Applications:
Taxes, Subsidies.
Demand for Coffee
Law of demand: when the price goes up the quantity demanded
goes down
PriceQuantity
Demanded
20 cents a cup
5 cups/day
30 cents a cup
4 cups/day
40 cents a cup
2 cups/day
50 cents a cup
1 cups/day
The demand curve
0
10
20
30
40
50
60
0 1 2 3 4 5 6
Quantity
Pri
ce p
er c
up
Important to notice the difference between the demand function and the quantity demanded at each price.
PriceQuantity
DemandedQuantity
Demanded
20 cents a cup
5 cups/day 6 cups/day
30 cents a cup
4 cups/day 5 cups/day
40 cents a cup
2 cups/day 3 cups/day
50 cents a cup
1 cups/day 2 cups/day
Changes in DemandTwo consumers with different demand curves
Changes in the demand curve
D’D
D’’
Pric
e pe
r cu
p
Quantity
P
Q’’ Q Q’
Coffee and Tea: The price of tea increases
Coffee and Cream: The price of cream increases
Income changes: you win the lottery
Engel Curves
Qua
ntity
Income
Normal GoodInferior Good
Application: Demand for Crime
Number of Crimes Committed
Pro
babi
lity
of B
eing
Cau
ght
(per
crim
e co
mm
itted
)
DD’
D’’
P’
Q*
P*
Q**
Application: Job Market and Discrimination
Hours
Wag
e pe
r ho
ur
D
D’ (black)
(white)
Firms demand labor
Quiz
1- When the price goes up, do we expect to see a change in demand or a change in quantity demanded? Do we expect to see a movement along the demand curve or a shift of the demand curve itself?
2- How do you think the demand for fast food shift with an increase in income?
3- How does the demand for popcorn change with a decrease in the price of theater tickets?
4- How might an increase in the price of Big Macs affects the demand for Whoppers?
Market Demand
D1+D2D2
D1
Pric
e
Quantity
P
Q1 Q2 Q1+Q2
Q1
Elasticity of Demand
D2D1
Pric
e
Quantity
P
Q
P’
Q’1 Q’2
Why do we use the elasticity and not just the slope?
$
Cups per month
D
Cups per week
D’
Why do we use the elasticity and not just the slope?
$
Cups per month
D
D’
Euros
Elasticity
• To compare how responsive is the demand to a change in prices we use elasticities instead of slopes.
• Elasticity=Percentage change in quantity/Percentage change in price
• Elasticity= )/)(/()//()/( QPPQPPQQ
Elasticity of Demand
$
Cups per month
D
D’
Elasticity=0
Infinite Elasticity
Think about elasticities of parallel demands and linear demands
Supply of Coffee
Law of Supply: when the price goes up
the quantity supplied goes up
PriceQuantity Supplied
20 cents a cup
100 cups/day
30 cents a cup
300 cups/day
40 cents a cup
400 cups/day
50 cents a cup
500 cups/day
Supply curve
Pric
e
Quantity
P
Q
S
P’
Q’
S’’
S’
Q’’
Changes in costs or technology shift the supply curve
Reduction in price of an input
Elasticity
• Elasticity is a mathematical concept and can be applied to any function.
• Elasticity=
• Elasticity of supply=Percentage change in quantity divided by percentage change in price
• Elasticity of an Engel Curve=Percentage change in quantity divided by the percentage change in income (is a steep Engel curve elastic or inelastic?)
)/)(/()//()/( yxxyxxyy
Quiz
1- How do you think an innovation that reduces the cost of producing corn shift the supply of corn?
2- How might predicted bad weather affect the supply of corn?
Equilibrium
Pric
e
Quantity
P*
Q*
QD=QS
SD
P
QSQDQ’s Q’D
P’
Excess Supply
Excess Demand
Numerical problemThe demand curve for oranges is Q=500-50P and the supply curve for oranges is Q=800P+250. Compute the equilibrium price and quantities.
Numerical Example of EquilibriumQd=100–20pQs=20+20p
Two equations in two unknownsQd=Qs
100-20p=20+20p
80=40pp=2
Q=100-20*2=60=20+20*2{p=2; Q=60}
Equilibrium
D
0
1
2
3
4
5
6
0 10 20 30 40 50 60 70 80 90 100 110 120 130
Quantity
Pri
ce
DS
Qs=20+20p thenP=-1+Q/20
Qd=100–20p then P=100/20-Qd/20
Changes in Equilibrium QuantitiesMusic Market and File Sharing
Quantity of CDs
Pric
e of
a C
D
D
D’
S
QQ’
P
P’
Tax on ConsumersTotal Amount Consumers Pay=Consumers Pay to the Government
(tax)+Consumers Pay to the Firm
Quantity Total Amount
Consumers Pay
Consumers Pay to the
Government (tax)
Consumers Pay to the
Firm
Q* P* 5 cents Pf
P*=Pf+5cents
Q** P** 5 cents Pff
P**=Pff+5 cents
Policy Application
Tax on Consumers
Pric
e
Quantity
P*
D
Q*
D’P**
5 cents
Q**
Pf5 cents
Pff
Tax on Firms
Quantity Total Amount Firms
Receive from
Consumers
Firms Pay to the
Government (tax)
Net Amount Firms Keep
Q** Pcc 5 cents P**
Policy Application
Tax on Firms
Pric
e
Quantity
P**
Q**
S
5 centsPcc
S’
Policy Application
Tax on Suppliers Vs Tax on Consumers
Pric
e
Quantity
P*
SD
Q*
D’
S’
Q’
Pc
Pf
5 cents
Incidence on Firms and on Consumers
Pric
e
Quantity
P*
S
D
Q*
D’
Q’
Pc
Pf
5 cents
Incidence on Firms and on Consumers
Pric
e
Quantity
P*
S
D
Q*
D’
Q’
Pc
Pf
5 cents
Policy Application: Labor Market
Tax on Firms Vs Tax on Workers
Wag
e pe
r ho
ur
Hours
w*
SD
Q*
D’
S’
Q’
w firms
w worker5 cents
What fraction of the tax is paid by workers and employers, respectively?
A tax on labor
hd=100–20w
hs=20+20w
{hs=hd=60, w=2}
$1 tax an hour is imposed on employers
Compute the new equilibrium quantity, the wage the employer pays after the tax is imposed,
and the wage that workers receive.
Tax Imposed on Employers
hd=100–20w20w=100-hd
w=100/20-hd/20A tax of $1 an hourw=(100/20-hd/20)-1
w=(5-hd/20)-1w=4-hd/20
From the supply functionhs=20+20w
w=-1+(1/20)hs
Tax Imposed on Employers
4-h/20=-1+(1/20)h
5=h/20+h/20=(2h)/20100=2h
h=50
w=4-hd/20w=1.5
Employers pay 1.5+1Employees receive 1.5
Policy Application: A Subsidy
Pric
e pe
r un
it
Quantity
P*
D’
Q*
D
S
Q**
Pf
Pc
S’
Policy problems
• Should taxes be imposed on producers or on consumers?
• How is the demand curve for cars affected by a $100 sales tax on cars? How is the supply curve affected by a $100 tax on suppliers of cars?
• Subsidies: Show in a graph the effect of giving a subsidy of 5 cents per pound to orange farmers.
• Labor Market: Use a graph to show that it is equivalent to impose a tax on workers and on firms. What is more fair: a tax on workers or on firms?
Questions from Previous Exams
True/False• The price of gas went up and the quantity sold
went down, therefore the law of supply has been violated.
Multiple Choice• If the supply of oil falls and all other relevant
factors remain unchanged, then
a) the demand for oil will fallb) the quantity demanded for oil will fallc) the demand for oil will rised) the quantity demanded of oil will rise
• ____ 3. An increase in the price of corn will cause a rise in the supply of corn.
• ____ 4. If the price and quantity exchanged of a good simultaneously rise, then the law of demand has been violated.
• ____ 6. Suppose the price of a commodity is $15 per unit. At that price, consumers wish to purchase 6,000 units weekly and producers wish to sell 4,000 units weekly. In this situation,
• a.unsatisfied consumers will bid up the market price.• b.the market price will fall because producers are
unsatisfied.• c.the price will rise and the demand will fall to bring the
market to equilibrium.• d.supply will increase by 2,000 units in order to satisfy
consumers.
• 10. To make child daycare more affordable, government advisors are debating two possible options. Plan A is to give daycare centers a $100 subsidy per month per child. Plan B is to give the parents $100 reduction in taxes per month per child in daycare. Which plan benefits parents more?
• a.Plan A because it will increase the supply of childcare and decrease the price.
• b.Plan B because the $100 goes directly to the parents.• c.The plans are equivalent in terms of their impact on the
price minus subsidy paid by parents.• d.Plan A because the price will fall, while under Plan B
the price will rise.
• ____ 14. Comparing the elasticity of demand when the price is 12 and when the price is 4, when is the elasticity bigger?
• a.They are equal.• b.The elasticity is bigger when the price is 12.• c.The elasticity is bigger when the price is 8.• d.More information is needed to answer this question.
0
2
4
6
8
10
12
14
16
18
0 2 4 6 8 10 12 14 16 18
Cups of coffee per week
Pri
ce (
US
$)