Consumer Theory Applications Lecture 14 Dr. Jennifer P. Wissink ©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved. March 22, 2017

Announcements: micro Spring 2017 Econ Week Events Left Wednesday: Economics Department Meet & Greet. Food Provided. 4:30-5:30PM, 477 Uris Hall Thursday: Free Screening of The Big Short. Pizza Provided. 4:45PM, G01 Uris Hall Make-Up Exam Registration Forms Don’t forget to submit form for Prelim 2 if you need to. Also, the registration form for the final is also up and live now. Odd MEL Quiz Due Dates – please take note

How to Find Maryclaire’s Demand for Beans When I=$40, PC=$2 & PB Varies from $4 to $2 to $1

i>clicker question So… are demand curves always necessarily downward sloping? That is, MUST they always satisfy the “law of demand”? Yes! No. Robert Giffen A Giffen Good is a good that violates the law of demand. That means, when $Px increases, the consumer buys more X. Or when the $Px decreases the consumer buys less X!

Reacting To An Own-Price Change with Fixed Income: Suppose the PX increases; what happens to QDX INCOME EFFECT SUBSTITUTION EFFECT X now looks relatively more expensive You feel poorer – your dollars now buy less “X” normal “X” inferior QDX increases QDX decreases QDX decreases QDX might increase OR decrease QDX decreases

i>clicker questions Consider only “own price” changes for goods where the consumer has a fixed income. If “X” is a normal good then its demand curve might be downward or upward sloping. it will never satisfy the law of demand. it will always satisfy the law of demand. it can’t have a substitution effect. it must only have an income effect. Consider only “own price” changes for goods where the consumer has a fixed income. If “Y” is an inferior good then its demand curve might be downward or upward sloping. it will never satisfy the law of demand. it will always satisfy the law of demand. it can’t have a substitution effect. it must only have an income effect. Consider only “own price” changes for goods where the consumer has a fixed income. If “W” is a good that violates the law of demand then it must be normal. it must be inferior. it might be inferior. it’s stupid. it’s hard to tell.

Seeing Total, Substitution & Income Effects on the Graph (The Hicks Way) Hicks’ Method: Use an indifference curve as an anchor – let us say, the original indifference curve. B

Challenge Question to Try: What would it look like if Beans were Giffen? Break it down into the Total Effect, the Substitution Effect and the Income Effect! B

IC/BL Application #1: From Individual to Market Demand DemandMC DemandK BMC BK BTot Maryclaire Katie Aggregate Market

Market Demand Blast From the Past How does our scratch demand compare to the one we bought off the shelf? Recall the demand function for X (mini speakers): QXD = f(PX, Ps, Pc, I, T&P, Pop) Where: PX = price of the mini speakers Ps = the price of substitutes for mini speakers Pc = the price of complements used with mini speakers I=income T&P=tastes and preferences Pop=population in market or market size

IC/BL Application #2: Effect of a Gas Tax with Rebate From The NYT (via Cornell) February 16, 2006, Economic Scene A Way to Cut Fuel Consumption That Everyone Likes, Except the Politicians By ROBERT H. FRANK, Cornell University http://www.nytimes.com/2006/02/16/business/16scene.html?_r=1&pagewanted=print

IC/BL Application #2: Effect of a Gas Tax w/Rebate $aog Slutsky’s TE/SE/IE Method: Use a bundle as the anchor– let us say, the original bundle. gallons of gas

IC/BL Application #3: “In Kind” vs. Cash – The Biggs $mlo BLcash BLo BLfs food

IC/BL Application #3: “In Kind” vs. Cash – The Littles $mlo BLfs BLo BLcash food

IC/BL Application #4: Two-Part Tariffs (Sam’s Club Example) Consider Sam (who owns Sam’s Club and sells only X) and Abe (a shopper) and suppose: IAbe = $2,000 PX = $10 and PY = $10 Initially for Abe: Xo* =100 and Yo* =100 Perfectly competitive firms sell Y Sam’s Club has a monopoly (only seller) on X Average total cost to make X for Sam’s Club is constant and equal to $5 Sam’s idea: Offer Abe the following deal Abe pays $200 to join Sam’s Club and then... Sam lowers price of X to PX = $8 Note: PY is still $10 and IAbe is still $2,000 Question: Is this a good idea? If so, for whom?

O N IAbe = $2000 Entry Fee = $200; PX = $8 and PY = $10 Note: By taking the deal Abe could still afford the original bundle Original bundle: Xo*=100 and Yo*= 100 Budget: $200 (to join) + $800 (spent on X) + $1,000 (spent on Y) = 2,000 IAbe = $2,000 PX = $10 and PY = $10 Initially for Abe: Xo* =100 and Yo* =100 Average total cost to make X for Sam’s Club is constant and equal to $5 Sam’s profit is $500 Y 200 IC0 ICnew 180 O N BLN BL0 225 Xold Xnew 200 X

IC/BL Application #5: Reacting to a Wage Change: The Odd Case of Labor/Leisure! BEWARE! Consider a day in the life of Fred. Fred is endowed with 24 hours of time. He can consume his time as Leisure (Z) or… He can sell his time at $w/hour as Labor (L). His time constraint is: Z + L = 24 Suppose Fred gets utility from Z and $aog. Suppose Fred’s only source of income is his labor income = $wL, which he spends on all other goods.

Z is relatively more expensive IC/BL Application #5: Reacting to a Wage Change: The Odd Case of Labor/Leisure! BEWARE! Suppose Fred’s wage ($w) increases INCOME EFFECT SUBSTITUTION EFFECT Fred feels RICHER–his endowment of time is more valuable Z is relatively more expensive Z normal Z inferior Quantity of Z demanded decreases Quantity of Z demanded increases  Labor supplied decreases Quantity of Z demanded decreases Labor supplied increases NOTE: This case is DIFFERENT, since when the price of leisure increased, Fred felt RICHER (not poorer). Beware! This situation can lead to a “backward bending demand for leisure” which generates a “backward bending supply of labor”!

The Odd Case of Labor/Leisure! BEWARE! $aog BLN BLO Hours of Leisure Demanded (Z) Hours of Labor Supplied (L)

Backward Bending Leisure Demand and Labor Supply Curves Z=Leisure L=Labor Fred gets utility from Leisure(Z) and $aog. Leisure(Z) + Labor(L) = 24 hour and $w = hourly wage rate