See Handout (contains whole of lectures 3-5) Topic 1: Lecture 3 The circular flow model Agent: Households Demand Supply Market: Goods/Services Market: Inputs Agent: Firms Demand Supply Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Demand Consider a Demand Relation: What are the influences on Demand for a good . . . ? How does a change in some other influence affect the demand curve? px a po What does the slope of the demand curve tell us? b D Xo X Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Supply Consider a Supply Relation: What are the influences on Supply a good . . . ? How does a change in some other influence affect the Supply curve? px S What does the slope of the Supply curve tell us? a po b Xo X Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Putting together Supply and Demand: What is meant by the ‘market equilibrium’? px S What are the possible properties of a market equilibrium? pe D Xe X Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Comparative Statics: What is the effect on market equilibrium of a shift in demand? px S pe D Xe X Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Comparative Statics: What is the effect on market equilibrium of a shift in supply? px S pe D Xe X Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Uniqueness of equilibrium and price bubbles: Suppose D is the Willingness to Pay for housing. It’s likely to depend on Consumer Confidence (CC). (i) What happens if CC rises? (ii) What might cause CC to rise? What is the implication of this? px S pe D Xe X Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 3 Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis (or analysis of ‘Consumer Choice’) Choice is based on . . . . . . Preferences and . . . Constraints We’ll analyse each of these in turn. Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences Suppose your happiness depends on just 2 commodities (that you might buy in the market): e.g., ??? Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences E.g., Books and Food We assume that you have preferences over these goods and that the nature of your preferences satisfies various properties: Non-satiation . . . . . . in words: Ordinal Ranking Transitivity Completeness Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences Non-satiation . . . in a diagram. B a b B1 F1 F2 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences Our assumptions about the properties of preferences imply that we can represent preferences using Indifference Curves. These ICs will have properties which depend upon the properties of the underlying preferences. B We can show that an IC must slope downwards because of non-satiation. a b B1 F1 F2 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences We can show that ICs cannot cross under the assumptions we have made about preferences: IC1 B IC2 a c b F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences The slope of the IC is the MRS between the 2 goods (refer to earlier slides). B a b IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences If the IC is linear, this means that the MRS is constant. B a b IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences It is more common to assume that the MRS is diminishing: why is this and what does it imply about the IC? B a b F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences It is more common to assume that the MRS is diminishing: why is this and what does it imply about the IC? B IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences What would it mean if the IC was upward-sloping? B IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences What would this mean? B IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences Under the assumption of completeness, there is an IC passing through every possible point: B b a IC2 IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 4 Demand Analysis: Preferences The consumer would like to get to the highest possible IC: what limits this? c ICn B b a IC2 IC1 F Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints We said that our understanding of Consumer Choice rests on the analysis of Preferences and Constraints. Let’s now turn to consider Constraints. Y Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints We can represent a budget set and a budget frontier (or constraint) Y Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints We can represent a budget set and a budget frontier (or constraint) Y What equation can we give this constraint? Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints The equation tells us that if we spend all our money income, M, on X and Y, our spending be equal to: Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints Re-arranging, the equation for the budget constraint is: How do you interpret this equation? And Graphically? Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints The equation of the budget constraint: Y Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constraints Given the position of the budget constraint, what will be the consumer’s choice of X and Y? This will depend on their preferences: Y Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constrained choice Given the position of the budget constraint, what will be the consumer’s choice of X and Y? This will depend on their preferences: IC3 Y IC1 IC2 Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constrained choice Given the position of the budget constraint, what will be the consumer’s choice of X and Y? This will depend on their preferences: ICmax Y Ymax X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constrained choice Given the position of the budget constraint, what will be the consumer’s choice of X and Y? This will depend on their preferences: Y Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Constrained choice So, by bringing together preferences and constraints, we have a model which predicts/explains the consumer’s choices (demands) for X and Y . . . given . . .? Y Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Comparative Statics What will happen to the optimal choices of X and Y if there are relevant changes to the parameters of the model? Y What are the ‘relevant parameters’? Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Comparative Statics What will happen to the optimal choices of X and Y if there are relevant changes to the parameters of the model? Y Consider a change in money income. How do we show this? Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Change in money income Y Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Change in money income Y What can you say about the demand for X as M↑? And the demand for Y? Ymax â a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Change in money income Y What can you say about the demand for X as M↑? And the demand for Y? â Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Change in money income Y What can you say about the demand for X as M↑? And the demand for Y? â Ymax a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Change in money income Y What can you say about the demand for X as M↑? And the demand for Y? Ymax â a Y* X* X Xmax Robin Naylor, Department of Economics, Warwick

Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 5 Demand Analysis: Change in money income Y What can you say about the demand for X as M↑? And the demand for Y? Ymax a Y* â X* X Xmax Robin Naylor, Department of Economics, Warwick