End of Consumer Theory Lecture 15 Dr. Jennifer P. Wissink ©2019 Jennifer P. Wissink, all rights reserved. March 18, 2019

Announcements: Micro Spring 2019 Please make sure you see the Bb message all about prelim 1. PICK UP your prelim 1 ASAP from the TA whose name you checked. Last day to change grade option or to drop is Tuesday March 19. ALL questions about grading go to me(Wissink) and only to me. Last day to give me re-grade requests is Monday March 25 in lecture, use this form. https://courses.cit.cornell.edu/econ1110jpw/regrade.pdf Be Mindful of MEL Stuff! Quiz#07 is due this coming Wednesday Friday Quiz#08 has been posted and is due Friday March 29 Quiz#09 will be posted soon and will be due right after Spring Break

i>clicker questions Stan gets utility from only nuts (N) and fruit (F). His utility is currently 147 utils. He is spending all his income. He is consuming N=100 grams and F=50 pounds. Prices are PN=$2/gram and PF=$10/pound. At this bundle Stan’s marginal utilities are MUN=10utils & MUF =20utils. The LDMU has already “set in” for Stan. Stan’s income is some value I can’t compute. $700 $150 $220 $30 Stan is successfully solving the consumer theory problem for himself. Yes. No. Maybe so. If Stan moves $10 from F to N his utility will increase by 30 utils. 20 utils. 3 utils. 5 utils. 2 utils. Stan should buy more F & less N. buy more N & less F. buy more of both. just buy more of F. quit tennis.

Reconciling the “Bang per Buck” Story with the MRS=ERS Result

Now What? Use the Model to Bake the Cake From Scratch What’s the cake again? The market demand curve for beans. What’s the recipe to bake the cake? Use the BL/IC diagram to get Maryclaire’s demand curve for beans. Keep preferences, income and $PC the same, and vary the $PB and see how Maryclaire reacts.

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… from our model… with its assumptions… …are demand curves necessarily downward sloping? That is, MUST demand curves always satisfy the “law of demand”? Yes! No. Robert Giffen Sir Robert Giffen KCB FRS (22 July 1837 – 12 April 1910), was a Scottish statistician and economist. The concept of a Giffen good is named after him. Alfred Marshall wrote in the third (1895) edition of his Principles of Economics: As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it. A Giffen good is a good that violates the law of demand. That means, when $Px increases, the consumer buys more X; when the $Px falls the consumer buys less X!

Reacting To An Own-Price Change with Fixed Income: Suppose the PX increases; what happens to QDX? And why? 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 decreases QDX might increase OR decrease

i>clicker questions to lead-off wednesday 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) Total Effect: Substitution Effect: Income Effect: B

What would it look like if Beans were Giffen? C Challenge Yourself: What would it look like if Beans were Giffen? Break it down into the Total Effect, the Substitution Effect and the Income Effect! Suppose O is the original optimal bundle. Suppose PB increases. If Beans are Giffen, where would the new bundle (N) have to be on the new green budget line? O BLO BLN B

Why Consumer Theory Reason #1: From Individual to Market Demand P P P 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

Why Consumer Theory Reason #2.1 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