Principles of Economics Dr Martin Jensen (this term / micro) Dr James Reade (next term / macro) Exam: Summer 2013 joint for micro and macro (each weights 50 %). Course homepage: socscistaff.bham.ac.uk/jensen/economics101.htm (or via people->academic staff -> etc.) (or via WebCT)

Principles of Economics The textbook is: Sloman, J., A. Wride, and D. Garrett: “Economics”, 8th Edition, 2012, Pearson. Backed up by the 101A booklet (for the few people who don’t have it already, you can get this from the secretaries in the Econ. Dep.)...And the course homepage.

Principles of Economics Apart from lectures, there are classes. Classes take place every two weeks, beginning either next week or the week after (depending on which group you’re in). To sign up for classes, enter Econ101 in WebCT and press the ”sign up for classes” link (this is pretty selfexplanatory).

Introduction and Indifference Analysis

PRICE AND OUTPUT DETERMINATION We call the price that obtains in the market, the market price, or the Equilibrium price We call the price that obtains in the market, the market price, or the Equilibrium price We call the quantity demanded and supplied the equilibrium output.We call the quantity demanded and supplied the equilibrium output. We find this by plotting the demand and the Supply curves.We find this by plotting the demand and the Supply curves.

Equilibrium price and output : The Market Demand and Supply of Potatoes (Monthly)

Quantity (tonnes: 000s) Price (pence per kg) E D C B A a b c d e Supply Demand The determination of market equilibrium (potatoes: monthly)

Quantity (tonnes: 000s) Price (pence per kg) E D C B A a b c d e Supply Demand The determination of market equilibrium (potatoes: monthly) Where the two lines cross is called the equilibrium point P e =12 Q e =350

Demand In this course we want to explore in more detail what lies behind the demand and supply decisions that people (agents) make by focusing on the economics that lie behind the decisions we actually observe.In this course we want to explore in more detail what lies behind the demand and supply decisions that people (agents) make by focusing on the economics that lie behind the decisions we actually observe. First we are going to focus on Demand. Then we turn to supply both under perfect competition and various sorts of imperfect competition. Finally, we use what we’ve learned to study some “selected topics”.First we are going to focus on Demand. Then we turn to supply both under perfect competition and various sorts of imperfect competition. Finally, we use what we’ve learned to study some “selected topics”.

Happiness Happiness Basically we demand goods because they make us ‘happy’Basically we demand goods because they make us ‘happy’ Or at least we would be unhappy if we didn’t have them.Or at least we would be unhappy if we didn’t have them. Either way we get ‘JOLLIES’ from themEither way we get ‘JOLLIES’ from them Economists have a special term for Jollies – we call it UTILITYEconomists have a special term for Jollies – we call it UTILITY

Utility Theory Even Better – we have a theory to explain consumers’ behaviour called:Even Better – we have a theory to explain consumers’ behaviour called: Utility TheoryUtility Theory This theory relies on an important foundation:This theory relies on an important foundation: RationalityRationality We assume people choose their desired consumption rationally or consistentlyWe assume people choose their desired consumption rationally or consistently

Rationality What do we mean by Rationality ?What do we mean by Rationality ? We do not mean that people are fully informed or fully conscious about every consumption decision they makeWe do not mean that people are fully informed or fully conscious about every consumption decision they make Rather we mean they act (consciously or otherwise) in a consistent manner.Rather we mean they act (consciously or otherwise) in a consistent manner.

Total Utility Packets of crisps Total Utility in Utils We imagine that consumers act as if they are trying to make themselves as happy as possible (broadly defined) given their circumstances. In the adjacent table the consumer gets ‘jollies’, called UTILS from consuming crisps. The table records his/her total utility..

Darren’s utility from consuming crisps (daily) Packets of crisps TU in utils Utility (utils) Packets of crisps consumed (per day) TU

MARGINAL UTILITY THEORY Total and marginal utilityTotal and marginal utility Marginal Utility:Marginal Utility: The change in Total Utility as a result of consuming one more unit of the good.The change in Total Utility as a result of consuming one more unit of the good.

Packets of crisps TU in utils MU in utils Utility (utils) Packets of crisps consumed (per day) TU Darren’s utility from consuming crisps (daily) Q 1 -Q 0 =3-2=1 TU 1 -TU 0

Utility (utils) Packets of crisps consumed (per day) TU Darren’s utility from consuming crisps (daily) Q 1 -Q 0 =3-2=1 TU 1 -TU 0  TU = 2  Q = 1 MU =  TU /  Q = 2/1 = 2

MU  TU = 2  Q = 1 Utility (utils) Packets of crisps consumed (per day) TU Alternative representation of Darren’s Marginal utility Packets of crisps TU in utils MU in utils

MU  TU = 2  Q = 1 MU =  TU /  Q = 2/1 = 2 Utility (utils) Packets of crisps consumed (per day) TU Alternative representation of Darren’s Marginal utility) Note this is effectively measuring the slope of the curve

MU  TU = 2  Q = 1 MU =  TU /  Q = 2/1 = 2 Utility (utils) Packets of crisps consumed (per day) TU Alternative representation of Darren’s Marginal utility

Packets of crisps TU in utils MU in utils Utility (utils) Packets of crisps consumed (per day) TU MU Graphing Darren’s Marginal utility we get:

MARGINAL UTILITY THEORY Total and marginal utilityTotal and marginal utility Marginal Utility:Marginal Utility: The change in Total Utility as a result of consuming one more unit of the good.The change in Total Utility as a result of consuming one more unit of the good.

The principle of diminishing marginal utility Note that the Marginal Utility curve is downward Sloping This gives us: The principle of diminishing marginal utility –As more units of a good are consumed, additional units will provide us with less additional satisfaction than previous units

Now let’s look at two goods Packets of crisps TU in utils MU in utils Pints of Beer TU in utils MU in utils

Packets of crisps TU in utils MU in utils Pints of Beer TU in utils MU in utils Looking at the utility from beer compared with crisps do you think Darren should spend all his money on beer?

Packets of crisps TU in utils MU in utils Pints of Beer TU in utils MU in utils Suppose that Crisps cost 25p And Beer cost 1.50 per pint, How should Darren allocate his income between beer and crisps

Bang per buck Packets of crisps TU in utils MU in utils Pints of Beer TU in utils MU in utils The crucial issue is not how many utils you get from consuming another beer or packet of crisps But rather the ‘bang per buck’ or utils per pound

Bang per buck Packets of crisps TU in utils MU in utils Pints of Beer TU in utils MU in utils The crucial issue is not how many utils you get from consuming another beers or packet of crisps But rather the ‘bang per buck’ or utils per pound

Packets of crisps TU in utils MU in utils Pints of Beer TU in utils MU in utils MU/P We should allocate our spending such that

Etc,etc

Alternatively we can write the condition for equilibrium as:

INDIFFERENCE ANALYSIS A more sophisticated way to analyse this problem is to use what is known as Indifference Analysis. For that we need to:A more sophisticated way to analyse this problem is to use what is known as Indifference Analysis. For that we need to: –Construct an indifference curve

Pears Oranges Point abcdefgabcdefg Combinations of pears and oranges that Clive likes the same amount as 10 pears and 13 oranges Constructing an indifference curve The data in this table tells us about various combinations that make ‘Clive’ equally happy. He is ‘Indifferent’ between 10 Pears and 13 Oranges And 14 pears and 10 Oranges

a Pears Oranges Pears Oranges Point abcdefgabcdefg Constructing an indifference curve

a b Pears Oranges Pears Oranges Point abcdefgabcdefg Constructing an indifference curve

a b c d e f g Pears Oranges Pears Oranges Point abcdefgabcdefg Constructing an indifference curve

a b c d e f g Pears Oranges Pears Oranges Point abcdefgabcdefg Constructing an indifference curve Joining all these points gives us AN indifference curve

INDIFFERENCE ANALYSIS Indifference curvesIndifference curves –constructing an indifference curve –the shape of an indifference curve

a b c d e f g Pears Oranges Constructing an indifference curve Notice that this curve is downward sloping Why is this and does it have any economic meaning?