Price Controls and the Benefits of Exchange An efficient market maximizes the sum of producer and consumer surplus Price ceilings and floors harm efficiency by reducing the quantity exchanged, and therefore reducing this surplus (there can’t be surplus from items not exchanged!) While price ceilings may help a few consumers, they hurt others, and definitely harm producers While price floors may help a few producers, they hurt others, and definitely harm consumers

Price Controls and Benefits of Exchange Q P D S PePe QeQe CS PS 2

Price CEILING Q P D QeQe Q ceiling DEADWEIGHT LOSS The Lost CS and PS. INEFFICIENT! PS 3 S CS Price Controls and Benefits of Exchange PePe

Q P D S QeQe CS PS 4 Price Controls and Benefits of Exchange PePe

Price FLOOR Q P D QeQe Q floor DEADWEIGHT LOSS The Lost CS and PS. INEFFICIENT! CS PS S Price Controls and Benefits of Exchange PePe

Do Now 1.Pick up Consumer Theory notes from cart 2.Answer the following in your notebook: One common type of price floor is the minimum wage: a law prohibiting businesses from paying their employees less than a certain dollar amount per hour. Currently, the national minimum wage is $7.25/hour. Presidential candidate Bernie Sanders has proposed a law that would raise the minimum wage to $15/hour. Do you think this law is a good idea? Explain.

S Wage Q Labor D Minimum Wage 7 $15 $7.25 $

S Wage Q Labor D Q demanded falls. Q supplied increases Surplus of workers (Unemployment) Minimum Wage $15 $7.25 $6

Quiz Answers

SUVs Price Quantity S P1 D Q1 D2 S2 Q2 P2 Supply__________ Demand_________ Price ___________ Quantity ________ Decrease Unknown Decrease

Cat Food Price Quantity S P1 D Q1 D2 S2 Q2 P2 Supply__________ Demand_________ Price ___________ Quantity ________ Increase Decrease Unknown

Luxury Cars Price Quantity S P1 D Q1 D2 Q2 P2 Supply__________ Demand_________ Price ___________ Quantity ________ Stay same Increase

Mustard Price Quantity S P1 D Q1 D2 P2 Q2 Supply__________ Demand_________ Price ___________ Quantity ________ Stay same Decrease

Soybeans Price Quantity S P1 D Q1 D2 S2 Q2 P2 Supply__________ Demand_________ Price ___________ Quantity ________ Increase Decrease Unknown

A consumer is anyone who uses – or consumes – goods and services generated within the economy. Consumer Theory

Economists assume that people are rational, and will use their limited wealth to maximize their total utility from consumption Wait, why did I buy this? I don’t even know how to use it. Consumer Theory

Economists use the term utility to describe the satisfaction, happiness or benefit gained from consumption. Economists sometimes use the term utils as a hypothetical measurement of utility Consumer Theory

Total utility is the total amount of satisfaction received from the consumption of a certain amount of a product. Marginal utility is the additional utility gained from the consumption of the next unit of a product. The law of diminishing marginal utility states that the marginal utility from consumption of the same product will eventually start to decrease Consumer Theory

Calculate Marginal Utility # of Slices of Pizza Total Utility (in dollars) Marginal Utility

# of Slices of Pizza Total Utility (in dollars) Marginal Utility How many pizzas would you buy if the price per slice was $3? 20 Calculate Marginal Utility

# of Slices of Pizza Total Utility (in dollars) Marginal Utility How many pizzas would you buy if the price per slice was $3? 21 A rational consumer will continue to consume as long as the marginal benefit is greater than the marginal cost Calculate Marginal Utility

# of Big Macs Total Utility (in dollars) Marginal Utility Practice How many hamburgers would you buy if a Big Mac costs $3.50?

You plan to take a vacation and want to maximize your utility. Based on the info below, which should you choose? 23 Consumer Behavior Destination Marginal Utility (In Utils) Tahiti3000 Chicago1000

You plan to take a vacation and want to maximize your utility. Based on the info below, which should you choose? Destination Marginal Utility (In Utils) Cost Marginal Utility Per Dollar Tahiti3000$3,0001 Chicago1000$ Consumer Behavior

# Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Bowling) MU/P (Price =$5) 1st3010 2nd205 3rd102 4th51 Utility Maximization $10 $5 If you only have $25, what combination of movies and games of bowling maximizes your utility?

# Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Bowling) MU/P (Price =$5) 1st nd rd th Utility Maximization $10 $5 If you only have $25, what combination of movies and games of bowling maximizes your utility?

Utility-Maximizing Rule When choosing between goods, rational consumers will choose the good that offers the highest marginal utility per dollar i.e. the most “bang for your buck” Ultimately, the marginal utility per dollar for the last unit of each good that a rational person consumes will be equal MU Good A = MU Good B 27 P Good A P Good B

Suppose you have $7 to spend on Snickers and Twix. The table below shows the total utility (in dollars) that you would receive from consuming various quantities of these two fruits. What combination of Snickers and Twix would maximize your utility? Practice Snickers = $1 eachTwix = $2 each Q Total Utility Q

Snickers = $1 eachTwix = $2 each Q Total Utility Q

Snickers = $1 eachTwix = $2 each Q Total Utility Marginal Utility Q Total Utility Marginal Utility

Snickers = $1 eachTwix = $2 each Q Total Utility Marginal Utility Q Total Utility Marginal Utility

Snickers = $1 eachTwix = $2 each Q Total Utility Marginal Utility MU/PQ Total Utility Marginal Utility MU/P

Snickers = $1 eachTwix = $2 each Q Total Utility Marginal Utility MU/PQ Total Utility Marginal Utility MU/P $7$6 $3$0 Utility-Maximizing Combination: 3 Snickers, 2 Twix

Snickers = $1 eachTwix = $2 each Q Total Utility Marginal Utility MU/PQ Total Utility Marginal Utility MU/P $7$6 $3$0

Budgeting A good way to plan ahead in order to maximize utility with your money is to create a budget A budget is an estimate of income and spending over a specific period of time Budgets are used by individuals, families, a businesses, government, charities, and just about anyone else who makes and spends money

Budgeting Individuals and families must carefully weigh their spending against current and future income – the money they earn at their job, from investments, from government benefits, etc. If a person spends less than she earns, she is saving money In order for a person to spend more than he earns, he must either: 1)use money that he has already saved, OR 2)borrow money

Saving $1000 that is saved today may grow into much more than $1000 several years from now. How is this possible? Money that is saved can be invested Common types of investments include stocks, bonds, savings accounts, and real estate Investments tend to increase in value over time

Borrowing Someone who borrows $1000 today may owe much more than $1000 several years from now. How? Money that is borrowed must be paid back with interest Interest is the price that a lender charges a borrower for charging money Interest is almost always charged as a percentage of the amount borrowed –e.g. If a lender charges 5% annual interest, it will cost $5 to borrow $100 from that lender for one year –at the end of 1 year, the borrower must repay the lender $105 ($100 of principal, plus $5 of interest)

41 Elasticity

HOW MUCH MORE OR LESS? DOES IT MATTER? THE LAW OF DEMAND SAYS... Consumers will buy more when prices go down and less when prices go up 42

Elasticity Elasticity shows how sensitive quantity is to a change in price.

2 Types of Elasticity 1.Elasticity of Demand 2.Elasticity of Supply

1. Elasticity of Demand Elasticity of Demand Measurement of consumers’ responsiveness to a price change. What will happen if price increases? How much will it affect quantity demanded? Who cares? Firms! – can we get away with a big price increase? How many more customers would we get if we lowered our prices? Governments – how much sales tax can we get away with?

Inelastic Demand

If price increases, quantity demanded will fall a little If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 20% 5% INelastic = Quantity is INsensitive to a change in price. Examples Gasoline Milk Diapers Chewing Gum Medical Care Toilet paper

Inelastic Demand 20% 5% General Characteristics of INelastic Goods: Few Substitutes Necessities Small portion of income % Change in Quantity % Change in Price

Elastic Demand

If price increases, quantity demanded will fall by a lot If price decreases, quantity demanded increases a lot. The amount people buy is very sensitive to price. Elastic = Quantity is sensitive to a change in price. Examples Soda Beef Cars Boats

Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxuries Large portion of income % Change in Quantity % Change in Price

Elastic or Inelastic? Beef- Gasoline- Real Estate- Medical Care- Electricity- Gold- Elastic INelastic -.20 Elastic INelastic -.31 INelastic -.13 Elastic What about diabetics’ demand for insulin?

2. Price Elasticity of Supply Elasticity of Supply- Elasticity of supply shows how sensitive producers are to a change in price. Elasticity of supply is based on time limitations. Producers need time to produce more. INelastic = Insensitive to a change in price Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price Most goods have elastic supply in the long-run Perfectly Inelastic = Q doesn’t change (Vertical line) Set quantity supplied % Change in Quantity % Change in Price

% Change in Quantity (Demanded or Supplied) % Change in Price Elasticity Coefficient (E) = _____________ Calculating Elasticity

% Change in Quantity (Demanded or Supplied) % Change in Price E = ________________ If E > 1 : Demand (or supply) is ELASTIC If 0<E<1: INELASTIC If E = 1: UNIT ELASTIC If E = 0: PERFECTLY INELASTIC If E = undefined : PERFECTLY ELASTIC

Percent Change % change between two numbers = New Number ________________ Old Number -

Percent Change % change between two numbers = Old Number ________________ New Number - _________

Percent Change % change between two numbers = Old Number ________________ New Number - _________ OLD NUMBER!!!

Percent Change % change between two numbers = New Number OLD NUMBER ________________ Old Number - x 100 _________

Percent Change % change between two numbers = New Number OLD NUMBER ________________ Old Number - The price of a good increased from $10 to $15. What was the percent change? x 100 _________

Percent Change % change between two numbers = $15 OLD NUMBER ________________ Old Number - The price of a good increased from $10 to $15. What was the percent change? x 100 _________

Percent Change % change between two numbers = $15 OLD NUMBER ________________ $10 - The price of a good increased from $10 to $15. What was the percent change? x 100 _________

Percent Change % change between two numbers = $5 OLD NUMBER ________________ The price of a good increased from $10 to $15. What was the percent change? x 100 _________

Percent Change % change between two numbers = $5 $10 ________________ The price of a good increased from $10 to $15. What was the percent change? x 100 _________

Percent Change % change between two numbers = ________________ The price of a good increased from $10 to $15. What was the percent change? x

Percent Change % change between two numbers = The price of a good increased from $10 to $15. What was the percent change? 0.5 x 100

Percent Change % change between two numbers = The price of a good increased from $10 to $15. What was the percent change? 50%

% Change in Quantity (Demanded or Supplied) % Change in Price E = ________________ When the price of a good increased from $10 to $20, quantity demanded decreased from 100 to 80. What is the elasticity of demand coefficient? Is demand for the good elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic in this range?

Percent Change % change between two numbers = New Number OLD NUMBER ________________ Old Number to 80 x 100 _________

Percent Change % change between two numbers = 80 OLD NUMBER ________________ Old Number to 80 x 100 _________

Percent Change % change between two numbers = 80 OLD NUMBER ________________ to 80 x 100 _________

Percent Change % change between two numbers = ________________ to 80 x 100 _________

Percent Change % change between two numbers = 100 ________________ to 80 x 100 _________

Percent Change % change between two numbers = 100 ________________ to 80 x 100

Percent Change % change between two numbers = 5 _____ to 80 x 100

Percent Change % change between two numbers = to 80 x 100

Percent Change % change between two numbers = 20% 100 to 80

% Change in Quantity (Demanded or Supplied) % Change in Price E = ________________ When the price of a good increased from $10 to $20, quantity demanded decreased from 100 to 80. What is the elasticity of demand coefficient? Is demand for the good elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic in this range?

20% % Change in Price E = ________________ When the price of a good increased from $10 to $20, quantity demanded decreased from 100 to 80. What is the elasticity of demand coefficient? Is demand for the good elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic in this range?

Percent Change % change between two numbers = New Number OLD NUMBER ________________ Old Number - $10 to $20 x 100 _________

Percent Change % change between two numbers = $20 OLD NUMBER ________________ Old Number - $10 to $20 x 100 _________

Percent Change % change between two numbers = $20 OLD NUMBER ________________ $10 - $10 to $20 x 100 _________

Percent Change % change between two numbers = $20 $10 ________________ $10 - $10 to $20 x 100 _________

Percent Change % change between two numbers = $10 ________________ $10 $10 to $20 x 100

Percent Change % change between two numbers = $10 to $20 x 100 1

Percent Change % change between two numbers = $10 to $20 100%!

20% % Change in Price E = ________________ When the price of a good increased from $10 to $20, quantity demanded decreased from 100 to 80. What is the elasticity of demand coefficient? Is demand for the good elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic in this range?

20% E = ________________ 100% When the price of a good increased from $10 to $20, quantity demanded decreased from 100 to 80. What is the elasticity of demand coefficient? Is demand for the good elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic in this range?

E = 0.2 When the price of a good increased from $10 to $20, quantity demanded decreased from 100 to 80. What is the elasticity of demand coefficient? Is demand for the good elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic in this range?

E = If E > 1 : Demand (or supply) is ELASTIC If 0<E<1: INELASTIC If E = 1: UNIT ELASTIC If E = 0: PERFECTLY INELASTIC If E = ∞ : PERFECTLY ELASTIC 0.2

E = Inelastic! 0.2