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

2. 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

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

4. 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!

5. 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

6. 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.

7. 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

8. 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

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

10. 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

11. 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

12. 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

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

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

15. 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?

16. 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

17. 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.

18. 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”!

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

20. 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