1. End of Consumer Theory Lecture 15
Dr. Jennifer P. Wissink
©2018 John M. Abowd and Jennifer P. Wissink, all rights reserved.
March 19, 2018

2. Seeing Total, Substitution & Income Effects on the Graph (The Hicks Way)
Total Effect:
Substitution Effect:
Income Effect: B

3. Challenge Question to Try: TRUST ME
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

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

5. 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

6. 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

7. IC/BL Application #2: Effect of a Gas Tax w/Rebate
$aog or $mlo
Slutsky’s TE/SE/IE Method: Use a bundle as the anchor– let us say, the original bundle.
gallons of gas

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

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

10. 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 on X
Sam’s total cost to make X is total cost = $5X
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?

11. O N IAbe = $2000 Entry Fee to Sam’s = $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
Sam’s total cost: tc=5X
Sam’s profit is $500 = $10∙10 – $5∙10 Y
200
IC0
ICnew
180 O N
BLN
BL0
225
Xold
Xnew
200 X