1. Chapter 2 Economic Tools and Economic Thinking making choices functions supply and demand empirical methods making choices functions supply and demand empirical methods

2. With scarcity, must choose making rational choices maximizing something given certain limits or constraints maximize well-being, profits, etc. making rational choices maximizing something given certain limits or constraints maximize well-being, profits, etc.

3. we assume people maximize their utility (a measure of well being) we assume firms maximize their profits constraints: income, prices, time we assume people maximize their utility (a measure of well being) we assume firms maximize their profits constraints: income, prices, time

4. Choose X to maximize V(X) subject to constraints involving X and Z X is endogenous variable (choose X) Z is exogenous variable (Z is given) Choose X to maximize V(X) subject to constraints involving X and Z X is endogenous variable (choose X) Z is exogenous variable (Z is given)

5. exampleexample choose # of children (X) to maximize utility, V(X) constrained by earnings (Z1) cost of children (Z2) choose # of children (X) to maximize utility, V(X) constrained by earnings (Z1) cost of children (Z2)

6. best choice of X =X* X* depends on V(X), and Z best choice of X =X* X* depends on V(X), and Z

7. What affects choice of X? how does choice of X change when Z changes? comparative statics how does choice of X change when Z changes? comparative statics

8. exampleexample how is # of children affected by female earnings? male earnings? cost of education? how is # of children affected by female earnings? male earnings? cost of education?

9. Using models simplification of reality better understand how something works to use: make assumptions apply them to a framework look at implications simplification of reality better understand how something works to use: make assumptions apply them to a framework look at implications

10. if model is too simple implications are not helpful if model is too complicated no implications test the model do the implications match real world data? if model is too simple implications are not helpful if model is too complicated no implications test the model do the implications match real world data?

11. FunctionsFunctions relationship between variables utility function production function relationship between variables utility function production function

12. Utility function U = U(X,Y) utility depends on X and Y X and Y are consumptions goods X, Y are arguments of the function U = U(X,Y) utility depends on X and Y X and Y are consumptions goods X, Y are arguments of the function

13. more utility is better so if U(choice 1) > U (choice 2) always pick choice 1 rational choice more utility is better so if U(choice 1) > U (choice 2) always pick choice 1 rational choice

14. If we observe people making choice 1, then choice 1 must have higher utility revealed preference If we observe people making choice 1, then choice 1 must have higher utility revealed preference

15. example 1 if my U(married) > U(not married), then I get married OR given I am married, then we conclude U(married) > U(not married) if my U(married) > U(not married), then I get married OR given I am married, then we conclude U(married) > U(not married)

16. example 2 we observe that most U.S. households contain > 1 person so we conclude U(living with people) > U(living alone) we observe that most U.S. households contain > 1 person so we conclude U(living with people) > U(living alone)

17. Production function amount of output depends on amount of inputs labor capital (machines, factories, etc) amount of output depends on amount of inputs labor capital (machines, factories, etc)

18. household production household good production depends on time (T) other inputs (Z) G = G(T, Z) household good production depends on time (T) other inputs (Z) G = G(T, Z)

19. example of household good meals inputs: -- food -- pots/pans -- appliances time to make it meals inputs: -- food -- pots/pans -- appliances time to make it

20. working with functions interested in total of function total production total utility AND interested in marginal changes change in function value if one of arguments changes interested in total of function total production total utility AND interested in marginal changes change in function value if one of arguments changes

21. marginal changes how much does my utility change if eat one more oreo? marginal utility of an oreo how much does my utility change if eat one more oreo? marginal utility of an oreo

22. dimishing marginal utility marginal utility falls as I consume more and more 1 st oreo adds more utility than 10 th oreo marginal utility falls as I consume more and more 1 st oreo adds more utility than 10 th oreo

23. how many more meals can I make if I get a microwave? marginal product of a microwave how many more meals can I make if I get a microwave? marginal product of a microwave

24. diminishing marginal returns marginal product declines with more and more input first microwave boosts my meal output more than 2 nd or 3 rd microwave at some point I really have no need for additional microwaves marginal product declines with more and more input first microwave boosts my meal output more than 2 nd or 3 rd microwave at some point I really have no need for additional microwaves

25. Supply and Demand model behavior of buyers Demand model the behavior of sellers Supply buyers & sellers determine quantity & price model behavior of buyers Demand model the behavior of sellers Supply buyers & sellers determine quantity & price

26. MarketMarket haircuts in CNY per week what factors affect buyer decisions? price of haircuts income population fashion price of substitutes haircuts in CNY per week what factors affect buyer decisions? price of haircuts income population fashion price of substitutes

27. what factors affect sellers decisions? price of haircuts costs of haircuts profitability of alternative business what factors affect sellers decisions? price of haircuts costs of haircuts profitability of alternative business

28. Assume:Assume: first look at relationship between quantity and price hold other factors constant men and women do not differ in buying decision men and women not viewed differently by sellers first look at relationship between quantity and price hold other factors constant men and women do not differ in buying decision men and women not viewed differently by sellers

29. DemandDemand relationship between quantity of haircuts demanded (Qd) price of haircuts as price rises, Qd falls holding other factors constant Law of Demand relationship between quantity of haircuts demanded (Qd) price of haircuts as price rises, Qd falls holding other factors constant Law of Demand

30. why does Qd fall when price rises? substitution effect substitute less expensive goods income effect higher prices leave you feeling poorer why does Qd fall when price rises? substitution effect substitute less expensive goods income effect higher prices leave you feeling poorer

31. Demand schedule PQd $3015,000 $2020,000 $1025,000 PQd $3015,000 $2020,000 $1025,000

32. P Q haircuts $30 15K $20 20K $10 25K D

33. SupplySupply relationship between quantity of haircuts supplied price of haircuts as price rises, Qs rises holding other factors constant Law of Supply relationship between quantity of haircuts supplied price of haircuts as price rises, Qs rises holding other factors constant Law of Supply

34. Supply schedule PQs $3025,000 $2020,000 $1015,000 PQs $3025,000 $2020,000 $1015,000

35. P Q haircuts $20 20K 15K $10 $30 25K S

36. the market supply and demand together graph each schedule supply and demand together graph each schedule

37. P Q haircuts $30 15K $20 20K $10 25K D S P = $20 Q = 20K

38. equilibriumequilibrium P=$20, Q=20,000 Qs = Qd with other factors constant, P & Q will stay at this point P=$20, Q=20,000 Qs = Qd with other factors constant, P & Q will stay at this point

39. Allow factors to change CNY population increases more people, more haircuts demanded at every price increase in demand CNY population increases more people, more haircuts demanded at every price increase in demand

40. P Q haircuts $20 20K D S D’ D increases: P increases Q increases

41. Allow factors to change NY increases fee for cosmetology license more costly to provide haircuts fewer haircuts supplied decrease in supply NY increases fee for cosmetology license more costly to provide haircuts fewer haircuts supplied decrease in supply

42. P Q haircuts $20 20K D S S’ S decreases: P increases Q decreases

43. Men vs. women & haircuts assume sellers view women’s haircuts as more costly at any price, sellers willing to provide fewer haircuts for women than for men Women’s supply curve to the left of men’s supply curve assume sellers view women’s haircuts as more costly at any price, sellers willing to provide fewer haircuts for women than for men Women’s supply curve to the left of men’s supply curve

44. P Q haircuts D S men S womenWomen’s haircuts have a higher price

45. assume women are less price sensitive to haircuts than men price increase causes small decrease in Qd women’s demand for haircuts is less elastic than men’s women’s demand curve is steeper than men’s assume women are less price sensitive to haircuts than men price increase causes small decrease in Qd women’s demand for haircuts is less elastic than men’s women’s demand curve is steeper than men’s

46. P Q haircuts D men S Women’s haircuts have a higher price D women

47. is this discrimination? some laws forbid different prices for men vs. women haircuts drycleaning is this fair? is this efficient? some laws forbid different prices for men vs. women haircuts drycleaning is this fair? is this efficient?