Business Economics MECO 6303 Fall 2014

1. Business Economics MECO 6303Fall 2014 Instructor: Alejandro Zentner

2. Business Economics Lecture Notes Demand, Supply, and Equilibrium. Engel Curves. Policy Applications: Taxes, Subsidies.

3. Demand for Coffee Law of demand: when the price goes up the quantity demanded goes down

4. The demand curve Important to notice the difference between the demand function and the quantity demanded at each price.

5. Two consumers with different demand curves Changes in Demand

6. Changes in the demand curve Coffee and Cream: The price of cream increases D’ Price per cup Coffee and Tea: The price of tea increases D D’’ Income changes: you win the lottery P Q’’ Q Q’ Quantity

7. Engel Curves Quantity Inferior Good Normal Good Income

8. Application: Demand for Crime D’ P’ D D’’ Probability of Being Caught (per crime committed) P* Q* Q** Number of Crimes Committed

9. Application: Job Market and Discrimination Firms demand labor D Wage per hour (white) D’ (black) Hours

10. Quiz 1- When the price goes up, do we expect to see a change in demand or a change in quantity demanded? Do we expect to see a movement along the demand curve or a shift of the demand curve itself? 2- How do you think the demand for fast food shift with an increase in income? 3- How does the demand for popcorn change with a decrease in the price of theater tickets? 4- How might an increase in the price of Big Macs affects the demand for Whoppers?

11. Market Demand Price D2 D1+D2 D1 P Q1 Q1 Q2 Q1+Q2 Quantity

12. Elasticity of Demand Price D2 D1 P P’ Q Q’1 Q’2 Quantity

13. Why do we use the elasticity and not just the slope? $ D D’ Cups per month Cups per week

14. Why do we use the elasticity and not just the slope? $ D Euros D’ Cups per month

15. Elasticity • To compare how responsive is the demand to a change in prices we use elasticities instead of slopes. • Elasticity=Percentage change in quantity/Percentage change in price • Elasticity=

16. Elasticity of Demand D Elasticity=0 $ Infinite Elasticity D’ Cups per month Think about elasticities of parallel demands and linear demands

17. Supply of Coffee Law of Supply: when the price goes up the quantity supplied goes up

18. Supply curve Changes in costs or technology shift the supply curve Price S’’ S S’ P’ P Reduction in price of an input Q’’ Q Q’ Quantity

19. Elasticity • Elasticity is a mathematical concept and can be applied to any function. • Elasticity= • Elasticity of supply=Percentage change in quantity divided by percentage change in price • Elasticity of an Engel Curve=Percentage change in quantity divided by the percentage change in income (is a steep Engel curve elastic or inelastic?)

20. Quiz 1- How do you think an innovation that reduces the cost of producing corn shift the supply of corn? 2- How might predicted bad weather affect the supply of corn?

21. Equilibrium Numerical problem The demand curve for oranges is Q=500-50P and the supply curve for oranges is Q=800P+250. Compute the equilibrium price and quantities. Price D Excess Supply S P P* P’ Excess Demand Q’s QD Q* QD=QS Q’D QS Quantity

22. Numerical Example of Equilibrium Qd=100–20p Qs=20+20p Two equations in two unknowns Qd=Qs 100-20p=20+20p 80=40p p=2 Q=100-20*2=60=20+20*2 {p=2; Q=60}

23. Equilibrium S D D Qs=20+20p then P=-1+Q/20 Qd=100–20p then P=100/20-Qd/20

24. Changes in Equilibrium QuantitiesMusic Market and File Sharing S Price of a CD D D’ P P’ Q’ Q Quantity of CDs

25. Tax on ConsumersTotal Amount Consumers Pay=Consumers Pay to the Government (tax)+Consumers Pay to the Firm

26. Policy ApplicationTax on Consumers Price D D’ P** 5 cents Pff P* 5 cents Pf Quantity Q** Q*

27. Tax on Firms

28. Policy ApplicationTax on Firms S’ Price S Pcc 5 cents P** Quantity Q**

29. Policy ApplicationTax on Suppliers Vs Tax on Consumers S’ Price D S D’ Pc 5 cents P* Pf Quantity Q’ Q*

30. Incidence on Firms and on Consumers D Price D’ S Pc 5 cents P* Pf Q’ Q* Quantity

31. Incidence on Firms and on Consumers S Price Pc P* 5 cents D Pf D’ Quantity Q’ Q*

32. Policy Application: Labor Market Tax on Firms Vs Tax on Workers S’ Wage per hour D S D’ What fraction of the tax is paid by workers and employers, respectively? w firms 5 cents w* w worker Hours Q’ Q*

33. A tax on labor hd=100–20w hs=20+20w {hs=hd=60, w=2} $1 tax an hour is imposed on employers Compute the new equilibrium quantity, the wage the employer pays after the tax is imposed, and the wage that workers receive.

34. Tax Imposed on Employers hd=100–20w 20w=100-hd w=100/20-hd/20 A tax of $1 an hour w=(100/20-hd/20)-1 w=(5-hd/20)-1 w=4-hd/20 From the supply function hs=20+20w w=-1+(1/20)hs

35. Tax Imposed on Employers 4-h/20=-1+(1/20)h 5=h/20+h/20=(2h)/20 100=2h h=50 w=4-hd/20 w=1.5 Employers pay 1.5+1 Employees receive 1.5

36. Policy Application: A Subsidy S Price per unit D’ S’ D Pf P* Pc Q* Q** Quantity

37. Policy problems • Should taxes be imposed on producers or on consumers? • How is the demand curve for cars affected by a $100 sales tax on cars? How is the supply curve affected by a $100 tax on suppliers of cars? • Subsidies: Show in a graph the effect of giving a subsidy of 5 cents per pound to orange farmers. • Labor Market: Use a graph to show that it is equivalent to impose a tax on workers and on firms. What is more fair: a tax on workers or on firms?

38. Questions from Previous Exams True/False • The price of gas went up and the quantity sold went down, therefore the law of supply has been violated. Multiple Choice • If the supply of oil falls and all other relevant factors remain unchanged, then a) the demand for oil will fall b) the quantity demanded for oil will fall c) the demand for oil will rise d) the quantity demanded of oil will rise

39. ____ 3. An increase in the price of corn will cause a rise in the supply of corn. • ____ 4. If the price and quantity exchanged of a good simultaneously rise, then the law of demand has been violated. • ____ 6. Suppose the price of a commodity is $15 per unit. At that price, consumers wish to purchase 6,000 units weekly and producers wish to sell 4,000 units weekly. In this situation, • a.unsatisfied consumers will bid up the market price. • b.the market price will fall because producers are unsatisfied. • c.the price will rise and the demand will fall to bring the market to equilibrium. • d.supply will increase by 2,000 units in order to satisfy consumers.

40. 10. To make child daycare more affordable, government advisors are debating two possible options. Plan A is to give daycare centers a $100 subsidy per month per child. Plan B is to give the parents $100 reduction in taxes per month per child in daycare. Which plan benefits parents more? • a.Plan A because it will increase the supply of childcare and decrease the price. • b.Plan B because the $100 goes directly to the parents. • c.The plans are equivalent in terms of their impact on the price minus subsidy paid by parents. • d.Plan A because the price will fall, while under Plan B the price will rise.

41. ____ 14. Comparing the elasticity of demand when the price is 12 and when the price is 4, when is the elasticity bigger? a.They are equal. b.The elasticity is bigger when the price is 12. c.The elasticity is bigger when the price is 8. d.More information is needed to answer this question.