Principles of Microeconomics

1. Principles of Microeconomics Summer 2009

2. About Me… • Where I’m from:

3. About Me… • My “kids”…

4. About Me… • How many of you are here to “avoid” Econ 1014 at Mizzou?

5. About Me… • My personality…

6. Webpage • http://web.missouri.edu/~dls6w4 • Syllabus • Calendar • Practice Materials • Homework • Exam Information

7. Blackboard • Make sure you have access to Blackboard • You need to either: • Activate your stlcc email account • Update Blackboard to different email • You are responsible for any announcements I post/email

8. Homework Homework • “Long and painful” • Absences will not excuse you from completing homework • All will be posted on the webpage • You’ll need to have a strong understanding of the material • “End of Class” • Group work… • I will take your top 5 scores

9. Exams 4 exams • Final is cumulative • I will drop your lowest exam score of the first three • The final exam counts • Format: • You’ll have options • Each has its trade-offs

10. Attendance • Attendance includes being present, but it also includes: • Not disrupting class • Being attentive • Not excessively talking • Not doing anything I deem “annoying” • This will cost you attendance credit • If you come in after roll call, it is your job to notify me in person that day

11. Point Breakdown • Exams: 60% • Three Midterm exams: 100 points each • Final Exam (cumulative): 100 points • Homework: 40% • Each homework worth fifty points each • I’ll count the top 5 • Attendance: Loss of 3%

12. Exam I Material Introduction and Toolkit

13. What is Economics? • Economics • The study of how society manages its scarce resources • Scarcity • The limited nature of society’s resources • The resource must be “desirable” • In Microeconomics, we want to study how people/firms/etc. make decisions

14. Why Economics? • Specifically, we wish to answer three questions: • What gets produced? • How to produce/Who produces? • Who gets what is produced? • Costs/Benefits are keys • Application: “Detroitasaurus Wrecks”

15. How decisions are made • All decisions are made with the specific intention of “maximizing surplus” • This is what economists consider “rational” • Any decision that maximizes one’s own surplus • House, MD, 2:19 • Surplus = Benefits – Costs • Things to remember/consider • Opportunity Costs • Sunk Costs • Psychic Costs/Benefits • “After the fact” changes

16. How this process is affected • Incentives • Rewards/Punishments to encourage behavior • Most common source of “unintended consequences” • Externalities • Decisions of one affect others • “Decider” must not care/know about affects • Marginal Analysis • Few (if any) do full “pro-con” list • Most “take a step” and evaluate

17. Demand • Quantity Demanded: the amount of a good that one is willing and able to purchase at a given price • Inversely related to prices • Price increases, people buy less, and vice versa • Collection of “Qd”: Demand Curve • Law of Demand: As price increases, the quantity demanded falls, all else equal

18. Demand • Demand curve is a measurement of willingness (and ability) to pay • Willingness to Pay • Demand curve also measures the marginal benefit of the product • If you’re willing to pay $10 for something, it must be worth $10 to you • Reservation Price-Highest amount you’re willing to pay

19. Demand • Law of Demand is caused by three things • Income Effect • Substitution Effect • Law of Diminshing Marginal Returns

20. Demand • Illustrates the law of demand • Graphically • Results in a negatively-sloped line • Note: This illustrates the reaction of consumers when price changes • Call this “Change in Quantity Demanded”

21. Demand • Income increase from $10,000 to $50,000 • Graphically • Changing something other than price: must shift the demand curve • Not one of the axes

22. Demand • Remove the “all else equal” • Change something other than price • What will make you buy more/less of something if its own price doesn’t change? • Income • Prices of related goods • Tastes and preferences • Expectations • Number of buyers • This illustrates a Change in Demand

23. Supply • Quantity Supplied: the amount of a good one is willing and able to produce at a given price • Directly related to prices • Price increases, people sell more, and vice versa • Collection of “Qs”: Supply Curve • Law of Supply: As price increases, the quantity supplied increases, all else equal • Caused by increasing marginal costs

24. Supply • Supply curve is a measurement of willingness (and ability) to produce • Willingness to Produce • Supply curve also measures the marginal cost of the product • If you’re willing to take $10 for a good, it must cost $10 or less for you to produce it • Reservation Price-Lowest amount you’re willing to accept

25. Supply • Illustrates the law of supply • Graphically • Results in a positively-sloped line • Note: This illustrates the reaction of producers when price changes • Call this “Change in Quantity Supplied”

26. Supply • Technology Upgrade • Graphically • Changing something other than price: must shift the supply curve • Not one of the axes

27. Supply • Remove the “all else equal” • Change something other than price • What would make you sell more of something if its own price doesn’t change? • Technology • Input Prices • Expectations • Number of sellers • This illustrates a Change in Supply

28. Market Supply and Demand • Simply add up all quantity supplied (or quantity demanded) at each given price • Example

29. Equilibrium Price and Quantity • Denoted Pe and Qe, respectively • Point where: • QS = QD • D = S • Only “stable” point in the market

30. What if Price is Too High? • QS > QD • Excess Surplus • Downward Pressure exerted on price • Price drop causes Qs ↓, Qd ↑ • Equilibrium Reached

31. What if Price is Too Low? • QD > QS • Excess Shortage • Upward Pressure exerted on price • Price increase causes Qd ↓, Qs ↑ • Equilibrium Reached

32. Demand and Supply Shocks • Suppose something changes in the market other than the price of the good • Consider the market for oranges • Minimum Wage Increase… • And Minimum Wage increase… • This is rare; most shocks only cause one shift

33. Demand and Supply Shocks • Identify which curve is shifting • Make appropriate shift • Identify change in Pe and Qe • With simultaneous shocks, one will be indeterminant (unless size is known)

34. Price Elasticity of Demand • Denoted by εD • Measures responsiveness of quantity demanded to a price change • Defined by:

35. Elasticity • ε > 1 or ε < -1 • Elastic • High responsiveness • Value in numerator is “over-adjusting” to the change from the denominator

36. Elasticity • -1 < ε < 1, ε≠ 0 • Inelastic • Low responsiveness • Value in numerator is “under-adjusting” to the change from the denominator

37. Elasticity • ε = -1 or ε = 1 • Unit Elastic • One-to-one responsiveness • Value on top is reacting in exactly the same amount as the value causing the change

38. Price Elasticity of Demand • Always negative • Due to the Law of Demand • Steepness of demand curve • Examples of price elastic goods? Price inelastic goods? • Determinants • Availability of Substitutes • Necessity/Luxury • Definition of Market • Time Horizon

39. Price Elasticity of Demand • Alternative way of calculating it Highly Useful when dealing with a graph

40. Price Elasticity of Demand P • First you’ll need the slope • Then use the slope and find the elasticity at different points • Straight Line D curves have multiple elasticities 20 18 10 2 Q 2 10 18 20

41. Price Elasticity of Demand P 20 Elastic Points 18 Single Unit Elastic Point 10 Inelastic Points 2 Q 2 10 18 20

42. Total Revenue and εD • Examine the equation for price elasticity of demand • Elastic points • To increase TR, lower price • Inelastic points • To increase TR, raise price • Between elastic and inelastic: • TR is maximized • Price elasticity of demand = -1

43. Some common εd’s’s • Salt: -0.1 • Coffee: -0.25 • Gasoline: -0.2 • Movies: -0.9 • Airline travel (long-run): -2.4 • Restaurant meals: -2.3

44. Price Elasticity of Supply • Denoted by εS • Measures responsiveness of quantity supplied to a price change • Defined by:

45. Price Elasticity of Supply • Always positive • Due to the Law of Supply • Steepness of supply curve

46. Price Elasticity of Supply • Alternative way of calculating it Highly Useful when dealing with a graph

47. Cross-Price Elasticity of Demand • Denoted by εxy • Measures responsiveness of quantity demanded of one good to a price change of another • Defined by:

48. Cross-Price Elasticity of Demand • Positive εxy • Substitutes • Pepsi and Coke • Budweiser and Miller Genuine Draft • Negative εxy • Complements • Coffee and Milk • Automobiles and Gasoline • Number tells how related the two goods are

49. Income Elasticity of Demand • Denoted by εI • Measures responsiveness of quantity demanded to a change in income • Defined by:

50. Income Elasticity of Demand • Positive εI • Normal Good • High-performance automobiles • Event tickets • Negative εI • Inferior Good • Used automobiles • Ramen Noodles • The number will gauge the good’s tie to income