Transcript section2powerpoint

UTILITY AND
DEMAND
© 2003 Pearson Education Canada Inc.
7
CHAPTER
7-1
Budget Constraint
• The budget constraint refers to the limits
imposed on household choices by
income, wealth, and product prices
• The choice set or opportunity set refers to
the set of options that is defined and
limited by a budget constraint.
Choice Sets: An Example
Table 6.1Possible Budget Choices of a Person
Earning $1000 per Month After Taxes
Option
Monthly
Rent
Food
Other
Expenses
Total
Available?
A
$400
$250
$350
$1000
Yes
B
600
200
200
1000
Yes
C
700
150
150
1000
Yes
D
1000
100
100
1200
No
Budget Constraint and Opportunity Set for Trudee and
Mark
• Points A, B, and C are
each on the budget
constraint, meaning
that Trudee and Mark
have spent their
income.
• Point D does not spend
the entire $200 and
point E is unattainable
as it would cost more
than $200.
The Effect of a Decrease in Price on Trudee and
Mark’s Budget Constraint
• When the price of a
good decreases, in
this case Thai meals
fall from $20 to $10,
the budget constraint
swivels to the right,
increasing the
opportunities
available and
expanding choice.
The Basis of Choice: Utility
• Utility is the satisfaction, or reward, a product
yields relative to its alternative. It is the basis
for choice.
• Marginal utility is the additional satisfaction
gained by the consumption or use of one more
unit of something.
• Total utility is the total amount of satisfaction
obtained from consumption of a good or
service.
Law of Diminishing Marginal
Utility
• The more of any one good consumed in a
given period, the less satisfaction (utility) is
generated by consuming each additional
(marginal) unit of the same good.
Allocation of Fixed Expenditures per Week Between
Two Alternatives
Frank’s utility maximizing decision between basketball games
and trips to the club.
Frank’s Total and Marginal Utility of Trips to the Club
Utility-Maximizing Rule
• A utility maximizing consumer allocates his
or her expenditures such that the marginal
utility per dollar spent on each activity is
equal:
MUx = MUy
Px
Py
POSSIBILITIES,
PREFERENCES,
AND CHOICES
© 2003 Pearson Education Canada Inc.
8
CHAPTER
8-11
Consumption Possibilities
•
The Budget Equation
–
–
We can describe the budget line by using a budget equation.
The budget equation states that:
–
•
Expenditure = IncomePPQP
+ PMQM = Y
QP = Y/PP – (PM/PP)QM
The term Y/PP is Lisa’s real income in terms of pop.
•
•
•
A household’s real income is the income expressed as a quantity of goods
the household can afford to buy.
Lisa’s real income in terms of pop is the point on her budget line where it
meets the y-axis.
The term PM/PP is the relative price of a movie in terms
of pop.
•
•
•
A relative price is the price of one good divided by the price of another good.
It is the magnitude of the slope of the budget line.
The relative price shows how many pops must be forgone to see an additional
movie.
8-12
Preferences and Indifference Curves
–An indifference curve is a
line that shows combinations
of goods among which a
consumer is indifferent.
–All the points above the
indifference curve are
preferred over the points on
the curve.
–And all the points on
the indifference curve are
preferred over the points
below the curve.
8-13
Preferences and Indifference Curves
–An indifference curve
above I1 is I2 . All the
points on I2 are preferred
to those on I1 .
–For example, point J is
preferred to either point
C or point G.
8-14
Preferences and Indifference Curves
•Marginal Rate of Substitution
–The marginal rate of substitution, (MRS) measures the
rate at which a person is willing to give up good y (the good
measured on the y-axis) to get an additional unit of good x
(the good measured on the x-axis) and at the same time
remain indifferent (remain on the same indifference curve).
•The marginal rate of substitution is the ratio at
which a household is willing to substitute good Y for
good X.
•
MRS = MUx / MUy
–The magnitude of the slope of the indifference curve
measures the marginal rate of substitution.
8-15
Preferences and Indifference Curves
–A diminishing marginal rate of substitution is the
key assumption of consumer theory.
–A diminishing marginal rate of substitution is a
general tendency for a person to be willing to give
up less of good y to get one more unit of good x,
and at the same time remain indifferent, as the
quantity of good x increases.
–If the indifference curve is relatively steep, the MRS is high.
–In this case, the person would be willing to give up a large quantity
of y to get a bit more x.
–If the indifference curve is relatively flat, the MRS is low.
–In this case, the person would be willing to give up a small quantity
of y to get more x.
8-16
Preferences and Indifference Curves
–Figure 8.4 shows the
diminishing MRS of
movies for pop.
–At point C, Lisa is
willing to give up 2 sixpacks to see one more
movie—her MRS is 2.
–At point G, Lisa is
willing to give up 1/2 a
six-pack to see one more
movie—her MRS is 1/2.
8-17
Preferences and Indifference Curves
•Degree of Substitutability
–The shape of the indifference curves reveals the degree of
substitutability between two goods.
–Figure 8.5 shows the indifference curves for ordinary
goods, perfect substitutes, and perfect complements.
8-18
Predicting Consumer Behaviour
– The consumer’s best affordable point:
– Is on the budget line
– Is on the highest attainable indifference curve
– Has a marginal rate of substitution between the
two goods equal to the relative price of the two
goods
8-19
Predicting Consumer Behaviour
–At point F, Lisa’s MRS
is greater than the
relative price.
–At point H, Lisa’s MRS
is less than the relative
price.
–At point C, Lisa’s MRS
is equal to the relative
price.
8-20
Predicting …
•A Change in Price
–The effect of a change in the
price of a good on the quantity
consumed is the price effect.
–Figure 8.7 illustrates the price
effect and shows how a
demand curve is generated.
–Initially, the price of a movie
is $6 and Lisa consumes at
point C in part (a) and at point
A in part (b).
8-21
Predicting …
–The price of a movie
then falls to $3.
–The budget line rotates
outward.
–Lisa’s best affordable
point is now J in part (a).
–In part (b), Lisa moves to
point B, which is a
movement along her
demand curve for movies.
8-22
Predicting Consumer Behaviour
•
–
–
Substitution Effect and Income Effect
For a normal good, a fall in price always increases the
quantity consumed.
We can prove this assertion by dividing the price effect
into two parts:
1. Substitution effect:
–
is the effect of a change in price on the quantity bought when the
consumer remains indifferent between the original situation and the new
situation.
2. Income effect:
–
–
When a good is a normal good, the quantity consumed changes in the
same direction as the change in income.
When a good is an inferior good, the quantity consumed changes in the
opposite direction to the change in income.
8-23
• Substitution Effect
• When the relative price (opportunity cost) of a good or service
rises, people seek substitutes for it, so the quantity demanded
decreases.
• When the price of a product falls, that product becomes more
attractive relative to potential substitutes.
• Income Effect
• When the price of a good or service rises relative to income,
people cannot afford all the things they previously bought, so
the quantity demanded decreases.
• When the price of a product falls, a consumer has more purchasing
power with the same amount of income and is better off.
3-24
Predicting Consumer Behaviour
–The price of a movie
falls from $6 to $3 and
her budget line rotates
outward.
–Lisa’s best affordable
point is then J.
8-25
Predicting Consumer Behaviour
–We’re going to
break the move from
C to J into two parts.
–The first part is the
substitution effect,
and the second is the
income effect.
8-27
Predicting Consumer Behaviour
–To isolate the substitution
effect, we give Lisa a
hypothetical pay cut.
–Lisa is now back on her
original indifference curve
but with a lower price of
movies, and her best
affordable point is K.
–The move from C to K is the
substitution effect.
8-29
Predicting Consumer Behaviour
–The direction of the
substitution effect never
varies: a fall in price
brings an increase in the
quantity bought.
–The substitution effect is
the first reason why the
demand curve slopes
downward.
8-30
Predicting Consumer Behaviour
–To isolate the income
effect, we reverse the
hypothetical pay cut
and restore Lisa’s
income to its original
level (its actual level).
–Lisa is on indifference
curve I2 and her best
affordable point is J.
–The move from K to J
is the income effect.
8-31
Predicting Consumer Behaviour
–For Lisa, movies are a
normal good.
–When her income increases,
she sees more movies—the
income effect is positive.
–For a normal good, the
income effect reinforces the
substitution effect and is the
second reason why the
demand curve slopes
downward.
8-32
ORGANIZING
PRODUCTION
© 2003 Pearson Education Canada Inc.
9
CHAPTER
9-33
Profit
• Profit is the difference between total
revenue and total costs.
Profit = Total Revenue (TR) - Total Cost (TC)
Where Total Revenue is the receipts
from the sale of a product (P x q)
Calculating Total Revenue, Total Cost and
Profit For a Small Belt Firm
Technology and Economic Efficiency
–Technological efficiency occurs when a firm
produces a given level of output by using the least
amount of inputs.
–Economic efficiency occurs when the firm
produces a given level of output at the least cost.
–The difference between technological and economic efficiency is
that technological efficiency concerns the quantity of inputs used in
production for a given level of output, whereas economic efficiency
concerns the cost of the inputs used.
–An economically efficient production process is also
technologically efficient.
–A technologically efficient process may not be economically
efficient.
9-36
OUTPUT AND
COSTS
© 2003 Pearson Education Canada Inc.
10
CHAPTER
10-37
Decision Time Frames
–The short run is a time frame in which the
quantity of one or more resources used in
production is fixed.
–For most firms, the capital, called the firm’s plant, is fixed in the
short run.
–Other resources used by the firm (such as labour, raw materials,
and energy) can be changed in the short run.
–The long run is a time frame in which the
quantities of all resources—including the plant
size—can be varied.
Short-Run Technology Constraint
•Product Schedules
–Total product is the total output produced in a given period.
–The production function or total product function is a numerical or
mathematical expression of a relationship between inputs and outputs.
–It shows units of total product as a function of units of inputs.
–The marginal product of labour is the change in total product
that results from a one-unit increase in the quantity of labour
employed, with all other inputs remaining the same.
–Marginal product is the additional output that can be produced by adding one
more unit of a specific input, ceteris paribus.
–The average product of labour is equal to total product
divided by the quantity of labour employed.
–The average product is the average amount produced by each unit of a variable
factor of production.
Law of Diminishing Returns
• The law of diminishing returns states that
when additional units of an input are added
to fixed inputs after a certain point, the
marginal product of the variable input
declines.
Production Function (Sandwich
Making)
Labor
Units
0
1
2
3
4
5
6
Total
Product
0
10
25
35
40
42
42
Marginal
Product
--10
15
10
5
2
0
Average
Product
--10.0
12.5
11.7
10.0
8.4
7.0
Typical Production Function
• Marginal and average
product curves can be
derived from total
product curves.
• The marginal product of
labour is the slope of the
total product curve.
• Average product
follows marginal
product; it rises when
marginal product is
above it and falls when
marginal product is
below it.
Short-Run Cost
•Total Cost
–A firm’s total cost (TC) is the cost of all resources
used.
–Total fixed cost (TFC) is the cost of the firm’s
fixed inputs. Fixed costs do not change with output.
–A fixed cost is any cost that a firm bears in the short run that
does not depend on its level of output. These costs are
incurred even if the firm is producing nothing. There are no
fixed costs in the long run.
–Total variable cost (TVC) is the cost of the firm’s
variable inputs. Variable costs do change with
output.
–A variable cost is any cost that a firm bears that depends on
the level of production chosen
Total Costs (TC)
– Total cost equals total fixed cost plus total
variable cost. That is:
• Total Costs =
Total + Total
Fixed Costs Variable Costs
•
• TC = TFC + TVC
Short-Run Cost
–Figure 10.4 shows a
firm’s total cost curves.
–Total fixed cost is the
same at each output level.
–Total variable cost
increases as output
increases.
–Total cost, which is the
sum of TFC and TVC, also
increases as output
increases.
Short-Run Cost
• Marginal Cost
– Marginal cost (MC) is the increase in total cost that results
from a one-unit increase in total product (producing one more
unit of output).
– Marginal costs reflect changes in variable costs.
– In the short run, every firm is constrained by some fixed
input that leads to diminishing returns to variable inputs and
that limits its capacity to produce. As the firm approaches
capacity, it becomes increasingly costly to produce more
output. Marginal costs ultimately increase with output in
the short run.
– Over the output range with increasing marginal returns,
marginal cost falls as output increases.
– Over the output range with diminishing marginal returns,
marginal cost rises as output increases.
Declining Marginal Product Implies That
Marginal Cost Will Eventually Rise With
Output
Short-Run Cost
•Average Cost
–Average cost measures can be derived from each
of the total cost measures:
–Average fixed cost (AFC) is total fixed cost per
unit of output.
–Average variable cost (AVC) is total variable cost
per unit of output.
–Average total cost (ATC) is total cost per unit of
output.
ATC = AFC + AVC
Short-Run Cost
–The ATC curve is also Ushaped.
–The MC curve is very
special.
–Where AVC is falling,
MC is below AVC.
–Where AVC is rising, MC
is above AVC.
–At the minimum AVC,
MC equals AVC.
Short-Run Cost
•Shifts in Cost Curves
–The position of a firm’s cost curves depend on two
factors:
– Technology
– Prices of productive resources
Long-Run Cost
•Long-Run Average Cost Curve
–The long-run average cost curve is the
relationship between the lowest attainable average
total cost and output when both the plant size and
labour are varied.
–The long-run average cost curve is a planning
curve that tells the firm the plant size that minimizes
the cost of producing a given output range.
–Once the firm has chosen that plant size, it incurs
the costs that correspond to the ATC curve for that
plant.
Long-Run Cost
Figure 10.8 illustrates the long-run average cost (LRAC) curve.
Long-Run Cost
•Economies and Diseconomies of Scale
–Economies of scale are features of a firm’s
technology that lead to falling long-run average cost
as output increases.
–Diseconomies of scale are features of a firm’s
technology that lead to rising long-run average cost
as output increases.
–Constant returns to scale are features of a firm’s
technology that lead to constant long-run average
cost as output increases.
Long-Run Cost
Figure 10.8 illustrates economies and diseconomies of scale.
Long-Run Cost
–A firm experiences economies of scale up to some
output level.
–Beyond that output level, it moves into constant
returns to scale or diseconomies of scale.
–Minimum efficient scale is the smallest quantity
of output at which the long-run average cost reaches
its lowest level.
–If the long-run average cost curve is U-shaped, the
minimum point identifies the minimum efficient
scale output level.