Transcript Welcome to International Economics

CDAE 254 - Class 10 Sept. 27
Last class:
3. Individual demand curves
Today:
3. Individual demand curves
Class exercise
Next class:
3. Individual demand curves
4. Market demand and elasticities
Quiz 3 (Chapter 3)
Important date:
Problem set 3: due Thursday, Oct. 4
Problem set 3
-- Due at the beginning of class on Thursday, Oct. 4
-- Please use graphical paper to draw graphs
-- Please staple all pages together before you turn them in
-- Scores on problem sets that do not meet the requirements
Problems 3.1., 3.2., 3.3. and 3.4. from the textbook
Two more problems:
A. Suppose an individual’s demand function is Q = 20 – 0.5P
(a) Calculate the consumer surplus (CS) when P = 10
(b) Calculate the change in CS when P increased from 10 to 13
B. Draw a graph and use the graph to explain why many individuals
with low income prefer income subsidy over price subsidy. Then
explain why many governments use price subsidies rather than
income subsidies.
Take-home exercise
(Tuesday, Sept. 18)
While city B faces a likely shortage of electricity in the summer
and a surplus of electricity in the winter, the following pricing
policy has been proposed to replace the current fixed rate of $0.1
per unit:
Summer (June to Sept): $0.10 per unit for the first 200 units of
each month and then $0.14 for each additional unit
Winter (Dec. to March): $0.10 per unit for the first 200 units of
each month and then $0.08 for each additional unit
Other months: $0.10 per unit
How will the proposed policy affect Mr. A who consumes about
500 units per month, Mrs. B who consumes about 150 units per
months, and Ms. C who consumes about 200 units per month?
3. Individual demand curves
3.1.
3.2.
3.3.
3.4.
3.5.
3.6.
3.7.
3.8.
Basic concepts
Demand functions
Changes in income
Change in a good’s price
Change in the price of another good
Construction of individual demand curves
Consumer surplus
Applications
3.4. Changes in a good’s price
3.4.5. Substitution & income effects for an inferior
good
(1) What is an inferior good?
(2) A graphic analysis (Fig. 3.5)
Take-home exercise
(Thursday, Sept. 27)

What is a Giffen good (page 99 of the
textbook)?

Draw a graph to show the income and
substitution effects of a Giffen good
3.4. Changes in a good’s price
3.4.6. The lump-sum principle
(1) What is the lump-sum principal?
To collect the same amount of tax revenue, taxing
income has smaller welfare (utility) impacts than
taxing one commodity or a narrow selection of
commodities. Similarly, to increase the welfare
(utility) to a particular level, subsiding income will
cost less than subsiding the price of one commodity
or a narrow selection of commodities.
3.4. Changes in a good’s price
3.4.6. The lump-sum principle
(2) A graphic analysis
(a) Effects of a tax on X:
-- Budget constraint
-- Utility
-- Tax revenue T = t X1
(b) Effect of a tax on income
-- Budget constraint
-- Utility
-- Tax revenue = t X1
3.4. Changes in a good’s price
3.4.6. The lump-sum principle
(3) Explanation of the lump-sum principle
(a) A tax on X affects welfare in two ways:
-- It reduces purchase power (income effect)
-- It directs consumption away from the the
taxed commodity (substitution effect)
(b) A tax on income affects welfare in only one
way (income effect)
(4) The lump-sum principle and policy
3.5. Changes in the price of another good
3.5.1. Graphical analysis: impact of a change in Px on
the demand for Y
(1) A fall in Px ==> An increase in both
X and Y (Figure 3.3)
(2) A fall in Px ==> An increase in X
but a decrease in Y (Fig. 3.7)
3.5. Changes in the price of another good
3.5.2. Substitutes and complements
(1) Substitutes:
Two goods such that when the price of
one increases, the quantity demanded
of the other good increases.
(2) Complements:
Two goods such that when the price of
one increases, the quantity demanded
of the other good decreases
3.6. Construction of individual demand curves
3.6.1. Individual demand curve:
A graphical representation of the relationship
between quantity demanded (X) and its own
price (PX), holding all other factors constant.
3.6.2. An example of a linear case:
PX = 10 - 0.5 X or X = 20 - 2PX
How to graph this?
3.6 Construction of individual demand curves
3.6.3. Construction of an individual demand curve:
-- Income and PY are fixed
-- Relation between X and PX
-- A graphical analysis (Fig. 3.8)
Deriving an
individual’s
demand
curve
Budget 1: 12X + 35Y = 419
Budget 2: 6X + 35Y = 419
Budget 3: 4X + 35Y = 419
3.6 Construction of individual demand curves
3.6.4. Shift in individual demand curves for X
(1) An increase in income
If X is a normal good 
IF X is an inferior good 
(2) A decrease in income
If X is a normal good 
IF X is an inferior good 
(3) An increase in the price of Y
If X and Y are substitutes 
If X and Y are complements 
(4) A decrease in the price of Y
If X and Y are substitutes 
If X and Y are complements 
3.6. Construction of individual demand curves
3.6.5. A change in quantity demanded vs. a change
in demand:
-- A change in quantity demanded:
A movement along a demand curve.
-- A change in demand:
A shift of the entire demand curve from
one position to another position
3.7. Consumer surplus and welfare analysis
(1) What is consumer surplus (CS)?
The extra value individuals receive from
consuming a particular amount of a good over
what they pay for that.
CS = Amount of willingness to pay – actual cost
(2) A graphical analysis (Fig. 3.10)
(3) Change in CS
(4) Applications
Class Exercise
(Thursday, Sept. 27)
For demand function Q = 28 - 2P,
(a) What is the consumer surplus when the price (P) is
equal to $6 per unit?
(b) What is the change in consumer surplus when the
price increased from $6 to $8