Transcript 5DiminReturnsAPUnit2Micro

ECONOMICS
What does it mean to me?
Part V:
•Law of Diminishing Marginal Utility
•Price Ceilings & Price Floors
•Blackmarkets
The LAW of
DIMINISHING
MARGINAL
UTILITY
In what kind
of machines
are
newspapers
sold?
Why don’t we sell CocaCola in machines similar
to those we use to sell
newspapers?
REASON:
The value of a 2nd newspaper
diminishes fast…..unlike the
value of Coca-Cola.
People use this information to
make appropriate machines.
This is called the
LAW of DIMINISHING
MARGINAL UTILITY
The value given to the amount of gratification
derived from something will decrease with each
additional unit of that item.
TOTAL UTILITY is the total amount of
satisfaction a person gets from consuming a specific
quantity (such as 20 units).
This law operates ALWAYS
with respect to time.
How much do you make?
-----> $1000
???
Day? Week? Month? Year?
The period of time in which you make $1000 will
make a difference in the amount of money you
have to spend.
What day would be
most likely for
newspapers be stolen
from the machines?
The answer is: Sunday
because that is coupon day.
However, people can still get TOO
MANY coupons, so the law still
applies.
The relationship between an
individual’s consumption bundle
and the total amount of utility is
called the UTILITY FUNCTION.
The utility function differs for
each person.
We will measure Utility in
hypothetical units called UTILS.
Candy Total Utility
0
0
1
10
2
18
3
24
4
28
5
30
6
30
7
28
Marginal
Utility
10
Total
Utility
30
8
6
20
4
2
10
0
-2
0
1
2
3
4
5
6
7
Units consumed
**As more of a product is consumed, total utility
increases at a diminishing rate, reaches a
maximum, and then declines.
Candy Total Utility
0
0
1
10
2
18
3
24
4
28
5
30
6
30
7
28
Marginal
Utility
Marginal
Utility
10
10
8
6
8
6
4
2
4
0
2
-2
0
1
2
3
4
5
6
7
Units consumed
** Marginal utility reflects the change in total utility.
Marginal
Utility
Total
Utility
10
30
8
20
6
4
10
2
0
1
2
3
4
5
6
7
0
1
2
3
Units consumed
4
5
6
Units consumed
1) When MU is zero in graph b, total utility in graph a is:
a) also zero
b) neither rising nor falling
d) rising, but at a declining rate
7
c) negative
Marginal
Utility
Total
Utility
10
30
8
20
6
4
10
2
0
1
2
3
4
5
6
7
0
1
2
3
4
5
6
7
Units consumed
Units consumed
2) Suppose the person represented here experienced a diminished taste for candy.
As a result:
a)
TU curve would get steeper
c) TU & MU would shift downward
b) MU curve gets flatter
d) MU curve (not TU) would
collapse to horizontal axis
Debbie makes $20 and cokes are $2
and chips are $4 a pound.
How does Debbie decide HOW MUCH
to consume based on the fact that the
more cokes she consumes, the fewer
chips she can purchase?
The answer is to determine the
Marginal Utility per dollar.
The equation we will use is:
MUx
Muy
____ = ____
Px
Py
Calculate Debbie’s MU per dollar for coke
Qcoke
Ucoke
0
0
1
15
2
25
3
31
4
34
5
36
MUper/coke
MU$
15
3.75
10
2.5
6
1.5
3
.75
2
.5
The price per coke is $4
Calculate Debbie’s MU per dollar for Chips/pound.
Qcoke
Ucoke
0
0
1
15
2
25
3
31
4
34
5
36
MUper/coke
15
10
6
3
2
MU$
3.75
2.5
1.5
.75
.5
The price per pound of chips
is $2.
Qcoke
Ucoke
0
0
1
11.5
2
21.4
3
29.8
4
36.8
5
42.5
6
47
7
50.5
8
53.2
9
55.2
10
56.7
MUper/coke
MU$
11.5
5.75
9.9
4.95
8.4
4.2
7
3,5
5.7
2.85
4.5
2.25
3.5
1.75
2.7
1.35
2
1.00
1.5
.75
Calculate Debbie’s MU per dollar for coke
Qcoke
Ucoke
0
0
1
15
2
25
3
31
4
34
5
36
MUper/coke
15
10
6
3
2
MU$
3.75
2.5
1.5
.75
.5
Debbie’s optimal
consumption is 2 cokes and
6 pounds of chips because
she consumes these
amounts, her MU per dollar
is 2.
Qcoke
Ucoke
0
0
1
11.5
2
21.4
3
29.8
4
36.8
5
42.5
6
47
7
50.5
8
53.2
9
55.2
10
56.7
MUper/coke
MU$
11.5
5.75
9.9
4.95
8.4
4.2
7
3,5
5.7
2.85
4.5
2.25
3.5
1.75
2.7
1.35
2
1.00
1.5
.75
Optimum Consumption and the
Budget Line
Assume that Debbie earns $20. Coke is $4 a can
and chips are $2 a pound.
Quantity
of chips
(pounds)
The budget line represents all the
possible combinations of coke
and chips Debbie can purchase.
10
8
If Debbie wants to consume 1
more coke, she must give up 2
pounds of chips.
6
4
2
0
1
2
3
4
5
6
Quantity
of Coke
NOTE: (Slope of the line is -2)
Changes in income shifts the
budget line.
Quantity 10
of chips
8
(pounds)
6
4
2
0
1
2
3
4
5
6
Quantity
of Coke
Now, let’s apply the
Law of Marginal Utility
to artificial pricing
systems such as
those applied by
governments.
What happens when
prices are “fixed” by
the government?
Let’s look at a graph which
shows the average
consumption of beer in the
United States.
PRICE CEILINGS &
PRICE FLOORS
(Consumer Surplus &
Producer Surplus)
In this
example, the
average beers
consumed per
week is 6
at an
average
price of
$2.50.
S
$4
$3
E
$2
$1
D
0 1 2 3 4 5 6 7 Beers per
Ge
week
This chart illustrates the effects upon
people if they were forced to go from
Ge to zero.
You might be
willing to pay
$4 for your first
beer, but price
is $2.50 …..now
you are $1.50
better off. This
is called
CONSUMER
SURPLUS.
S
$4
$3
E
$2
$1
D
0 1 2 3 4 5 6 7 Beers per week
Ge
The 9th beer is
worth to people
what it is worth to
people.
It is different for
everybody.
S
From the
suppliers’
standpoint,
they could
supply at a
lower price but
they CAN get
more. This is
called
PRODUCER
SURPLUS.
$4
$3
E
$2
$1
D
0 1 2 3 4 5 6 7 Beers per
Ge
week
The
colored
area is the $4
total value
$3
to society
of the cost $2
of 6 beers.
$1
S
Consumer
Surplus
Producer
Surplus
E
D
0 1 2 3 4 5 6 7 Beers per
Ge
week
What if government mandate limited the
maximum number of beers one could drink to 4
per week?
Four beers is
not enough
(too little,
inefficient)
….This is
called
DEADWEIGHT
loss.
$4
Government
Mandated
Supply
$3
S
E
$2
$1
D
0 1 2 3 4 5 6 7 Beers per week
Ge
What if government mandate limited
the maximum price of a beer to $1.00?
$4
$3
$2
$1
However,
suppliers
would not
want to
produce as
much beer.
E
S
Consumers
would want to
buy more beer.
D
10
0 1 2 3 4 5 6 7 Beers
per
Ge
week
Producers will not want to
produce for low prices.
If
government
limited the
maximum
price of a
beer to $1.00,
it would
create a
shortage.
S
$4
$3
E
$2
$1
shortage
D
0 1 2 3 4 5 6 7 Beers per week
Ge
The legal maximum price that
can be charged is called a
PRICE CEILING. A legal
minimum price that can be
charged is called a PRICE
FLOOR. Price ceilings and
floors keep markets from
reaching equilibrium.
Politically popular ideas include:
--$ minimums on inputs (wages).
--$ maximums on outputs (prices).
When POLITICS vs.
ECONOMICS => Politics always
wins
A price ceiling keeps the market from
reaching equilibrium.
The
S
government
mandating $4
the
maximum $3
E
price of a
$2
beer is
shortage
called a
$1
PRICE
D
CEILING.
0 1 2 3 4 5 6 7
Ge Beers per week
The shortage created from the price
ceiling will result in increased demand.
S
$4
$3
E
$2
shortage
$1
D
X
0 1 2 3 4 5 6 7
G Beers per week
e
The increased demand
and a willingness to pay
higher prices will result
in a BLACK MARKET for
beer.
When the government mandates a the
minimum price of something, it is called
a PRICE FLOOR.
S
The
minimum
wage is an
example of
a price
floor.
$5
$4
E
$3
$2
$1
D
0 1 2 3 4 5 6 7
Ge
Labor
The minimum wage increases the number of
people who want to work (supply of labor). . .
. . . And
decreases the
number of
$5
businesses
who want to
$4
hire (demand
$3
for labor)
$2
Creating a
SURPLUS
of labor.
S
SURPLUS
E
$1
D
0 1 2 3 4 5 6 7
Ge
Labor
CONCLUSION:
A price floor stops the market
from reaching equilibrium
and creates a surplus.
A price ceiling stops the
market from reaching
equilibrium and creates a
shortage.
Typically, the
government jumps
in during a surplus,
buys the surplus….
and the surplus rots.
QUESTION 1:
Using economic principles
and the impact of government
mandate, why was the 18th
Amendment to the U.S.
Constitution considered “the
great experiment that failed?”
ANSWER: The 18th Amendment created a
shortage of alcohol for consumption
When the price of
alcohol increased
under black
market conditions,
this initiated the
development of
the syndicate and
the notoriety of
such underworld
figures as Al
Capone.
S
$5
$4
E
$3
$2
$1
D
0 1 2 3 4 5 6 7
Ge
Beers per week
QUESTION 2:
Using economic principles,
explain the impact of
government mandates on the
supply and demand of the
illegal marijuana market.
ANSWER: In 1937, the government reduced the
availability of marijuana to zero by making it illegal.
This created a shortage in the market.
Because
people have
been willing to
pay a high
price for the
product, black
market
conditions
have existed
since the
shortage was
created.
S
$300
$250
$200
E
$150
$100
$ 50
D
0 1 2 3 4 5 6 7 Marijuana use
Ge
QUESTION 3:
In 1973, President Nixon froze
gasoline prices after the
OPEC cartel created a
shortage in the United States.
What impact did this have on
the market economy at that
time?
ANSWER:
President
Nixon initiated
a price ceiling
of $1.60.
Consequently, a
shortage existed
because gas
companies were
taking a loss.
This resulted in
long lines and
gas stations
running out of
fuel.
REMEMBER: Producers will not
want to produce for low prices.
S
$4
$3
E
$2
$1
shortage
D
0 1 2 3 4 5 6 7 Gallons of Gas
Ge
QUESTION 4:
Using economic principles
and the impact of government
mandate, explain what would
happen if cigarette smoking
were made illegal.
What would be the opportunity
cost of making cigarettes
illegal?
ANSWER: The government would reduce the supply of
cigarettes to zero by making it illegal.
This will create a shortage in the market.
Because some
people will be
willing to pay
a high price
for the
product, black
market
conditions will
exist and the
price of
cigarettes will
increase.
S
$10
$8
E
$6
$4
$2
D
0 1 2 3 4 5 6 7 Cigarette use
Ge
ANSWER: The opportunity costs
would include:
•Lower environmental costs
•Cleaner air
•Lower costs for health care
•Healthier population
•Higher unemployment for lost jobs
Question
5:
Many experts contend that the Food and
Drug Administration (FDA) directly creates
the high price of prescription drugs. Do
you agree? Why or why not? Explain
your answer.
ANSWER: The FDA, a government regulatory agency, reduces the
supply of certain drugs by making them unavailable to certain
people through the use of prescriptions.
This results in a
limited market.
Because
doctors
prescribe drugs
for illness and
the patient
requests good
health, they pay
the higher price
created by the
government.
S
$100
$80
E
$60
$40
$20
D
0 1 2 3 4 5 6 7
Ge
Drug use
Question
6:
In May 2001, President Bush visited with
Governor Gray of California to discuss the
energy crisis in that state. It will take 10 years
to build the power plants necessary to provide
the electricity needed to support the
population and costs will skyrocket as demand
exceeds supply. Governor Gray is requesting
that President Bush place a federal price
ceiling on the cost of energy. Why did
President Bush refuse?
ANSWER:
President Bush
realizes that a
price ceiling will
result in a shortage
of electricity.
Limiting the price
that power
companies can
charge for
electricity will cause
them to lose money,
not produce
efficiently, and
result in a shortage
of power.
REMEMBER: Producers will not
want to produce for low prices.
S
$D
$C
E
$B
$A
shortage
D
0 a b c d e f g Kilowatts
Ge
THE END
Sources:
Economics, by Krugman, Wells.
Economics, by McConnell, Brue
Economics, by Mankiw
Compiled by Virginia Meachum
Economics Teacher, Coral Springs High
School, Florida