Principles of Economics

# Principles of Economics

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## Principles of Economics

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1. Principles of Economics Dr Martin Jensen (this term / micro) Dr James Reade (next term / macro) Exam: Summer 2013 joint for micro and macro (each weights 50 %). Course homepage: socscistaff.bham.ac.uk/jensen/economics101.htm (or via people->academic staff -> etc.) (or via WebCT)

2. Principles of Economics The textbook is: Sloman, J., A. Wride, and D. Garrett: “Economics”, 8th Edition, 2012, Pearson. Backed up by the 101A booklet (for the few people who don’t have it already, you can get this from the secretaries in the Econ. Dep.) ...And the course homepage.

3. Principles of Economics Apart from lectures, there are classes. Classes take place every two weeks, beginning either next week or the week after (depending on which group you’re in). To sign up for classes, enter Econ101 in WebCT and press the ”sign up for classes” link (this is pretty selfexplanatory).

4. Introduction and Indifference Analysis

5. PRICE AND OUTPUT DETERMINATION • We call the price that obtains in the market, the market price, or the Equilibrium price • We call the quantity demanded and supplied the equilibrium output. • We find this by plotting the demand and the Supply curves.

6. Equilibrium price and output:The Market Demand and Supply of Potatoes (Monthly)

7. The determination of market equilibrium(potatoes: monthly) e E Supply d D c C Price (pence per kg) b B a A Demand Quantity (tonnes: 000s)

8. The determination of market equilibrium(potatoes: monthly) e E Where the two lines cross is called the equilibrium point Supply d D Pe=12 c C Price (pence per kg) b B a A Qe=350 Demand Quantity (tonnes: 000s)

9. Demand • In this course we want to explore in more detail what lies behind the demand and supply decisions that people (agents) make by focusing on the economics that lie behind the decisions we actually observe. • First we are going to focus on Demand. Then we turn to supply both under perfect competition and various sorts of imperfect competition. Finally, we use what we’ve learned to study some “selected topics”.

10. Happiness Happiness • Basically we demand goods because they make us ‘happy’ • Or at least we would be unhappy if we didn’t have them. • Either way we get ‘JOLLIES’ from them • Economists have a special term for Jollies – we call it UTILITY

11. Utility Theory • Even Better – we have a theory to explain consumers’ behaviour called: • Utility Theory • This theory relies on an important foundation: • Rationality • We assume people choose their desired consumption rationally or consistently

12. Rationality • What do we mean by Rationality ? • We do not mean that people are fully informed or fully conscious about every consumption decision they make • Rather we mean they act (consciously or otherwise) in a consistent manner.

13. Total Utility Total Utility in Utils Packets of crisps 0 7 11 13 14 14 13 0 1 2 3 4 5 6 We imagine that consumers act as if they are trying to make themselves as happy as possible (broadly defined) given their circumstances. In the adjacent table the consumer gets ‘jollies’, called UTILS from consuming crisps. The table records his/her total utility. .

14. Darren’s utility from consuming crisps (daily) Packets of crisps TU in utils 0 1 2 3 4 5 6 0 7 11 13 14 14 13 TU Utility (utils) Packets of crisps consumed (per day)

15. MARGINAL UTILITY THEORY • Total and marginal utility • Marginal Utility: • The change in Total Utility as a result of consuming one more unit of the good.

16. Darren’s utility from consuming crisps (daily) MU in utils Packets of crisps TU in utils - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 7 11 13 14 14 13 TU1-TU0 TU Utility (utils) Q1-Q0 =3-2=1 Packets of crisps consumed (per day)

17. Darren’s utility from consuming crisps (daily) TU1-TU0 TU DTU = 2 DQ = 1 MU = DTU / DQ = 2/1 = 2 Utility (utils) Q1-Q0 =3-2=1 Packets of crisps consumed (per day)

18. Alternative representation of Darren’s Marginal utility MU in utils Packets of crisps TU in utils - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 7 11 13 14 14 13 TU DTU = 2 DQ = 1 Utility (utils) MU Packets of crisps consumed (per day)

19. Alternative representation of Darren’s Marginal utility) Note this is effectively measuring the slope of the curve TU DTU = 2 DQ = 1 Utility (utils) MU = DTU / DQ = 2/1 = 2 MU Packets of crisps consumed (per day)

20. Alternative representation of Darren’s Marginal utility TU DTU = 2 DQ = 1 Utility (utils) MU = DTU / DQ = 2/1 = 2 MU Packets of crisps consumed (per day)

21. Graphing Darren’s Marginal utility we get: MU in utils Packets of crisps TU in utils - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 7 11 13 14 14 13 TU Utility (utils) MU Packets of crisps consumed (per day)

22. MARGINAL UTILITY THEORY • Total and marginal utility • Marginal Utility: • The change in Total Utility as a result of consuming one more unit of the good.

23. The principle of diminishing marginal utility Note that the Marginal Utility curve is downward Sloping This gives us: The principle of diminishing marginal utility • As more units of a good are consumed, additional units will provide us with less additional satisfaction than previous units

24. Now let’s look at two goods MU in utils MU in utils Packets of crisps Pints of Beer TU in utils TU in utils - 70 60 50 37 12 0 -220 - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 0 70 130 180 217 220 220 0 0 7 11 13 14 14 13

25. MU in utils MU in utils Packets of crisps Pints of Beer TU in utils TU in utils - 70 60 50 37 12 0 -220 - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 0 70 130 180 217 220 220 0 0 7 11 13 14 14 13 Looking at the utility from beer compared with crisps do you think Darren should spend all his money on beer?

26. MU in utils MU in utils Packets of crisps Pints of Beer TU in utils TU in utils - 70 60 50 37 12 0 -220 - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 0 70 130 180 217 220 220 0 0 7 11 13 14 14 13 Suppose that Crisps cost 25p And Beer cost 1.50 per pint, How should Darren allocate his income between beer and crisps

27. Bang per buck MU in utils MU in utils Packets of crisps Pints of Beer TU in utils TU in utils - 70 60 50 37 12 0 -220 - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 0 70 130 180 217 220 220 0 0 7 11 13 14 14 13 The crucial issue is not how many utils you get from consuming another beer or packet of crisps But rather the ‘bang per buck’ or utils per pound

28. Bang per buck MU in utils MU in utils Packets of crisps Pints of Beer TU in utils TU in utils - 70 60 50 37 12 0 -220 - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 0 70 130 180 217 220 220 0 0 7 11 13 14 14 13 The crucial issue is not how many utils you get from consuming another beers or packet of crisps But rather the ‘bang per buck’ or utils per pound

29. We should allocate our spending such that MU in utils Pints of Beer TU in utils MU in utils Packets of crisps TU in utils MU/P MU/P - 7 4 2 1 0 -1 0 1 2 3 4 5 6 0 7 11 13 14 14 13 - 28 16 8 4 0 -4 - 70 60 50 37 12 0 -220 0 1 2 3 4 5 6 7 0 70 130 180 217 229 220 0 - 46.6 40 33.3 24.6 8 0 -146.6

30. Alternatively we can write the condition for equilibrium as:

31. INDIFFERENCE ANALYSIS • A more sophisticated way to analyse this problem is to use what is known as Indifference Analysis. For that we need to: • Construct an indifference curve

32. Constructing an indifference curve Pears Point Oranges a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 The data in this table tells us about various combinations that make ‘Clive’ equally happy. Combinations of pears and oranges that Clive likes the same amount as 10 pears and 13 oranges He is ‘Indifferent’ between 10 Pears and 13 Oranges And 14 pears and 10 Oranges

33. Constructing an indifference curve a Pears Point Oranges a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Pears Oranges

34. Constructing an indifference curve a Pears Point Oranges b a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Pears Oranges

35. Constructing an indifference curve a Pears Point Oranges b a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 c Pears d e f g Oranges

36. Constructing an indifference curve a Pears Point Oranges b a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 c Pears d e f g Joining all these points gives us AN indifference curve Oranges

37. INDIFFERENCE ANALYSIS • Indifference curves • constructing an indifference curve • the shape of an indifference curve

38. Constructing an indifference curve a Notice that this curve is downward sloping Why is this and does it have any economic meaning? b c Pears d e f g Oranges