GPP 501 Microeconomic Analysis for Public Policy Fall 2017 Given - PowerPoint PPT Presentation

GPP 501 Microeconomic Analysis for Public Policy Fall 2017 Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture Sept 12th: Demand GPP501: Lecture Sept 12 1 of 24

Agenda for today: 1. Go from choice to preference maps. 2. Budget sets. 3. Demand Curves. GPP501: Lecture Sept 12 2 of 24

Axioms of choice: Reminder: why are we going through this? • We want to build up to demand curves and supply curves. • Once we understand demand and supply curves, we can start doing some economic analysis of policy issues. Q: do you remember the three from last lecture? Q: what did we say about choices that satisfied the three axioms? GPP501: Lecture Sept 12 3 of 24

Axioms of choice: From last time: 1. Completeness 2. Transitivity 3. Reflexivity Where do we want to go? We want to build a structure for preferences that we can represent in diagrams and in math. To do so, we will need to add more assumptions…. GPP501: Lecture Sept 12 4 of 24

Axioms of choice: 4. Continuity : assumes that rankings are “smooth” • A technical assumption that assures that preference rankings don’t ‘jump’ around the edges. • This is necessary in order to write down preference curves. 5. Strong monotonicity: more is preferred to less. • For any comparison, we assume that more is preferred to less. • This can be weakened to “local non - satiation.” • Necessary so that we don’t have ‘fuzzy’ or ‘thick’ comparisons. 6. Convexity : assures ‘well - behaved’ preference curves. • Interior points on a line between two bundles are at least as good as boundary points. • This one is much easier to see in a diagram….. GPP501: Lecture Sept 12 5 of 24

Indifference curves: • Each indifference curve shows a constant level of enjoyment from bundles of x 1 and x 2 . x 2 • What does non-monotonicity do? • What does convexity do? • Can indifference curves cross? • Which direction makes us best off? o Is this true even for small jumps? U 2 U 1 U 0 x 1 GPP501: Lecture Sept 12 6 of 24

Exploring indifference curves: • Does this violate any of the assumptions? x 2 • How would you describe the way people like to consume x 1 and x 2 ? • Any examples come to mind? U 2 U 1 U 0 x 1 GPP501: Lecture Sept 12 7 of 24

Exploring indifference curves: • Does this violate any of the assumptions? x 2 • How would you describe the way people like to consume x 1 and x 2 ? • Any examples come to mind? U 2 U 1 U 0 x 1 GPP501: Lecture Sept 12 8 of 24

Agenda for today: 1. Go from choice to preference maps. 2. Budget sets. 3. Demand Curves. GPP501: Lecture Sept 12 9 of 24

Budget sets: We now know how to talk about choices over bundles of goods. • Indifference, utility, preferences. But which bundle should we choose? • What is our ultimate favourite bundle going to look like under strong monotonicity? • What stops us from getting to that favourite bundle? GPP501: Lecture Sept 12 10 of 24

Budget sets: Our model of choice is much more useful if we put a constraint on resources. • Income • Wealth • Time We know time is a hard constra int; can’t budge it. But income and wealth — where do they come from? • Complex choices about work, consumption, savings, human capital, and time. • We’ll just work with an endowment economy for now. “Helicopter” money. GPP501: Lecture Sept 12 11 of 24

Budget sets: Imagine we have: • Income set at fixed y . • Goods x 1 and x 2 . • Prices for goods fixed at p 1 and p 2 . Let’s express this as a budget. 𝑧 ≥ 𝑞 1 𝑦 1 + 𝑞 2 𝑦 2 All choices of bundles of x 1 and x 2 that satisfy the budget constraint are feasible choices. Q: Why did I use a “ ≥ ” sign? Q: Under what assumption would this hold strictly at “=”? GPP501: Lecture Sept 12 12 of 24

Budget sets: • What points can we afford? x 2 • What points can we not afford? 𝑧 = 𝑞 1 𝑦 1 + 𝑞 2 𝑦 2 x 1 GPP501: Lecture Sept 12 13 of 24

Budget sets: • What happens if I get more y ? x 2 𝑧 0 < 𝑧 1 < 𝑧 2 • Parallel shifts outward of budget line. 𝑧 2 𝑧 0 𝑧 1 x 1 GPP501: Lecture Sept 12 14 of 24

Budget sets: • If you give up one unit of 𝑦 1 you are + x 2 𝑞 1 dollars. 𝑞 1 • This means you can afford 𝑞 2 more 𝑧 = 𝑞 1 𝑦 1 + 𝑞 2 𝑦 2 units of 𝑦 2 . • So, the slope of the budget line is: 𝑞1 −𝑞 1 𝑞2 ∆𝑦 2 −𝑞 1 • Slope is 𝑞 2 . ∆𝑦 1 = −1 = 𝑞 2 x 1 GPP501: Lecture Sept 12 15 of 24

Agenda for today: 1. Go from choice to preference maps. 2. Budget sets. 3. Demand Curves. GPP501: Lecture Sept 12 16 of 24

Putting preferences and budget constraints together What happens when we combine our diagrams? • Put down a given budget constraint. • What is the best bundle we can afford? • If we do this and then repeat the exercise for different prices of good 𝑦 1 , we will trace out a demand curve for 𝑦 1 . • Let’s give this a shot! GPP501: Lecture Sept 12 17 of 24

Putting preferences and budget constraints together x 2 • Start with our normal budget constraint. • Which points are feasible for us to pick? 𝑧 = 𝑞 1 𝑦 1 + 𝑞 2 𝑦 2 • What points are not feasible? • How should we choose among feasible points? x 1 GPP501: Lecture Sept 12 18 of 24

Putting preferences and budget constraints together • Consider A, B, C, D. x 2 • Which is the point we like best if we could afford any of them? • Considering our budget constraint, which should we choose? • What is true of the slope of the budget D B C line and the slope of the indifference curve at the best point? A x 1 GPP501: Lecture Sept 12 19 of 24

Let’s redo it for different prices for 𝒚 𝟐 : • Start off at our initial price for 𝑦 1 , price x 2 0 . We choose point 𝐷 0 . is 𝑞 1 • Now increase the price to 𝑞 1 1 > 𝑞 1 0 . −𝑞 1 Slope is 𝑞 2 . • We can afford less now, so budget constraint swings inward. We can only C 0 afford point 𝐷 1 now. That has less good 𝑦 1 . C 2 C 1 • Note that we can’t necessarily say whether we consume more/less good 𝑦 2 . • Finally, tighten prices even more: 2 > 𝑞 1 1 . We now choose point 𝐷 2 . 𝑞 1 x 1 GPP501: Lecture Sept 12 20 of 24

Demand Curve for 𝒚 𝟐 : p 1 • Note that this is a different graph from the previous one. • Previous one showed good 𝑦 1 and good 𝑦 2 . C 2 • This is just good 𝑦 1 . C 1 C 0 x 1 GPP501: Lecture Sept 12 21 of 24

Demand Curve for 𝒚 𝟐 : • What happens to demand curve if p 1 incomes go up? • What happens to demand curve if price of other good goes up? o Does answer change for substitutes and complements? • What happens to demand curve if price of good 𝑦 1 goes up? x 1 GPP501: Lecture Sept 12 22 of 24

Concept: Elasticity of demand How can we characterize whether the change in demand when price changes is big or small? • We use the concept of “elasticity”. We define it this way: Price elasticity of demand  %∆𝑌 1 %∆𝑞 1 ⁄ . • What is the percentage change in the quantity compared to the percentage change in price? • We generally use 1.0 as the cutoff between “elastic” and “inelastic” o If greater than 1.0, we call it elastic. o If less than 1, we call it inelastic. GPP501: Lecture Sept 12 23 of 24

For next time… We will move on to the other side: producers/supply. Homework: Watch this 9 minute youtube video … https://youtu.be/ybobE0ijbeY GPP501: Lecture Sept 12 24 of 24