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Key issuesDeriving Demand CurvesSlide 3Deriving an Individual’s Demand CurvePrice-consumption curveHow income changes shift demand curvesEffect of a Budget Increase on an Individual’s Demand CurveIncome elasticitiesMimi's income elasticitiesAre children inferior?Income-consumption curves and income elasticitiesIncome-Consumption Curves and Income ElasticitiesIncome elasticities may vary with incomeA Good That Is Both Inferior and NormalQuality and income elasticitiesEffects of a price changeSubstitution effectIncome effectIncome and substitution effectsSubstitution and Income Effects with Normal GoodsIncome and substitution effect with an inferior goodGiffen GoodInflationSlide 24Slide 25Cost-of-living adjustmentsSlide 27Consumer Price Index (CPI)Real vs. nominal pricesGovernment collects pricesSummary statisticsAveragingCPI approachPrice of bundlesCalculate rate of inflationCPI adjustmentThe Consumer Price IndexSource of BiasTotal CPI biasUSPSSlide 41Federal GovernmentHow rich are developing countries?International Monetary FundResultSlide 46More plausibleSlide 48Deriving labor supply curvesPrice of leisureUtilityBudget constraintTime constraintDemand for LeisureSupply curve of laborSupply Curve of LaborSolved problemRestatementSlide 59Slide 60AnswerIncome and substitution effectsIncome and Substitution Effects of a Wage ChangeEstimated labor supply curvesMarried women's supply curvesDo animals make rational choices?Wages and incomeResearchers foundIncome TaxesIncome tax rates and labor supplyTax cutsTax ratesReagan Tax Reform Act of 1986Bush Administration’s Tax Relief Act of 2001International Comparison (2001)Effect of taxLabor Supply Curve That Slopes Upward and Then Bends BackwardLabor Supply Curve That Slopes Upward and Then Bends BackwardTax revenue and tax rateSlide 80Effects of U.S. tax cutsSlide 82Effects of tax cuts in other countriesSlide 84Solved problemSlide 86Slide 87State general fund revenuesWinning the Good LifeResultsDemographic differencesChild-Care SubsidiesChild-Care Subsidies (cont.)QuestionQuestion (cont.)Slide 96SolutionSolution (cont.)1 Deriving demand curvesIncome effect3 Effects of a price change4 CPI bias5 Labor supply curvesKey issues1. deriving demand curves2. income effect3. effects of a price change4. CPI bias5. labor supply curve•trace out the demand curve by holding income and the price of wine constant, and varying the price of beer •example: estimated set of indifference curves for the typical American consumer are bowed away from origin, so beer and wine are imperfect substitutionsDeriving Demand CurvesDeriving an Individual’sDemand CurvePrice-consumption curve shows how the optimal pairs of beer and wine vary as the relative price variesHow income changes shift demand curves•hold prices fixed and vary income•increase in income causes•shift of the demand curve•movement along income-consumption curve•movement along the Engel curveEffect of a Budget Increase on an Individual’s Demand CurveIncome elasticities•income elasticity:•normal good: EI > 0•inferior good: EI 0percentage change in quantity demandedpercentage change in income//IEQ QI I=D=DMimi's income elasticities•beer: Eb = 0.88•wine: Ew = 1.38•both are normal goodsAre children inferior?•mother with relative little education: EI = -0.18•mother relatively well educated: EI = 0.044Income-consumption curves and income elasticities•shape of income-consumption curve for 2 goods tells us sign of income elasticities •some goods must be normal: not all goods can be inferiorIncome-Consumption Curves and Income ElasticitiesIncome elasticities may vary with income Gail may view hamburger as •a normal good at a low income•an inferior good at a high incomeA Good That Is Both Inferior and NormalQuality and income elasticities•when their incomes rise, some people buy higher quality goods rather than more of what they’re currently buying•examples:•fancier cars•fancier foods•designer clothingEffects of a price change as price of one good goes up (all else the same), there are two effects:•a substitution effect•an income effectSubstitution effect•consumers substitute other, now relatively cheaper, goods for the one whose price rose •direction of the effect is unambiguousIncome effect •price increase consumers' buying power falls, reducing “income” (opportunity set)•so consumer buys less of at least some goods•direction of income effect depends on income elasticity of each goodIncome and substitution effects price rise substitution effect income effectnormal good negative negativeinferior good negative positiveSubstitution and Income Effects with Normal GoodsIncome and substitution effect with an inferior good•substitution effect: opposite of price movement•income effect: same direction as price movement•Giffen good: good for which a decrease in its price causes the quantity demanded to fall•potatoes in Ireland?•quinine water for lab ratsGiffen GoodInflation•because of inflation, prices today are not directly comparable to past prices•inflation harms people on fixed incomes, net lenders, and othersCost-of-living adjustments many long-term contracts include cost-of-living adjustments (COLAs):•general business contracts•rental•alimony payments•salaries•pensionsConsumer Price Index (CPI) •many governments report a cost-of-living measure: CPI•measure of inflation: overall rise in prices over time•CPI overestimates how true cost-of-living changes over time•overestimate hurts you if your landlord increases rent on your apartment using CPIReal vs. nominal prices •nominal price = “current dollars” price•real price = “constant dollar” price (adjusted for inflation)• •real price = nominal price divided by CPI CPI for 2000 168.7 price of a burger = 15¢ 94¢CPI for 1955 26.8 Government collects priceson 364 individual goods and services, such as:•housing•dental services•watch and jewelry repairs•college tuition fees •taxi fares•women's hair pieces and wigs•hearing aids•slip covers and decorative pillows•bananas•funeral expensesSummary statistics•if government reports all price increases separately, information is overwhelming •instead use a single summary statistic, CPI: how prices rose on averageAveraging•one way to average price increases: weight the good equally •but do we really want to weight price increase of skateboards as
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