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OSU ECON 4001.01 - Income Effect

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Econ 4001 1st Edition Lecture 7Outline of Last Lecture I. Demand Curve for an Individuala. DefinitionII. Consumer Choice with changing priceIII. Aspects of the Price-Consumption Curvea. Defining the curveIV. Consumer Choice with Changing IncomeV. Income Consumption CurveVI. Engel CurvesVII. Substitutes and ComplimentsVIII. Income and Substitution EffectsIX. Substitution Effects of a Price Increasea. Price Increase ExampleOutline of Current Lecture II. Income and Substitution Effects- Price IncreaseIII. Several Famous Economistsa. Alfred Marshallb. John Hicksc. EvgenySlutskyIV. Consumer SurplusV. Network Externalities: Impact on DemandVI. Empirical Estimation of DemandVII. Producer Theory- Rebuilding the Supply Sidea. Boundaries of the Firmb. Production Technologyc. Types of Input for FIrmsVIII. Simplified Production FunctionCurrent Lecture- Income and substitution effects-Price Increaseo Substitution effect causes reduction in the quantity demanded- Several Famous names in Economicso Consumer demand without income/wealth impacts: Marshallian Demand after Alfred MarshallThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o Consumer demand with wealth/income impacts: Hicksian Demand- after John Hickso Decomposing income and substitution effects: Slutsky- Consumer Surpluso Value received from consumption of a good in excess of the amount paid for the goodo For an individual- difference between maximum willingness to pay and the priceo Consumer surplus is different for every consumer: it is whatever they don’t have to pay/always estimating CS, not a direct number- What do we know about CS?o Taxes drive a wedge between price paid by buyers and price received by sellers reducing CS 2 ways Part of CS goes to government Part is lost to economy in dead weight losso Price ceilings and floors reduce Q and, therefore CSo Monopoly raises prices to consumers and so reduces CSo First degree price discrimination eliminates DWL, but transfers all CS to the sellers- Network Externalities-Impact on Demando Network externality: If consumer’s value from consumption depends on the size of the market (ie. Number of consumers)o Each individual’s demand depends on purchases of other buyers/also called bandwagon effect (example: Facebook, LinkedIn)o Negative externalities- common resources, congestion goods, snob goods- Empirical Estimation of Demando Using time-series data Advantages: Easy to obtain many data points/allows statistical analysis Disadvantages: Assumes underlying demand static (tastes haven’t changed/demand is stable/income hasn’t changed, etc.) and there are no externalities (can make it seems more elastic than it really is) Adaptations: estimate demand and income simultaneously, and use frequent (monthly vs. annual) datao Using cross-sectional data Advantages: Assumption of static demand is justified/may be able to sub-divide geography to increase data points Disadvantages: Assumes sub-markets are independent / preventing arbitrage may be difficult/data collection costs may be high Adaptations: May be able to substitute lower-cost options: variable coupons, club stores- Producer Theory- Rebuilding the Supply Sideo Unit of analysis is the firmo Our theory of the firm will answer the following: Why are there firms? How do firms make the goods they sell? How do firms decide what resources to employ?o What is a firm and why do they exist? A firm is a collection of resources brought together and organized to produce goods and/or services Alternative to firms: a universe of independent contractors who supply goods and services to each other Contracting and negotiation would consume a great deal of time and energy; this is inefficiento Boundaries of the Firm Firm internalizes many of the contracting issues, replacing a market for services with a command and control structure: supervisors and employees  gets rid of all the different contracts and puts them all under one umbrella Forms choose to contract some specialized skills, rather than maintaining them “in-house” Boundaries of firms are constantly changing  don’t know exactly what the boundaries look like, because they are always changingo Production Technology Firms have one objective: maximizing profits Profit= Total revenue- Total cost To maximize profit, firms can minimize costs and/ or maximize revenue Firms purchase inputs (labor, capital, and materials) and transform them into salable productso Types of Input for Firms Labor- highly skilled workers, less skilled workers, supervisors, middle andtop management (over time firms want labor to become more skilled) Materials- raw materials (steel, plastic, chemicals) utilities (power, water) supplies Capital- land, buildings, machinery, and equipment (things we associate with fixed costs)- Simplified Production Functiono Output= q= F(K,L) where K=capital and L= laboro If firm maximizes profits, production function is efficient- produces most output with least inputso Fixed input: any input that cannot be varied in the short run, but can be varied in the long run (examples are machinery, equipment, land,


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