Law of DemandSummary(1st) Law of Demand1. Find Quantity Demanded at a given Price2. Find marginal value for the next unit of a goodAll Three Principles at WorkSlide 7Slide 8There are no Exceptions!Welfare Participation (AFDC/TANF), by YearWhat about guns?Moral HazardExample: One way capitalismOther examplesMoral Hazard (cont’d)Slide 16Law of DemandDownward sloping demand curves.SummaryThese three principles describe our preferences:•Maximization•Substitution•Diminishing Marginal Value (DMV)(1st) Law of DemandThere is an inverse (negative) relationship between price and quantity demanded.Quantity Demanded (Q)Price (P)D = Demand Curve1. Find Quantity Demanded at a given PriceSTEP 1: move horizontally across until you meet the demand curveSTEP 2: move downwards to the x-axisp1 q1 QP2. Find marginal value for the next unit of a goodSTEP 1: go up vertically to the demand curveSTEP 2: move horizontally across to the y-axismv1 = p1 q1QPp1 = maximum price willing to pay = marginal value = mv11. Substitute away from good Y towards more of good X when price of X fallsAll Three Principles at Workp1p2 q1 q2QXPD2. The maximum price one is willing to pay (marginal value) for each added unit diminishes the more that is consumedAll Three Principles at Workmv1 = p1mv2 = p2 q1 q2QXPD3. Every point on the demand curve is an optimal choice – it reflects a process of maximizationAll Three Principles at Workp1 q0 q1 q2QXPDThere are no Exceptions!To deny the “law of demand” is to deny the principle of substitution•Food•Gasoline•Seat Belts•Divorce•WelfareWelfare Participation (AFDC/TANF), by YearWhat about guns?Lott (1997) found that, controlling for other possible factors, the introduction of concealed carry laws is associated with:8% reduction in murder5% reduction in rape3% reduction in robbery7% reduction in aggravated assaultMoral HazardWhen people’s actions cannot be observed people tend to behave in an opportunistic mannerExample: One way capitalismOther examples•This can be graphic•A little less graphicMoral Hazard (cont’d)•The dysfunctional behavior arising from moral hazard underscores the importance of monitoringSummary•When the price of something goes up, we consume less of it•This applies to all things – no
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