praxeology through price theory, lecture 8 with robert murphy - mises academy

Mises AcademyAustrian Econ I:

Praxeology Through Price Theory

Robert P. MurphySpring 2011

Lecture 8June 15

2nd half Chapter 4

I. ElasticityII. ComplementarityIII. Pricing Durable GoodsIV. Mainstream Utility Results

V. Indifference Curves VI. Subjective vs. Market Value

I. Elasticity

The more substitutes for a good, the more elastic will its demand tend to be.

II. Complementarity

III. Pricing Durable Goods

A. Rent

Rent - the price of buying the services of a durable good for a period of time.

B. Capitalization

The purchase price (i.e. capital value) of a durable good is the present discounted value of its expected flow of future rents (i.e. services).

C. Capital Gains/Losses

Mistaken forecasts of future rental income will lead to capital gains or capital losses.

E.g. apartment building expected to yield $10,000 in rent per year, forever, at 5% interest. Original price $200,000.

After purchase, owner realizes can only rent out for $9,000 per year. New appraisal: Building worth $180,000. Owner suffers a one-time capital loss of $20,000.

D. Interest Income

Reaping larger money balances over time, due to investment in durable goods, does not constitute a capital gain (a form of profit) but rather constitutes interest income.E.g. apartment building expected to yield $10,000 in rent

per year, forever, at 5% interest. Original price $200,000.

Each year, owner receives cash flow of $10,000. This can be spent on consumption w/o impairing capital value of asset. Same as investing $200k in bonds at 5%.

IV. Mainstream Utility Results

Mainstream texts say that consumers adjust purchases of goods such that:

(MUx / Px) = (MUy / Py)

Or

(MUx / MUy) = (Px / Py)

V. Indifference Curves

VI. Subjective vs. Market Value