principles of economics dr martin jensen (this term / micro) dr james reade (next term / macro)...

Principles of EconomicsPrinciples of Economics

Dr Martin Jensen (this term / micro)Dr Martin Jensen (this term / micro)

Dr James Reade (next term / macro)Dr James Reade (next term / macro)

Exam: Summer 2013 joint for micro and Exam: Summer 2013 joint for micro and macro (each weights 50 %).macro (each weights 50 %).

Course homepage:Course homepage:socscistaff.bham.ac.uk/jensen/economics101.htmsocscistaff.bham.ac.uk/jensen/economics101.htm

(or via people->academic staff -> etc.)(or via people->academic staff -> etc.)

(or via WebCT)(or via WebCT)

Principles of EconomicsPrinciples of Economics

The textbook is:The textbook is:

Sloman, J., A. Wride, and D. Garrett: Sloman, J., A. Wride, and D. Garrett: “Economics”, 8th Edition, 2012, Pearson.“Economics”, 8th Edition, 2012, Pearson.

Backed up by the 101A booklet (for the few Backed up by the 101A booklet (for the few people who don’t have it already, you can people who don’t have it already, you can get this from the secretaries in the Econ. get this from the secretaries in the Econ. Dep.)Dep.)

...And the course homepage....And the course homepage.

Principles of EconomicsPrinciples of Economics

Apart from lectures, there are classes.Apart from lectures, there are classes.

Classes take place every two weeks, Classes take place every two weeks, beginning either next week or the week beginning either next week or the week after (depending on which group you’re in).after (depending on which group you’re in).

To sign up for classes, enter Econ101 in To sign up for classes, enter Econ101 in WebCT and press the ”sign up for classes” WebCT and press the ”sign up for classes” link (this is pretty selfexplanatory). link (this is pretty selfexplanatory).

Introduction and Indifference Analysis

Introduction and Indifference Analysis

PRICE AND OUTPUT DETERMINATIONPRICE AND OUTPUT DETERMINATION

• We call the price that obtains in the We call the price that obtains in the market, market, the market pricethe market price, or the , or the Equilibrium priceEquilibrium price

• We call the quantity demanded and We call the quantity demanded and supplied the supplied the equilibrium outputequilibrium output..

• We find this by plotting the demand We find this by plotting the demand and the Supply curves. and the Supply curves.

Equilibrium price and outputEquilibrium price and output::The Market Demand and Supply of Potatoes (Monthly)The Market Demand and Supply of Potatoes (Monthly)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Pri

ce (

pen

ce p

er k

g)

E

D

C

B

Aa

b

c

d

e

Supply

Demand

The determination of market equilibriumThe determination of market equilibrium (potatoes: monthly)(potatoes: monthly)

0

4

8

12

16

20

0 100 200 300 400 500 600 700 800

Quantity (tonnes: 000s)

Pri

ce (

pen

ce p

er k

g)

E

D

C

B

Aa

b

c

d

e

Supply

Demand

The determination of market equilibriumThe determination of market equilibrium (potatoes: monthly)(potatoes: monthly)

Where the two lines cross is called the equilibrium point

Pe=12

Qe=350

DemandDemand

• In this course we want to explore in more detail In this course we want to explore in more detail what lies behind the demand and supply what lies behind the demand and supply decisions that people (agents) make by focusing decisions that people (agents) make by focusing on the economics that lie behind the decisions on the economics that lie behind the decisions we actually observe. we actually observe.

• First we are going to focus on Demand. Then we First we are going to focus on Demand. Then we turn to supply both under perfect competition turn to supply both under perfect competition and various sorts of imperfect competition. and various sorts of imperfect competition. Finally, we use what we’ve learned to study some Finally, we use what we’ve learned to study some “selected topics”. “selected topics”.

Happiness HappinessHappiness Happiness

• Basically we demand goods because they Basically we demand goods because they make us ‘happy’make us ‘happy’

• Or at least we would be unhappy if we Or at least we would be unhappy if we didn’t have them.didn’t have them.

• Either way we get Either way we get ‘JOLLIES’ ‘JOLLIES’ from themfrom them

• Economists have a special term for Jollies Economists have a special term for Jollies

– we call it – we call it UTILITYUTILITY

Utility TheoryUtility Theory

• Even Better – we have a theory to explain Even Better – we have a theory to explain consumers’ behaviour called:consumers’ behaviour called:

• Utility TheoryUtility Theory

• This theory relies on an important This theory relies on an important foundation:foundation:

• RationalityRationality

• We assume people choose their desired We assume people choose their desired consumption rationally or consistentlyconsumption rationally or consistently

RationalityRationality

• What do we mean by Rationality ?What do we mean by Rationality ?

• We do We do notnot mean that people are mean that people are fully fully informed or fully consciousinformed or fully conscious about every about every consumption decision they makeconsumption decision they make

• Rather we mean they act (consciously or Rather we mean they act (consciously or otherwise) in a consistent manner.otherwise) in a consistent manner.

Total UtilityTotal Utility

Packetsof crisps

0123456

07

1113141413

Total Utility in

Utils

We imagine that consumers act as if they are trying to

make themselves as happy as possible (broadly defined)

given their circumstances.

In the adjacent table the consumer gets ‘jollies’,

called UTILS from consuming crisps. The

table records his/her total utility.

..

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Darren’s utility from consuming crisps (daily)Darren’s utility from consuming crisps (daily)

Packetsof crisps

TUin utils

0123456

07

1113141413

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

MARGINAL UTILITY THEORYMARGINAL UTILITY THEORY

• Total and marginal utilityTotal and marginal utility

• Marginal Utility:Marginal Utility:

• The The change in Total Utility change in Total Utility as a result of as a result of consuming consuming one more unitone more unit of the good. of the good.

01

01

QQ

TUTUMU

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

Darren’s utility from consuming crisps (daily)Darren’s utility from consuming crisps (daily)

Q1-Q0 =3-2=1

TU1-TU0

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

Darren’s utility from consuming crisps (daily)Darren’s utility from consuming crisps (daily)

Q1-Q0 =3-2=1

TU1-TU0

TU = 2

Q = 1

MU = TU / Q = 2/1 = 2

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6MU

TU = 2

Q = 1

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

Alternative representation of Darren’s Marginal Alternative representation of Darren’s Marginal utilityutility

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6MU

TU = 2

Q = 1

MU = TU / Q = 2/1 = 2

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

Alternative representation of Darren’s Marginal Alternative representation of Darren’s Marginal utility)utility)Note this is

effectively measuring the

slope of the curve

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6MU

TU = 2

Q = 1

MU = TU / Q = 2/1 = 2

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

Alternative representation of Darren’s Marginal Alternative representation of Darren’s Marginal utilityutility

-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Util

ity (

util

s)

Packets of crisps consumed (per day)

TU

MU

Graphing Darren’s Marginal utility we get:Graphing Darren’s Marginal utility we get:

MARGINAL UTILITY THEORYMARGINAL UTILITY THEORY

• Total and marginal utilityTotal and marginal utility

• Marginal Utility:Marginal Utility:

• The The change in Total Utility change in Total Utility as a result of as a result of consuming consuming one more unitone more unit of the good. of the good.

Q

TU

QQ

TUTUMU

01

01

The principle of diminishing marginal utilityThe principle of diminishing marginal utility

Note that the Marginal Utility curve is downward Note that the Marginal Utility curve is downward

SlopingSloping

This gives us:This gives us:

The principle of diminishing marginal utilityThe principle of diminishing marginal utility

– As more units of a good are consumed, As more units of a good are consumed, additional units will provide us with less additional units will provide us with less additional satisfaction than previous unitsadditional satisfaction than previous units

Now let’s look at two goodsNow let’s look at two goods

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Pints of Beer

TUin utils

01234567

070

130180217220220

0

MUin utils

-7060503712

0-220

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Pints of Beer

TUin utils

01234567

070

130180217220220

0

MUin utils

-7060503712

0-220

Looking at the utility from beer compared with crisps do you think Darren should spend all his money on

beer?

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Pints of Beer

TUin utils

01234567

070

130180217220220

0

MUin utils

-7060503712

0-220

Suppose that Crisps cost 25p

And Beer cost 1.50 per pint,

How should Darren allocate his income between beer and crisps

Bang per buckBang per buck

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Pints of Beer

TUin utils

01234567

070

130180217220220

0

MUin utils

-7060503712

0-220

The crucial issue is not how many utils you get from consuming another beer or packet of crisps

But rather the ‘bang per buck’ or utils per pound

Bang per buckBang per buck

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Pints of Beer

TUin utils

01234567

070

130180217220220

0

MUin utils

-7060503712

0-220

The crucial issue is not how many utils you get from consuming another beers or packet of crisps

But rather the ‘bang per buck’ or utils per pound

P

MU

Packetsof crisps

TUin utils

0123456

07

1113141413

MUin utils

-74210

-1

Pints of Beer

TUin utils

01234567

070

130180217229220

0

MUin utils

-7060503712

0-220

-2816

840

-4

MU/P MU/P

-46.6

4033.324.6

80

-146.6

We should allocate our spending such that

B

B

c

c

P

MU

P

MU

50.1

128

25.

2

We should allocate our spending such that

E

E

D

D

c

c

B

B

A

A

P

MU

P

MU

P

MU

P

MU

P

MU

Etc,etc

Alternatively we can write the condition for equilibrium as:

B

A

B

A

P

P

MU

MU

B

B

A

A

P

MU

P

MU

INDIFFERENCE ANALYSISINDIFFERENCE ANALYSIS

• A more sophisticated way to analyse this A more sophisticated way to analyse this problem is to use what is known as problem is to use what is known as Indifference Analysis. For that we need to:Indifference Analysis. For that we need to:– Construct an indifference curveConstruct an indifference curve

Pears

3024201410

86

Oranges

678

10131520

Point

abcdefg

Combinations of pears andoranges that Clive likes

the same amount as10 pears and 13 oranges

Constructing an indifference curveConstructing an indifference curve

The data in this table tells us about various

combinations that make ‘Clive’ equally

happy.

He is ‘Indifferent’ between

10 Pears and 13 Oranges

And

14 pears and 10 Oranges

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

aP

ear

s

Oranges

Pears

3024201410

86

Oranges

678

10131520

Point

abcdefg

Constructing an indifference curveConstructing an indifference curve

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

a

b

Pe

ars

Oranges

Pears

3024201410

86

Oranges

678

10131520

Point

abcdefg

Constructing an indifference curveConstructing an indifference curve

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

a

b

c

d

ef

g

Pe

ars

Oranges

Pears

3024201410

86

Oranges

678

10131520

Point

abcdefg

Constructing an indifference curveConstructing an indifference curve

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

a

b

c

d

ef

g

Pe

ars

Oranges

Pears

3024201410

86

Oranges

678

10131520

Point

abcdefg

Constructing an indifference curveConstructing an indifference curve

Joining all these points gives us AN indifference

curve

INDIFFERENCE ANALYSISINDIFFERENCE ANALYSIS

• Indifference curvesIndifference curves– constructing an indifference curveconstructing an indifference curve

– the shape of an indifference curvethe shape of an indifference curve

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

a

b

c

d

ef

g

Pe

ars

Oranges

Constructing an indifference curveConstructing an indifference curve

Notice that this curve is downward sloping

Why is this and does it have any economic

meaning?