Documente Academic
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Documente Cultură
GOUTAM BUCHHA
PGPSE PARTICIPANT
2009
AFTERSCHO☺OL (www.afterschoool.tk)
– DEVELOPING CHANGE MAKERS
CENTRE FOR SOCIAL ENTREPRENEURSHIP
PGPSE PROGRAMME –
World’ Most Comprehensive programme
PGPSE NOTESin social entrepreneurship & spiritual 1
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entrepreneurship
1
INTRODUCTION
PGPSE NOTES 2
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1
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TEN PRINCIPLES OF
ECONOMICS
• A household and an economy
face many decisions:
– Who will work?
– What goods and how many of them should be
produced?
– What resources should be used in
production?
– At what price should the goods be sold?
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TEN PRINCIPLES OF
ECONOMICS
Society and Scarce Resources:
– The management of society’s resources is
important because resources are scarce.
– Scarcity. . . means that society has limited
resources and therefore cannot produce all
the goods and services people wish to have.
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TEN PRINCIPLES OF
ECONOMICS
Economics is the study of how society
manages its scarce resources.
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TEN PRINCIPLES OF
ECONOMICS
• How people make decisions.
– People face tradeoffs.
– The cost of something is what you give up to
get it.
– Rational people think at the margin.
– People respond to incentives.
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TEN PRINCIPLES OF
ECONOMICS
• How people interact with each other.
– Trade can make everyone better off.
– Markets are usually a good way to organize
economic activity.
– Governments can sometimes improve
economic outcomes.
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TEN PRINCIPLES OF
ECONOMICS
• The forces and trends that affect how the
economy as a whole works.
– The standard of living depends on a country’s
production.
– Prices rise when the government prints too
much money.
– Society faces a short-run tradeoff between
inflation and unemployment.
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Principle #1: People Face Tradeoffs.
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Principle #1: People Face Tradeoffs.
• Efficiency v. Equity
– Efficiency means society gets the most that it
can from its scarce resources.
– Equity means the benefits of those resources
are distributed fairly among the members of
society.
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Principle #2: The Cost of Something Is
What You Give Up to Get It.
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Principle #2: The Cost of Something Is
What You Give Up to Get It.
LA Laker basketball
star Kobe Bryant
chose to skip college
and go straight from
high school to the
pros where he has
earned millions of
dollars.
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Principle #3: Rational People Think at
the Margin.
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Principle #4: People Respond to
Incentives.
• Marginal changes in costs or benefits
motivate people to respond.
• The decision to choose one alternative
over another occurs when that
alternative’s marginal benefits exceed its
marginal costs!
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Principle #5: Trade Can Make
Everyone Better Off.
• People gain from their ability to trade with
one another.
• Competition results in gains from trading.
• Trade allows people to specialize in what
they do best.
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Principle #6: Markets Are Usually a
Good Way to Organize Economic
Activity.
• A market economy is an economy that
allocates resources through the
decentralized decisions of many firms and
households as they interact in markets for
goods and services.
– Households decide what to buy and who to
work for.
– Firms decide who to hire and what to produce.
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Principle #6: Markets Are Usually a
Good Way to Organize Economic
Activity.
• Adam Smith made the observation that
households and firms interacting in markets act as
if guided by an “invisible hand.”
– Because households and firms look at prices when
deciding what to buy and sell, they unknowingly take
into account the social costs of their actions.
– As a result, prices guide decision makers to reach
outcomes that tend to maximize the welfare of society
as a whole.
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Principle #7: Governments Can
Sometimes Improve Market Outcomes.
• Market failure occurs when the market fails
to allocate resources efficiently.
• When the market fails (breaks down)
government can intervene to promote
efficiency and equity.
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Principle #7: Governments Can
Sometimes Improve Market Outcomes.
• Market failure may be caused by
– an externality, which is the impact of one
person or firm’s actions on the well-being of a
bystander.
– market power, which is the ability of a single
person or firm to unduly influence market
prices.
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Principle #8: The Standard of Living
Depends on a Country’s Production.
• Standard of living may be measured in
different ways:
– By comparing personal incomes.
– By comparing the total market value of a
nation’s production.
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Principle #8: The Standard of Living
Depends on a Country’s Production.
• Almost all variations in living standards are
explained by differences in countries’
productivities.
• Productivity is the amount of goods and
services produced from each hour of a
worker’s time.
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Principle #8: The Standard of Living
Depends on a Country’s Production.
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Principle #9: Prices Rise When the
Government Prints Too Much Money.
• Inflation is an increase in the overall level
of prices in the economy.
• One cause of inflation is the growth in the
quantity of money.
• When the government creates large
quantities of money, the value of the
money falls.
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Principle #10: Society Faces a Short-
run Tradeoff Between Inflation and
Unemployment.
• The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Inflation Unemployment
It’s a short-run tradeoff!
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Summary
• When individuals make decisions, they face
tradeoffs among alternative goals.
• The cost of any action is measured in terms
of foregone opportunities.
• Rational people make decisions by
comparing marginal costs and marginal
benefits.
• People change their behavior in response to
the incentives they face.
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Summary
• Trade can be mutually beneficial.
• Markets are usually a good way of
coordinating trade among people.
• Government can potentially improve
market outcomes if there is some market
failure or if the market outcome is
inequitable.
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Summary
• Productivity is the ultimate source of living
standards.
• Money growth is the ultimate source of
inflation.
• Society faces a short-run tradeoff between
inflation and unemployment.
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On July 29, 2006 I was reading the Omaha World Herald. On this
Saturday morning my eye caught the car ads section. On the front
page of that section is a question and answer section by “Click &
Clack.” I do not remember their real names. They also host (used
to, anyway, and maybe they still do) a PBS radio show about cars.
I rarely read this section, but I did this day.
The first question had to do with going on a long trip in a car. The
question was about washing and waxing the car before the trip and
then washing the car along the way. The person asking the
question felt the washing would help save on gas and so the
questioner wanted information from the experts.
The experts said that yes there is some benefit to the washing, but
so little benefit that the cost of the washing and waxing would be
larger than the benefits obtained. So, from a dollars and cents point
of view the washing did not pay off.
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I was all excited about reading the story because I thought it made
sense and maybe I could use the story in my classes – so here we
are. I would like to repackage the story to make a more general
point. I will make a little diagram to aid in my story.
Benefits
Policy or action
or proposal
Costs
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The policy in the example is
Wash car before, and while on, long car trips.
The benefit(s):
Better gas mileage and thus a cost saving.
The cost(s):
The cost of the car wash.
Economics is a science that when looking at policies the focal point
is on the benefits and costs of the policy.
In our personal lives, when a policy has benefits that clearly
outweigh the costs, many people engage in what the policy
recommends.
Examples: Brushing your teeth everyday, washing your hands after
using the restroom, and thewww.afterschoool.tk
list goes on and on.
PGPSE NOTES 33
We have government in our world. Policies are recommended in
this arena. Every policy that gets mentioned has benefits. But
every policy also has costs. Please remember this.
Is the following good social policy from an economic point of
view? Every person in northeast Nebraska should give Chuck
Parker $1 each time they drive by Dairy Queen .
Hey, businesses have policies too. Most organizations have
policies. The economic approach to viewing the world is looking
at the benefits and costs of the policy.
It seems that a lot of restaurants have a policy that if you buy a
pop you can get free refills. Is this a good business policy? The
benefits are…………………….
The costs are…………………..
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Well, here is my little story triggered by my reading the “Click &
Clack” article.
Should I make it a policy as a professor at WSC to bring in current
events and other items I find in the paper?
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Overview
In consumer theory we started with the x and y axes both referring to a good or
service, with each axis representing a different specific good. Sometimes,
though, we only want to focus on one good against everything else we could
buy.
If we think of the Y good as a composite commodity then we can say the price of
the good is $1 per unit and the commodity is really then how much we spend on
all goods except good x.
The budget line and indifference curves we saw before are essentially the same
as we saw before.
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Budget line
Y Before we said the budget line was
PxX + PyY = I, with vertical intercept
= I/Py, horizontal intercept = I/Px
and slope –Px/Py.
In the context of the composite
I commodity we have PxX + Y = I,
with vertical intercept = I (our
income amount), horizontal intercept
= I/Px still and slope = -Px
I/Px
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Utility max
With the composite good our
Y
utility max story is the same as
before except when we see
point X1 the Y point is the
amount of income we have left
after buying X1 units of X.
The point of the composite
commodity idea is we can
focus on the x good and
I – PxX1 everything else in a lumped up
amount.
X
X1
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Consumer Surplus
When consumers buy products in
the market they may pay less than
the full amount they are willing to
pay – they receive consumer
surplus.
Do you want to buy some eggs?
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consumer surplus
Consumer surplus is an idea people I know have
a hard time accepting. Consumer surplus equals
the maximum amount you are willing to pay for
an item minus what you have to pay. It seems
the hard part is distinguishing between what you
have to pay and what you would be willing to
pay.
P
What consumers are
willing to pay for the Q1
units
Q1 Q
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Consumer surplus again
P Say with S & D we get the
P = 10 and Q = 300.
25 Area A = .5(300)(25-10)
=2250
A Area B = 10(300)
10 = 3000
B Note consumers would be
300 Q willing to pay 3000 +
2250
But the consumers only have for 300to pay 3000 for the
units.
300 units.
So the consumer surplus is area A and equals
2250. PGPSE NOTES
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45
Refresher on areas
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consumer surplus again
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Market Demand from
Individual Demand
In this section we want to think about market demand as the
result of adding up demands from many individuals.
Remember individual demand is the result of each
consumer going about utility maximization.
Let’s do an example with 3 people. qi is the demand from
the ith consumer. Say,
q1 = 10 - p, q2 = 15 - 2p, and q3 = 18-3p.
Often the demand is written in inverse form (where we
isolate the p term). We have
p = 10 - q1, p = 15/2 - (1/2)q2, and p = 18/3 - (1/3)q3
We usually express demand in inverse form when we want
to graph the demands in the P, Q graph. I have a graph on
the next screen with each demand in it.
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P Note at a price above 10 no one demands
any units. At a price above 7.5 only
person 1 demands units. At a price above
6 only person 1 and person 2 demand
units. If price is below 6 all three people
demand units.
The dashed line here is the market
10
demand. It is found by looking at each
price and adding the quantities each
7.5
person would demand.
6
Q
10 15 18
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To get the market demand we horizontally add the demand
from each person. This amounts to saying q1 + q2 + q3 =
Q.
We saw before the demand from each person was
q1 = 10 - p, q2 = 15 - 2p, and q3 = 18-3p.
To get the market demand we add
q1 + q2 + q3 to get (10 - p) + (15 - 2p) + (18 -3p) = (10 +
15 + 18) - (p + 2p + 3P), or
Q = 43 - 6P, but this is only true when price is less than or
equal to 6. In other words all three people demand units
when the price is less than 6.
Note if P = 1 q1 = 9, q2 = 13, q3 = 15 and Q = 37, or
if P = 2 q1 = 8, q2 = 11, PGPSE
q3 = NOTES
12 and Q = 31. 51
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Remember if the price is above 6 but
P less than or equal to 7.5 the demand
comes from only the first two people
and the demand curve is
q1 + q2 = Q = 25 - 39, and
if the price is above 7.5 the demand is
only from the first person and the
demand curve is
q1 = Q = 10 - p.
Q
So the market demand curve we have
come to know and work with is really
the addition of the demand from many
people as they have gone about
maximizing their utility.
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Price elasticity of demand
Often in economics we look at
how the value of one variable
changes when another variable
changes. The concept called
elasticity is a summary statement
about those changes.
Elasticity
The law of demand or the law of supply is a
statement about the direction of change of the
quantity demanded, or supplied, respectively,
when there is a price change.
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own price elasticity of demand
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absolute value
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Elasticity can have three basic
values
If abs(Ed) > 1 we say demand is elastic. This
means the % change in the Qd is greater than
the % change in price.
TR in the market is
P1 equal to the price in
the market
multiplied by the
quantity traded in
the market. In this
Q diagram TR equals
Q1
the area of the
the horizontal and vertical axes. We know
rectangle fromby
made
math that the area of a rectangle
P1, is
Q1base
andtimes
height and thus here that means P times Q.
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Elasticity and total revenue
relationship
We will want to look at the change in values of a
variable and in order to do so we want to have a
consistent measure of change. In this regard
let’s say the change in a variable is
the later value minus the earlier
value.
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Elasticity and total revenue
P
relationship
Now in this graph
when the price is P1
the TR = a +
b(adding areas) and
P if the price is P2 the
1 a
b c TR = b + c.
P
Q In this diagram we
2 Q1 see c < a and thus
I think you willQ2
recall that in thethe
lower rightinofTR
change the<
demand the demand is price inelastic.
0. Thus if the
price falls in the inelastic range of demand TR
falls. PGPSE NOTES 69
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Elasticity and total revenue
P
relationship
Now in this graph
when the price is P1
P the TR = a +
a b(adding areas) and
1
P if the price is P2 the
b c TR = b + c.
2
Q In this diagram we
Q1 Q2 see c = a and thus
I think you will recall that in thethe change
middle in TR =
of the
demand the demand is unit elastic. 0. Thus if the
price falls in the unit elastic range of demand TR
does not change. PGPSE NOTES 70
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Elasticity and TR
P
When the price falls the quantity
demanded always rises. As the
quantity demanded rises
D
Q (because of the price change)
the TR is first rising in the
TR elastic range, levels off when
demand is unit elastic and TR
falls in the inelastic range.
Q
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Marginal revenue
Marginal revenue is defined as the change in total revenue as
the number of units cold changes. In the demand graph we
have seen that in order to sell more the price has to be
lowered. So, there is a relationship between elasticity and
marginal revenue.
If price falls and demand is elastic we know TR rises so MR
is positive.
If Price falls and demand is inelastic we know TR falls and so
MR is negative.
If price fall and demand is unit elastic we know TR does not
change.
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Other demand elasticities
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cross price elasticity of demand
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income elasticity of demand
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Elasticity of supply
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Decisions under uncertainty
A Different look at Utility Theory
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Overview
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Examples
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Example
In our example the EV for each gamble is positive. The EV is
the highest for gamble 3. But, remember we said not many folks
would probably like it because of the uneasiness they would feel
by losing the 10000.
A couple of guys named Von Neumann (both names are just the
person’s last name) and Morgenstern created a model we now
call the expected utility model to deal with situations like this.
They indicated folks make decisions based not on monetary
values, but based on utility values. Of course the utility values
are based on the monetary values, but the utility values also
depend on how people view the world.
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Expected Utility
Say we observe a person always buying chocolate ice cream
over vanilla ice cream when both are available and both cost
basically the same, or even when chocolate is more expensive
and always when chocolate is the same price or cheaper. So by
observing what people do we can get a feel for what is preferred
over other options.
When we assign utility numbers to options the only real rule we
follow is that higher numbers mean more preference or utility.
Even when we have financial options we can study or observe
the past to get a feel for our preferences.
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Expected Utility Theory is a methodology that incorporates
our attitude toward risk (risk is a situation of uncertain
outcomes, but probabilities are known) into the decision
making process. It is useful to employ a graph like
Utility this in our analysis. In the graph we
value will consider a rule or function that
translates monetary values into utility
values. The utility values are our
subjective views of preference for
monetary values. Typically we
assume higher money values have
higher utility.
Monetary
value
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In general we say people have one of three attitudes toward
risk. People can be risk avoiders, risk seekers , or indifferent
toward risk (risk neutral).
$
X1 X2
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Expected Utility
U2
EU
U1
$
X1 EV X2
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Example continued
X1 EV X2 wealth
=W PGPSE NOTES 95 95
W*
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Risk Seeker fair gamble
In this graph I have the
generic view of a risk seeker.
U
With the fair gamble we
have the EV and the EU is on
the chord above the EV.
If the person does not gamble
EU
wealth will be W and the
Uw utility there is just read off
the utility function here as
Uw (note a risk seeker has
X1 EV X2 W increasing marginal
=W utility of
PGPSE NOTES
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Risk Seeker fair gamble
On the next slide you can see I thickened part of the horizontal
axis and the chord connecting the two points on the utility
function associated with the wealth values under the gamble.
The probabilities of the gamble could be changed (and the
gamble would no longer be fair) and the only way the person
would NOT accept the gamble over having the certain wealth
W is if the EV was less than W*.
So, risk seeker may NOTPGPSE
gamble,
NOTES
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Risk Seeker fair gamble
If the EV of a gamble is
below W* (and is no longer a
U
fair gamble, but an
unfavorable one), then the
person will end up on the
chord segment that has not
EU
been thickened and thus only
Uw then have EU<Uw.
.
X1 EV X2 W
=W
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Risk Neutral fair gamble
Say a risky option will result in 4 50% of the time and 16 50%
of the time. The expected value is 10 because
.5(4) + .5(16) = 10 and the expected utility is 3 because
.5U(4) + .5U(16) = .5(2) + .5(4) = 3.
Now, if there is an option that will pay more than 9 with
certainty, than the certain option is better. So, 9 is the certainty
equivalent of this uncertain gamble. Let’s see this on the next
slide.
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U(x)
U(16)=4
U(x)
EU = 3
U(4)=2
4 9 10 16 x
EV =p1Y1 + p2Y2
EU = p1U(y1) + p2U(Y2)
U(Y2)
EU
U(Y1)
Y
Y1 EMV Y2
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Say we have a risk avoider and the gamble G
leavesY1 p1 % of the time and Y2 p2% of the
U time.
Y
Y1 EMV Y2
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On the last few slides I show you generic cases of a risk lover and
a risk avoider. You see a gamble with monetary values Y1 and
Y2, with associated probabilities p1 and p2 (where p2 = 1- p1).
I now want to show something we saw in the previous section, but
I want to be more precise in my language.
Sometimes we may have an opportunity that is known with
certainty. The utility of the opportunity will be on the utility
function for the individual and will be noted U(C).
The decision rule for choosing between a gamble and a certain
payoff is
-choose the certain option when U(C) > E[U(G)], and
-choose the gamble when U(C) < E[U(G)].
Of course, when the two arePGPSE
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Back on the slides I have some vertical dashed lines. I put them
there on purpose. I want you to think of the location as values of
a certain payoff, I now call C, and then we can see that
U(C) = EU. The payoff C is called the certainty equivalent of the
gamble.
Y
Y1 C EV Y2
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A Gamble of no fire insurance Say Y2 is value of property if
no fire and Y1 is the value of
U the property with a fire.
The EV = p1Y1 + p2Y2.
EU = p1u(Y1) + p2U(Y2)
U(Y2)
EU C is the certainty
U(Y1) equivalent of the
gamble.
Y
Y1 C EV Y2
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If a person buys insurance it changes the risky situation
into a certain situation.
If Y2 - C = fee paid for insurance the individual will have C
with certainty. To see this we note
If no fire the individual has Y2 - fee = C, and
If fire the individual gets restored to Y2 and has still paid
the fee so the certain property value is C.
SOOOOOO
Y2 - C is really the maximum fee the person would pay
for insurance and they would like to pay less. Y2 – C is
called the reservation price for insurance.
Y1 C EMV Y2
Y
situation with
information
Y
Y1’ c’ EMV’ Y2
Now, let’s say the row player picks up and the column player
picks left.
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Column player
left right
Row up a, A c, C
Player down b, B d, D
Now, let’s say the row player picks up and the column player
picks left just as an example to see what each would get.
If the game ended at up, left, the row player would get “a” and
the column player would get “A.”
Note all these letters usually are dollar amounts for us and can be
negative amounts. But, sometimes the letters represent other
concepts besides dollars. As an example the numbers could
represent jail time.
If the game ended at down, right, the row player would get “d”
and the column player would get “D.”
Caution: If as ROW Player you pick down thinking you get “b”
remember that what you get is also influenced by Column Player.
So, you could actually get “d” if the Column Player picks right.
Next we want to think about how each player should decide what
strategy to pick.
column player
left right
Row up 10, 20 15, 8
Player down -10, 7 10, 10
This is the same slide as before, but the column player looks at
his possibilities in each row.
column player
low price high price
Row low price 0, 0 50, -10
Player high price -10, 50 10, 10
column player
ad no ad
Row ad 4, 4 20, 1
Player no ad 1, 20 10, 10
x (usually we put Q)
Q1 Q2
(r t)
For the next few slides let’s just think about the
budget line and not about consumer utility
maximization.
y1
a
x
x1 x2
When we look at several consumer optimum points at
various levels of income and then trace out the points
with a line we get the income consumption path. Here
both goods are normal goods. Would the income
consumption path be downward sloping if only one of
PGPSE NOTES 173
the goods were inferior?
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y
Engel curve - normal good
income
I2
y1 I1
a
x x
x1 x2 x1 x2
In the right hand picture we can see an income
increase and from the left graph we take the new
x, x2, and draw it in with the new income level.
The Engel curve for a normal good is upward
sloping. What about for an inferior good?
PGPSE NOTES 174
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Budget Today or
Tomorrow
paid
back + Endowment
interest point (M1, M2)
Pay
back +
interest
C today
Lend today Borrow C1
PGPSE NOTES 177177
today
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Budget Line
C today
Thus,
1) If C1 = 0, C2 = M2 + M1(1 + r). This is the vertical
intercept.
2) If C2 = 0, 0 = M2 + M1(1 + r) – (1 + r)C1, or
C1 = M1 + M2[1/(1 + r)]. This is the horizontal intercept and
is called the present value of lifetime income.
C today
C tom.
Endowment point n
m
We have seen in the past that as the interest rate falls the
budget line becomes flatter. At the highest interest rate in the
example on the previous screen, we see the individual go to
point l (and is actually a lender.) This point has a certain
amount of C today involved (as well as a certain of C tom.)
As the interest rate falls the consumer moves to point m and
then point n. So the amount of current consumption rises as
the interest rate falls.
The point here is that the demand for current consumption is a
function of the interest rate. In fact, we say as the interest rate
falls the quantity demanded for current consumption rises.
PGPSE NOTES 195195
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Change in the interest rate
(0, 2250)
(1000, 1000)
(1800, 0)
c1
(1400, 1000)
(1000, 1000)
(2200, 0)
(1800, 0)
c1
(1400, 1000)
(1000, 1000)
(2200, 0)
(1800, 0)
c1
A
(1400, 1000)
(1000, 1000)
(2200, 0)
(1800, 0)
c1
On the next screen let’s put the information into a graph. The graph will have the
quantity of steak on the horizontal axis and the amount of potatoes on the
vertical axis. Each line in the table is represented by a point in the graph.
Note the amount spent on good X is the price of X times the quantity of X taken.
5,5
4 6, 4
7,3
2 8,2
9,1
0 10,0 Then as we go down the table
0 2 4 6 8 10 12 we move up the line in the
graph.
P o u n d s o f S te a k
6
4
2
0 When the individual gives up a
0 5 10 15 20 25 steak only half a potato can be
P o u n d s o f S te a k purchased. But here the same
type of comparison would
happen as before. In other
words, the 20th steak would be
given up if the utility of the first
half of potato is bigger than the
utility of the 20th steak.
PGPSE NOTES 212
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At this point in our study I hope you can accept on faith that in economics we
get the feeling that as the price of something falls people want a greater
quantity of it.
Before, when the price of steak is $1 we saw the demand from each of the
three people as
Sally – 4, Sammy – 6 and Billy – 7. So when the price is 50 cents, the demand
might be
Sally – 5, Sammy – 7 and Billy – 8.
Know, I have asked you to accept on faith that as the price of something falls a
greater quantity is demanded. Some ideas called the income effect of a price
change and the substitution effect of a price change provide some of the
reasoning for what I asked you to accept on faith.
Let’s think about a price decline. The logic behind the income effect of a price
decline is that if you buy the same amount of the good after the price decline as
you did before the price decline then you will have more money left in your
pocket. The price decline would make it seem like you got a raise in income –
hence why I wrote an income effect. Now, in the real world we might buy more
of a good if our income rises, but maybe we will buy less. It depends on the
good.
PGPSE NOTES 213
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An inferior good is one that as we get more income we want less of the good.
Do you have a good like this for you? What about cassette tapes for music?
Have you desired less when you have gotten more income? Or what about
white bread? Have you desired more of the other kinds and less white bread the
more income you have obtained? If so, these goods are inferior for you.
A normal good is one where as you get more income you want more of the good.
Maybe CD’s for music and rye bread are normal for you.
Review something: Before I mentioned that as the price of good falls I want you
to accept on faith that the amount people want will increase. Now the income
effect of a price decline says the amount will increase if the good is normal but
will decline if the good is inferior. What is the deal on the inferior good? Well I
need to mention the substitution effect.
It is thought that as the price of a good falls we will want more of it and use it as a
substitute for other things. As an example of this, as the price of gas falls we will
buy more gas to drive around instead of walking of riding our bike. (To walk or
ride your bike you need energy that comes from food, so the gas can substitute
for the food, the cheaper the gas.) So the substitution effect always says take
more when the price falls.
0.50
Quantity of steak
4 5
Market Q
In a market, consumers as a group are thought to
want to buy a greater quantity the lower the
price. We see this as a downward sloping
demand curve.
p* P=MR=D
D
Market Q Firm Q
In a competitive market, the market demand from
consumers interacts with market supply from many
sellers and we get an equilibrium price, like p* in the
graph. At this point, since any one firm is a small part
of the market, when we look at a firm it is a price
taker. Thus, when the firm thinks about selling
another unit it can sell that unit at the same price as
PGPSE NOTES 221
the previous unit andwww.afterschoool.tk
thus MR = P for a competitive
Analogy: To think about the marginal revenue for a competitive
firm I like to think about a pop machine. Say the price of a pop is
$1.25.
Say the machine has been refilled and the pops are not chilled to
perfection and you are the first one to make a purchase. What is
the total revenue in the machine after you make your purchase?
$1.25! Since the total revenue was zero before you bought, the
change in total revenue from the sale of another unit (in this case
the first one), was $1.25. This is exactly what we mean by
marginal revenue. Marginal revenue is the change in total revenue
from changing output by 1 unit.
Now say I buy a pop right after you. The total revenue in the
machine is 1.25(2) = 2.50 and the marginal revenue is 1.25.
SO, MR = P for a competitive firm.
PGPSE NOTES 222
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Monopoly
For a monopoly firm the demand is the same as the
market demand we see in competition. The demand
downward sloping to the right, what is called less than
perfectly elastic.
2 3 Market Q
Here the monopoly is the only firm in the market.
When the price is 6, in this example the
consumers want 2 units. Total revenue would be
12. But, this firm, if it wants to sell 3 units has to
lower the price on all units to 5. The competitive
firm didn’t have to worry about another price like
the monopoly firm.PGPSE NOTES 226
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Monopoly – marginal revenue
So, because the way consumers are in this
example on the previous screen, when P = 6, 2
units will be sold and when the P = 5, 3 units will
be sold. Total revenue would move from 12 to 15
when the quantity moves from 2 to 3.
MR = c - a = 5 - 2 = 3
TR = P Q = .1(20) = 2
TC = ATC Q = .12(20) = 2.4
Profit = TR – TC = 2 – 2.4 = - .4
Or
Profit = (P – ATC)Q = (1 - .12)20 = -.4 The firm
is losing money. PGPSE NOTES 240
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continue 2
If the AVC curve is AVC2 for the firm then at Q = 20 the AVC = .
08. This means the TVC = AVC Q = .08(20) = 1.6.
Thus the TR = 2 can cover the 1.6 of TVC and what is left of TR, .
4 can go to paying some of the total fixed costs. If the firm shuts
down it would have nothing going to fixed cost. So the firm should
operate.
Thus, operate if at the Q where MR = MC the P > AVC.
Note if the AVC is AVC 1 = .11 the P < AVC. The firm should
shut down. TR of 2 falls short of TVC of 2.2 and covers none of
fixed while if the firm shuts down it only has to cover the fixed
cost.
PGPSE NOTES 241
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Quiz
$
1 – not a real quiz
MC
Is this monopoly firm
earning a profit? If so
ATC draw in the graph the
P*
rectangle that
represents the profit.
D
Q*
MR
Pc
Q
Qc
The graph
reproduced
a b
Pm
c d e
Pc
f g
h
Q
Qm Qc
PGPSE NOTES 253
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Referring to the previous slide:
comp monop
con surp abcde ab
Prod surp fgh cdfg
So, consumers lose surplus of b, c, and e due to
monopoly. Producers gain c and d from the
consumers, but lose h.
Overall, there is a deadweight loss of e and h. This
loss is a major reason why we have laws against
monopoly. The Sherman Act of 1890 is the first
law in US to be against monopoly. We have had
revisions since, but basically this law is the driving
force. PGPSE NOTES 254
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Problems of monopoly
The problems of monopoly are higher price and less
output than in competition. Moreover,
1) The higher price means those who still buy have
less money to spend on other things – c and d are
surplus areas that consumer used to have for other
things but now pays to monopoly.
MC
AC
MC
AC
Profit
rectangle
Q
Q*
firm PGPSE NOTES 258
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Here, where MR = MC, the P = AC so profit would be zero. Remember that
zero profit means that accounting profit is greater than zero if there are some
opportunity costs that are not explicit. Since at this price the firm breaks even
we say the price here is the break-even price. So when MR = MC if P = AC,
the price is called the break-even price.
Note when MC =
$ AC, AC is at its
lowest. Now at
MC break-even point, P
AC = MC and P = AC,
so MC = AC.
Q
Q*
firm PGPSE NOTES 259
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Here, where MR = MC, the P < AC so profit would be negative. Firms would be
better off exiting the industry.
$ The loss
MC
AC
Q
Q*
firm PGPSE NOTES 260
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The MC curve above the AC curve is the supply curve for the firm in the long
run. If the price line comes through at any point in this area the firm will have
positive profit and the quantity supplied will correspond with the amount on the
MC curve. If the price is any lower the firm will exit and make nothing.
MC
AC
Q
Q*
firm PGPSE NOTES 261
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Let’s look at an example next.
Quantity TC MC AC P Q TR TC Profit
1 10 2 10
2 15 5 7.5
3 21 6 7
4 28 7 7
5 37 9 7.40
6 48 11 8
Here is an example of Floyd’s Barbershop. Floyd operates in a
competitive environment. If he didn’t have a barbershop he
would make 8 bucks at a gas station. This cost has been
factored into his TC. So, really at Q=0 TC=8 at the
barbershop. MC = change in TC divided by change in Q,
while AC = TC/Q. PGPSE NOTES 262
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Quantity TC MC AC P Q TR TC Profit
1 10 2 10 2 1
2 15 5 7.5
3 21 6 7
4 28 7 7
5 37 9 7.40
6 48 11 8
Here I added the TR for the Q=1 by taking the P times Q. Can
you fill in the rest of table? (SURE you can, because, dang it,
you are good enough!)
MC
AC
10 Profit=-8
2 P
Q
1
firm PGPSE NOTES 266
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Profits and losses
In a competitive industry it is felt the existence of profits at the
firm level will attract more firms into the industry.
This will increase supply and lower price in the market.
With a lower price firm level profit falls.
The existence of losses at the firm level will make some firms
leave the market.
This will decrease supply and raise market price.
The entry and exit of firms will stop when profit is zero. At that
point P = MC = AC.
P1 P=MR1
Q q
Q1 q1
Market Firm
PGPSE NOTES 271
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Hey, check this out.
Profit = TR – TC.
PQ = TR
ATC times Q = (TC/Q) times Q = TC
D1 S1 ATC1 MC1
P2 P2 =
MR2
P1 P1=MR1
Q q
Q1 q1
Market q2
Firm
PGPSE NOTES 275
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demand increase
In the short run when the demand increases,
existing firms find it worthwhile to produce more,
but they can not expand the production facility,
by definition, and other firms can not enter the
industry.
The profit that exists in the short run are enjoyed
by the firms in the industry. But in the long run
other firms can enter the industry, as well as have
existing firms expand their production facility. In
the long run we want to note
1) what impact profit has on firms and
2) what happens to input prices.
PGPSE NOTES 276
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profit impact
In the long run positive economic profit attracts
firms to the industry. Firms will enter the
industry until profit is driven to zero.
The presence of economic losses(negative
profits) forces some firms to leave the market.
Firms will exit until the profit is zero.
D1 S1 S2 ATC1 MC1
P2 P2 =
MR2
P1 P1=MR1
Q q
Q1 Q2 q1
Market q2
Firm
PGPSE NOTES 280
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no change in input prices
Since there is no change in input prices in this
example profit will again be zero when the supply
shifts out as far as the new demand to return the
price to P1.
D1 S1 S2 ATC1 MC1
P2 P2 =
MR2
P1 P1=MR1
Q q
Q1 Q2 q1
Market q2 Firm
long run supply
PGPSE NOTES 283
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Summary
In a constant cost industry in the long run
1) The supply curve in the industry is horizontal,
2) The supply curve is horizontal at the break-even price,
3) Each firm makes the amount where MR = MC, and P = AC.
Now,
Since MR = P for firms in comp., we also conclude
P = MC and since at break-even MC =AC, P = AC.
SO, P = MR = MC = AC at the profit maximizing level of output
for each firm in the industry.
Short Run
Perfect competition
Perfect competition is a type of market defined by:
1) All firms selling essentially the same product. The
product of one firm would be a perfect substitute for the
product of another firm.
2) All firms are price takers. No individual firm can have an
influence on the market price based on how much the one
firm produces. This usually occurs when there are a large
number of firms in a market (or industry), but may happen
with relatively few firms.
(two more conditions)
PGPSE NOTES 294
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Perfect competition
The firm in the short run has some inputs that are
fixed and some that are variable. The firm just
accepts the market price.
With this in mind the firms has to decide how much
output to sell to maximize profit.
Example: You can probably buy a 20 Mt. Dew at 10
places or so in Wayne and the price is basically
1.25, right? So the market for Mt. Dew is roughly
perfectly competitive and each store has to decide
how much to sell (which means they have to decide
how much to stock on any given day).
PGPSE NOTES 297
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Totals in a graph
TR
$ TC
If you plot the TR
and TC curves the
Q that gives the
greatest distance
Q between TR and TC
Q* is the profit max
level of output,
Profit here Q*.
Next let’s turn to
unit cost and price
Q concepts.
Q* PGPSE NOTES 298
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Revenue potential
The market demand curve is downward sloping - in
the whole market consumers will buy more at lower
prices.
But, let’s say for any one firm the demand curve for
the firm’s output is horizontal. Why? Any one
seller is small relative to the market. 1) If the
seller tries to charge a price higher than the market
price no one will buy from them(because there are
enough other places to buy), and
2) The seller will not charge a lower price because
they can sell all they want at the going price. The
reason for this is because
PGPSE NOTES they
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are a small part of
299
Revenue potential
P P
P1 d=P
D
Q
market Q
Firm
P
AVC
Q or units
If the price the firm accepts is above the AVC, then
the MC curve acts as the line that shows the price,
quantity relations we previously mentioned. The
MC curve above the AVC is the supply curve of the
PGPSE NOTES 313
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Summary
A competitive firm will produce the Q where MR = MC, or, what
is the same thing, P = MC, so long as at this Q the P > AVC.
The supply curve for the firm in this environment is the part of
the MC curve above the AVC curve.
$/unit MC
AC The firm is a price
P a MR
taker - say it
b AVC takes P
This firm should
operate where
c MR = MC and
Q or units make
Q1 a positive profit
If firm operates if it shuts down
TR = a + b + c TR = 0
TC = b + c TC = TFC = b
profit = a profit = -b.
PGPSE NOTES 316
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Profit
I copied the slide form a previous set of notes. Recall we said the firm should
produce the Q where MR = MC and have profit = (P – AC)Q.
Well PROFIT = TR – TC = P(Q) – TC(Q/Q) = (P – (TC/Q))Q = (P – AC)Q.
At the Q in the graph on the previous screen rectangle a has area (P – AC)Q.
This is the profit amount.
P1 P=MR1
=30
Q q
Q1=500 Q1=10
Market
PGPSE NOTES 325
Firm www.afterschoool.tk
Here we have the industry P and Q where S=D and the firm output
level q where MR = MC, or we could say P = MC since P=MR.
(presumably the firms MC are above AVC, so we have profit max
P positions.)
S MC = S
P=D =MR
= AR
Water level
Water level
Water level
Water level
Water level
P=D =MR
= AR
Q Q1 Q Q2 Q
Market – scale Firm 1 Firm 2
is larger than
each firm So price + something minus price =
something.
PGPSEMaking
NOTES firms change from what 337
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they want makes cost of market output rise.
Producer Surplus
When producers sell products in
the market they may receive more
than the amount they needed to
receive to supply a unit – they
receive producer surplus.
producer surplus
Recall that the supply curve shows various
prices and associated quantities producers
would make available for sale.
The amount they need to receive to induce them
to make available for sale units of a product are
located on the supply curve. In fact the law of
supply is an expression that they need to
receive more in order to make available
additional units.
P1 c d e Q
1 2
PGPSE NOTES 340
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need to receive
On the previous slide we see that to get 1 unit supplied P1 was
need. P1 times 1 = P1 and is the area of the rectangle made up
of C and D. This is the amount needed to supply the first unit.
If we ignore area c we could say the area under the supply up
to 1 unit is the amount needed to get that unit supplied. You
see the area under the curve is an under-estimate of the
amount needed but it makes life easy in terms of a visual look.
Similarly area b + e = P2, the amount needed to have the
second unit supplied. If you ignore b we have just the area
under the curve.
The area under the supply curve out to a quantity is the
amount needed to supply those units.
PGPSE NOTES 341
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Producer surplus
P
With S & D we get P = 10 and
Q = 300
25 Area A = .5(300)(10 - 4)
=900
Area A + B = 10(300)
10 = 3000
A
B Area B = A + B – A
4 = 2100
300 Q
P1
B
C D
Q
Q1
PGPSE NOTES 346
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On the previous slide we see that consumer surplus plus producer
surplus equals the area A + B, and this is the result of the market
equilibrium P1 and Q1.
Inside your own head can you tell if you are willing to pay more
for good x over good y? I would say you can because you can
determine what you like!
As you compare two people can you tell who is willing to pay
more for good x? This is harder, but we think the demand curve
orders units in such a way that the first unit is demanded by the
person who values it most in terms of their willingness to pay for
it. The market price cuts off people who value the good less than
those who value it more and thus the units of the good produced
go to the people who value it most.
e
P1 h g
B
C D
Q
qless Q1 quamore
PGPSE NOTES 349
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Another way to think about efficiency is the total amount of
consumer and producer surplus together.
The total surplus is less when output is less than the market
outcome at Q1, like at qless. Here we would see surplus fall by
area e + h.
If output is higher than Q1, like at quamore, then we force on the
market units of the good that costs more to make than people are
willing to pay to get. This is not good.
Summary
A competitive market is most efficient because we get the most
total surplus out of it.
C U3
A B
U2
U1
X
L M N
P1
P2
P3
x
(quantity
of x)
Demand of consumer
10
and MRd1
9
8
7
6
5
MC = 4 and
special case of
4
competitive
supply
Q
1 2 3 4 5 6 7
PGPSE NOTES 364
MRs
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On the previous screen we see the demand in the market. If
the market was competitive we know the MR = MC output
level is 7 because MR = P and P = MC cost at Q = 7.
Consumer surplus would be the large triangle formed by the
vertical axis, then horizontal line a $4 and the demand line.
If the market was single price monopoly we would use the
MRs line and the Q where MR = MC would be at 4 and the
price on the demand curve is 7. The consumer surplus falls to
a smaller triangle than the one before, here we have the
horizontal line at 7 as the base of the triangle. The monopoly
takes the consumer surplus that would have existed had the
market been competitive.
MC
D2
D1
MR2
MKT 1 MR1 MKT2 firm level
analysis MR
PGPSE NOTES 370
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3 degree
rd
4) surplus = Qs - Qd.
4) shortage = Qd - Qs.
Labor
PGPSE NOTES 390390
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Short run/long run
The notion of a fixed or variable input is related to
the time frame of production.
The short run is that period of time when at least
one input is fixed in amount.
The long run is that period of time in which all
inputs are variable.
As an example of this consider fast food in
Wayne. About any store in town could remodel
and increase floor space in about 3 months. So
after 3 months we have the long run, all inputs
can vary - even floor space. But less than three
months is the short run because there is only so
much floor space PGPSE
to use.
NOTES 391
391
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example Say Q = 2KL. In short
run say K=1.
K=1
Q=6
Q=4
Q=2
Labor
1 2 3 and so on
PGPSE NOTES 392392
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Short run production function
Units of Typically in the short run we
output Q use the graph here instead of
the previous one. We put the
variable input on the horizontal
axis and the output amount on
the horizontal axis. Implicitly
we have the capital amount
fixed at a level when we draw
the short run production
function.
Labor
amount
PGPSE NOTES 393393
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Short run production function
example Q = 2KL
Units of If K = 1 we have the production
output Q function Q = 2L. Some points
would be if L = 1 Q = 2,
If L=2, Q=4 and so on. The
graph is on the left here
4
2
12 Labor
amount
PGPSE NOTES 394394
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Short run Production example
Q = sqrt(KL) when K = 4
Labor
amount
PGPSE NOTES 396396
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Malthus and diminishing returns
T P or Q M ar g in a l P ro d u c t a n d Av e r a g e
P roduct
2500
2000 400
300
Total Product of Output
1500
200
MP and AP
1000
500 100
0 0
0 5 10 15 -1 0 0 0 5 10 15
Q u a n tity o f L a b o r Q u a n tity o f L a b o r
APL curve
PGPSE NOTES 401401
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Notes about MPL and APL
Note
1)When the MPL is above the APL the APL rises.
2)When the MPL is below the APL the APL falls.
3)The APL continues to rise while the MPL is falling
only when the MPL is above the APL.
L1
Labor
amount
PGPSE NOTES 405405
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MPL from the graph of TP
In the long run all inputs can be varied. On the next slide you
see what we call an isoquant. Along the curve the amount of
output is the same, but we have different combinations of K
and L.
Again say Q = 2KL. To get one isoquant you pick a level of
output. Say we pick Q = 100. Then we have
100 = 2KL. Since capital is on the vertical axis we might re-
express this function as
K = 100/2L = 50/L. If L = 1 K =50 to get Q = 100. If L = 2 K
= 25 to get Q = 100. Isoquants have properties similar to
indifference curves for consumers.
PGPSE NOTES
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408408
Marginal Rate of Technical
Substitution - MRTS
Capital
Change in K
slope =
Change in L
Labor
The MRTS = absolute value of the slope.
PGPSE NOTES 409409
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MRTS
0 0
1 5 5 5
2 12 7 6
3 21 9 7
4 28 7 7
5 33 5 6.6
6 36 3 6
7 37 1 5.285714
PGPSE NOTES 419
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example continued
In the example, the relationship between the
labor used and the total product (TP) is called the
short run production function. Behind the scenes
we assume there is a given amount of capital.
The marginal product of labor is the additional
output forthcoming from the additional unit of
labor. Note the first unit of labor has a marginal
product of 5.
25
of output
20 6 MPL
MPL, APL
15 4 APL
10
2
5
0 0
0 2 4 6 8 0 2 4 6 8
U n i ts o f l a b o r g i v e n a n a m o u n t o f c a p i ta l U n i ts o f l a b o r
200 16
14
150 12
VC AVC
10
AFC
100 FC 8
AC
TC 6
50 4 MC
2
0 0
0 10 20 30 40 0 10 20 30 40
OUTPUT OUTPUT
AVC
MC
Q
Note AVC and AC equal MC when AVC and AC are
at their minimum values.
PGPSE NOTES 429
www.afterschoool.tk
When you look back at slide nine at the marginal product and
average product curves note that the horizontal axis is measuring
labor units used and the curves are inverted u-shaped curves.
When you look back at slide 14 at the marginal cost and various
average cost curves note that the horizontal axis is measuring
output units and the curves are u-shaped curves.
There is a relationship between these two graphs
S2 represents a lower
supply.
Q
S1
P1
Q
Q1
PGPSE NOTES 449
www.afterschoool.tk
excise tax
If a lump sum excise tax is imposed then the
seller still needs to get P1 for their own efforts in
order to supply Q1. This means the price in the
market will have to be P1 plus the tax to supply
Q1. Thus the supply curve shifts up by the
amount
P of the tax.
S2
P2 = S1
P1 + tax
P1
Q
Q1
PGPSE NOTES 450
www.afterschoool.tk
Something seems weird about the sales tax and the
excise tax when I compare the two.
The sales tax is paid by the consumer. So prices on
the demand curve WILL NOT include the sales tax
because consumers know after they take the item
they will also have to pay the tax to the government.
But, consumers only want to pay a certain amount for
a good or service, regardless of taxes or not.
The excise tax is paid by the producer. So prices on
the supply curve WILL include the excise tax because
after the suppliers get the money they have to send
some on to the government and the suppliers still
need to get the amount they want for the item sold.
PGPSE NOTES 451
www.afterschoool.tk
Equilibrium
Equilibrium in a market is a situation where
1) Buyers can buy all they want at the price
considered and
2) Sellers can sell all they want at the price
considered.
4) Tax = P2 + tax - P1 + P1 - P2
Amount of
Amount of increase in per unit decrease in the
pay out made by the per unit amount
consumer. seller receives.
D Q
D Q
D Q
D Q
x
(I/Px, 0)
Note on the previous screen that the slope of the budget line
is telling us about how much good x is valued in the market
in relation to good y.
This implies that the slope of the budget is indicating the
market rate of substitution of good x for good y.
The slope of the budget is the relative price of x.
good y
The amount
of good y a
consumer
may have is
measured
vertically
good x
The amount of good x is measured on the
horizontal axis.
This type of diagram is used extensively when
considering the behavior of consumers.
PGPSE NOTES 475
www.afterschoool.tk
Indifference curves - definition
y
Say the consumer is
at point A. If the
consumer gives up
B one unit of x, m units
m of y must be given
A back to hold the
consumer at a
constant level of
x utility.
Indifference Map
Every point in the graph
has one, and only one,
indifference curve
running through it.
Curves farther out from
the origin have more
utility.
x So, the consumer can
compare every bundle
and make a
determination of
preference or
PGPSE NOTESindifference. 486
www.afterschoool.tk
y Indifference curves - feature 4
y
Mr. A
Mr. B
x
Note how Mr. A has a steeper curve than Mr. B.
From the
point where the curves cross if both give up a unit
of
x, note how Mr. A has to be given more y to
make up for the loss of x than Mr. B. Mr. A is said
PGPSE NOTES 489
to have a relatively strong preference
www.afterschoool.tk for x
A math example of a utility function might be
U = sqrt(XY) – this means utility is a function of the square root of
the product of the amount of x and the amount of y a person would
get.
To get an indifference curve pick a value of U. Let’s say U = 4.
Then some points on the indifference curve would be
X Y
16 1
1 16
4 4
8 2
PGPSE NOTES 490
2 8 www.afterschoool.tk
indifference curve when U = 16
20
15 1, 16
10 y
Y
2, 8
5 4, 4
8, 2 16, 1
0
0 5 10 15 20
X
b
x
Note why b from the previous screen was not the
best
point. To give up a unit of x and maintain the
same
utility the person needed to get back a certain
amount of
y. But the market actually gives back more y
than the individual requires. This trade is
PGPSE NOTES 498
beneficial. www.afterschoool.tk
y Utility Maximization
c
x
Note why c from two screens ago was not the best
point. To take a unit of x and maintain the same
utility the person is willing to give up a certain
amount of
y. But the market actually requires the individual
to give up less. This is a beneficial trade. The
individual
would thus take the unit of x and be happier for
PGPSE NOTES 499
the www.afterschoool.tk
Utility Maximization
a b
In thec final analysis, the individual maximizes
utility when the indifference curve is tangent to
the budget line.
P
What consumers are
willing to pay for the Q1
units
Q1 Q
PGPSE NOTES 506
www.afterschoool.tk
Consumer surplus again
P Say with S & D we get the
P = 10 and Q = 300.
25 Area A = .5(300)(25-10)
=2250
A Area B = 10(300)
10 = 3000
B Note consumers would be
300 Q willing to pay 3000 +
2250
But the consumers only have for 300to pay 3000 for the
units.
300 units.
So the consumer surplus is area A and equals
2250. PGPSE NOTES
www.afterschoool.tk
507
Refresher on areas
.9305 +
1.2627
.9305
x
(I/Px, 0)
Note on the previous screen that the slope of the budget line
is telling us about how much good x is valued in the market
in relation to good y.
This implies that the slope of the budget is indicating the
market rate of substitution of good x for good y.
Remember the indifference curve slope was indicating how
much of good x a person was willing to give up to get more
of good y.
The slope of the budget is the relative price of x.
Every transaction has two sides – the buying side and the
selling side. Other names used are the consumer and producer
sides.
A market is where the consumer and the producer interact.
The consumer would like to PAY LOW PRICES (given all
else the same).
The producer would like to RECEIVE HIGH PRICES.
In every transaction there is a struggle between the desires of
producers and consumers in terms of the market price. The
market is a mechanism that balances out the two desires.
PGPSE NOTES 553
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Bargaining Power
The power that consumers and producers have over the price is
influenced by relationships that exist between
consumer and producer
consumers and other consumers, and
producer and other producers.
Let’s explore these ideas on the next few screens, OK?
Later in the course we will think about why prices turn out
the way they do, and the rivalry among producers and
consumers and among themselves will play a key role.
A topic like this is often called price theory within the
economics community because a primary concept of study is
the price of products.
Now 1 2 3 4 5 n
Now is time zero, or when the decision is made. Each
following number is an “end of period” concept. We
have the end of the first period, end of the second period
and so on until the end of the nth period.
PGPSE NOTES 560
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Interest Rate Growth
If you have $1 today and can earn an interest rate of 10% by
the end of the first year then you will have $1.10.
The$1.10 is calculated as the amount you start the period with
plus the product of what you start the period with times the
rate of interest that period.
If F is the amount at the end of the period, P is the amount at
the beginning of the period and i is the rate of interest during
the period, then in general we have
F = P + Pi = P(1 + i).
If you start out with P and wait one period at rate i we just saw
you have F = P(1 + i). Now, if you again earn i, by the end of
the second period you would have
F = P(1 + i) + P(1 + i )i (start period with + start period with times i)
= P(1 + i)(1 + i)
= P(1 + i)2.
In general, at the end of n periods, you have
F = P(1 + i)n.
MB,
MC MC
go don’t MB
amount or Q
Q*
PGPSE NOTES 573
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Activity Rule
Isoquants
Labor
PGPSE NOTES 580
www.afterschoool.tk
Marginal Rate of Technical
Substitution - MRTS
Capital
Change in K
slope =
Change in L
Labor
PGPSE NOTES 581
www.afterschoool.tk
MRTS
0 0
1 76 76 76
2 248 172 124
3 492 244 164
4 784 292 196
5 1100 316 220
6 1416 316 236
7 1708 292 244
8 1952 244 244
9 2124 172 236
10 2200 76 220
11 2156 -44 196
PGPSE NOTES 589
www.afterschoool.tk
example continued
In the example, the relationship between the
labor used and the total product (TP), or output,
is called the short run production function.
Behind the scenes we assume there is a given
amount of capital.
The marginal product of labor is the additional
output forthcoming from the additional unit of
labor. Note the first unit of labor has a marginal
product of 76.
T P or Q M ar g in a l P ro d u c t a n d Av e r a g e
P roduct
2500
2000 400
300
Total Product of Output
1500
200
MP and AP
1000
500 100
0 0
0 5 10 15 -1 0 0 0 5 10 15
Q u a n tity o f L a b o r Q u a n tity o f L a b o r
0 0 2000 0 2000
2 248 172 124 2000 800 2800 8.06 3.23 11.29 2.33
3 492 244 164 2000 1200 3200 4.07 2.44 6.5 1.64
4 784 292 196 2000 1600 3600 2.55 2.04 4.59 1.37
5 1100 316 220 2000 2000 4000 1.82 1.82 3.64 1.27
6 1416 316 236 2000 2400 4400 1.41 1.69 3.11 1.27
7 1708 292 244 2000 2800 4800 1.17 1.64 2.81 1.37
8 1952 244 244 2000 3200 5200 1.02 1.64 2.66 1.64
9 2124 172 236 2000 3600 5600 0.94 1.69 2.64 2.33
7000
6000 C o s ts p e r u n it
Dollars of Cost
5000 TFC
4000
TVC
3000 35
2000 TC
1000
30
0 25
0 1000 2000 3000
20
AVC
MC
Q
Note AVC and AC equal MC when AVC and AC are
at their minimum values.
PGPSE NOTES 600
www.afterschoool.tk
When you look back at the marginal product and average product
curves note that the horizontal axis is measuring labor units used
and the curves are inverted u-shaped curves.
When you look back at the marginal cost and various average cost
curves note that the horizontal axis is measuring output units and
the curves are u-shaped curves.
There is a relationship between these two graphs. When you move
to the right by adding labor in the one graph you are moving to the
right in the other by having output increased.
0 0 2000 0 2000
2 248 172 124 2000 800 2800 8.06 3.23 11.29 2.33 3 400 516
3 492 244 164 2000 1200 3200 4.07 2.44 6.5 1.64 3 400 732
4 784 292 196 2000 1600 3600 2.55 2.04 4.59 1.37 3 400 876
5 1100 316 220 2000 2000 4000 1.82 1.82 3.64 1.27 3 400 948
6 1416 316 236 2000 2400 4400 1.41 1.69 3.11 1.27 3 400 948
7 1708 292 244 2000 2800 4800 1.17 1.64 2.81 1.37 3 400 876
8 1952 244 244 2000 3200 5200 1.02 1.64 2.66 1.64 3 400 732
9 2124 172 236 2000 3600 5600 0.94 1.69 2.64 2.33 3 400 516
Q
Q
Market Conditions
(0, 5) (4, 2)
x
(6 2/3, 0)
TR in the market is
P1 equal to the price in
the market
multiplied by the
quantity traded in
the market. In this
Q diagram TR equals
Q1
the area of the
the horizontal and vertical axes. We know
rectangle fromby
made
math that the area of a rectangle P1, is
Q1base
andtimes
height and thus here that means P times Q. The
rectangle here is TR.
PGPSE NOTES
www.afterschoool.tk
679
Elasticity and total revenue
relationship
We will want to look at the change in values of a
variable and in order to do so we want to have a
consistent measure of change. In this regard
let’s say the change in a variable is
the later value minus the earlier
value.
x (usually we put Q)
Q1 Q2
(r t)
For the next few slides let’s just think about the
budget line and not about consumer utility
maximization.
y1
a
x
x1 x2
When we look at several consumer optimum points at
various levels of income and then trace out the points
with a line we get the income consumption path. Here
both goods are normal goods. Would the income
consumption path be downward sloping if only one of
PGPSE NOTES 707
the goods were inferior?
www.afterschoool.tk
y
Engel curve - normal good
x
x2
y1 x1
a
x income
x1 x2 I1 I2
In the right hand picture we can see an income
increase and from the left graph we take the new
x, x2, and draw it in with the new income level.
The Engel curve for a normal good is upward
sloping. What about for an inferior good?
PGPSE NOTES 708
www.afterschoool.tk
Note that the second graph on the previous slide had income on
the horizontal axis and the quantity of x on the vertical. This is
different than most graphs you have probably seen in econ.
Mrs. Engel’s boy thought this idea up – to study how changes in
income change our consumption patterns.
good y
The amount
of good y a
consumer
may have is
measured
vertically
good x
The amount of good x is measured on the
horizontal axis.
This type of diagram is used extensively when
considering the behavior of consumers.
PGPSE NOTES 712
www.afterschoool.tk
Indifference curves - definition
y
Say the consumer is
at point A. If the
consumer gives up
B one unit of x, m units
m of y must be given
A back to hold the
consumer at a
constant level of
x utility.
Indifference Map
Every point in the graph
has one, and only one,
indifference curve
running through it.
Curves farther out from
the origin have more
utility.
x So, the consumer can
compare every bundle
and make a
determination of
preference or
PGPSE NOTESindifference. 723
www.afterschoool.tk
y Indifference curves - feature 4
y
Mr. A
Mr. B
x
Note how Mr. A has a steeper curve than Mr. B.
From the
point where the curves cross if both give up a unit
of
x, note how Mr. A has to be given more y to
make up for the loss of x than Mr. B. Mr. A is said
PGPSE NOTES 726
to have a relatively strong preference
www.afterschoool.tk for x
A math example of a utility function might be
U = sqrt(XY) – this means utility is a function of the square root of
the product of the amount of x and the amount of y a person would
get.
To get an indifference curve pick a value of U. Let’s say U = 4.
Then some points on the indifference curve would be
X Y
16 1
1 16
4 4
8 2
PGPSE NOTES 727
2 8 www.afterschoool.tk
indifference curve when U = 16
20
15 1, 16
10 y
Y
2, 8
5 4, 4
8, 2 16, 1
0
0 5 10 15 20
X
income
Note how the slope
of the budget line is
(0, the negative of the
24) wage rate. For
every unit of leisure
given up, $1 would
be earned as
leisure
income.
(24, 0) slope=(change in
inc)
(change in
leis.)
PGPSE NOTES 732
www.afterschoool.tk
=1/-1= -1 =
(0, 48)
Budget constraint
income
If the wage should rise,
to say $2 per hour, the
(0, budget constraint
24) rotates clockwise. The
point on the vertical
axis now has to indicate
$48 in income if one
leisure
worked all day.
(24, 0) The slope of the new
budget is - $2.
income
(0,
24) nonlabor income
leisure
(24, 0)
If the individual has nonlabor income, the budget line
shifts
up by the amount of nonlabor income. The slope
remains
PGPSE NOTES 734
as was - rememberwww.afterschoool.tk
the slope is the negative of the
Let’s come up with the equation for the budget
constraint.
The dollar volume of income – y - we can undertake
is made up of our income from work and any
nonlabor income we have. If the wage is w, h is the
number of hours we work, and the nonlabor income
is Z, then
y = wh + Z.
70
60
50
Income
40 budget V= 0
30 budget V = 10
20
10
0
0 10 20 30
Leisure
L
Note why b from the previous screen was not the
best
point. To give up a unit of leisure and maintain
the same utility the person needed to get back a
certain amount of income. But the market
actually gives back more income than the
individual requires for the same level of utility.
This trade is beneficial. The individual would thus
PGPSE NOTES 742
give up the unit of leisure and
www.afterschoool.tk be happier for the
Utility Maximization
c
Note why c from two screens ago was not the best
point. To take a unit of leisure and maintain the
same
utility the person is willing to give up a certain
amount of
income. But the market actually requires the
individual to give up less. This is a beneficial
trade. The individual would thus take the unit743
PGPSE NOTES
of
leisure and be happier for the trade.
www.afterschoool.tk
Utility Maximization
a b
In thec final analysis, the individual maximizes
utility when the MRS=wage(this means the
indifference curve is tangent to the budget line).
Distance cb is the amount of labor this individual
would supply. Distance ad is the amount of
income they would have.
PGPSE NOTES 744
www.afterschoool.tk
At the same wage, why two people supply different amounts of
A workaholic is a person with a labor
relatively weak preference for
leisure because little income is
Note the solid line
needed to give up a unit of leisure
indiff.
curve is for the
workaholic. At the
workaholics optimal
point, the leisure lover
finds it beneficial to
take on more leisure
Note that at each persons because or their
optimal point willingness to give up
MRS=wage. much more inccom to
get more
PGPSE NOTES leisure than the 745
www.afterschoool.tkmarket
Changes in wage and the
work decision
here we explore the income and
substitution effects of a wage
change.
Change in the wage rate
labor supply
income
Say a company will only
let employees work 8 hour
days. Point a has 16
hours of leisure and thus 8
hours of work. The person
involved
b a would like less leisure, but
can not get to point b
leisure because of the employer
restriction. This implies
the worker is
underemployed.
PGPSE NOTES 762
www.afterschoool.tk
Standard workday - 8 hour shift and uoveremploymentt
4) shortage = Qd - Qs.
b
x
Note why b from the previous screen was not the
best
point. To give up a unit of x and maintain the
same
utility the person needed to get back a certain
amount of
y. But the market actually gives back more y
than the individual requires. This trade is
PGPSE NOTES 780
beneficial. www.afterschoool.tk
y Utility Maximization
c
x
Note why c from two screens ago was not the best
point. To take a unit of x and maintain the same
utility the person is willing to give up a certain
amount of
y. But the market actually requires the individual
to give up less. This is a beneficial trade. The
individual
would thus take the unit of x and be happier for
PGPSE NOTES 781
the www.afterschoool.tk
Utility Maximization
a b
In thec final analysis, the individual maximizes
utility when the indifference curve is tangent to
the budget line.
Say the cross price elasticity for Coke with respect to the
price of Pepsi is 1.7. This means for every 1% Pepsi raises
price the demand for Coke will go up 1.7%.
Say Coke exec’s hear Pepsi is going to raise price by 2.5%.
How much will Coke exec’s expect demand to rise?
1.7 = 1.7= x/2.5 or x = 1.7(2.5) or 4.25%
Note that in the long run if ATC > P (at the Q where
MR = MC) the monopoly will continue to lose money an
should in that case cease operating.
Q*
MR
P=MR=D
D
Market Q Firm Q
In a competitive market, the market demand curve
represents the demand of all consumers in the
market. At the equilibrium price in the market, the
firm must merely sell what it wants at this price.
The firm is a price taker and we say the demand for
a firm is horizontal or perfectly elastic.
PGPSE NOTES 811
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Monopoly
For a monopoly firm the demand is the same as the
market demand we see in competition. The demand
downward sloping to the right, what is called less than
perfectly elastic.
The price needed to get the 4th unit was 132, but the M
is only 102. Why the difference between P and MR? (It
wasn’t like that for the competitive firm.)
MC1 MC2
equal
Pm
MC1 MC2
MR
Q1 Q2 Q = Q1 + Q2
So, we think there is a regression line out there that expresses the
relationship between x’s and Y. We have to go find it. In fact we
take a sample and get an estimate of the regression line.
Now, for an each value of x we have data values, called Y’s, and
we have the one value of the line, called Ŷ.
This part of multiple regression is very similar to simple
regression. But our interpretation will change a little.
F
Critical F
F
4.74 here
In our example here the critical F is 4.74. If from the sample we get
an F statistic that is greater than 4.74 we would reject the null and
conclude the x’s as a package have a relationship with the variable
Y.
On the previous slide is an example and the F stat is 32.8784 and so
the null hypothesis would be rejected in that case.
F
4.74 here 32.8784
P-value
The computer printout has a number on it that means we do not even
have to look at the F table if we do not want to. But, the idea is
based on the table. Here you see 32.8784 is in the rejection region.
I have colored in the tail area for this number. Since 4.74 has a tail
area = alpha = .05 here, we know the tail area for 32.8784 must be
less than .05. This tail area is the p-value for the test stat calculated
from the sample and on the computer printout is labeled
Significance F. In the example the value is .0003.
PGPSE NOTES 852
www.afterschoool.tk
SOOOOOOO,
Using the F table,
Reject the null if the F stat > critical F in the table, or
If the Significance F < alpha.
If you can NOT reject the null then at this stage of the game there
is no relation between the x’s and the Y and our work here would
be done. So from here out I assume we have rejected the null.
t tests – After the F test we would do a t test on each of the slopes
similar to what we did in a simple linear regression case to make
sure that each variable on its own has a relationship with y. There
we reject the null of a zero slope when the p-value on the slope is
less than alpha. The t test for each regression coefficient is
equivalent to testing for the contribution of each independent
variable. PGPSE NOTES 853
www.afterschoool.tk
Multicollinearity
Can you say multicollinearity? Sure you can. Let’s all say it
together on the count of 3. 1, 2, 3 multicollinearity! Very good
class, now listen up!
Multicollinearity is an idea that volumes have been written
about. We want to have a basic feel for the problem here.
You and I want x variables that help explain Y. The reason is so
that we can predict and explain movement in Y. As an example,
if we can predict and explain crop yield maybe we can make
yield higher so that we can feed the world!
So, we want x’s that are correlated with Y. This is a good thing.
But, sometimes the x’s will be correlated with each other. This
is called multicollinearity. The problem here is that sometimes
we can not see the separatePGPSE
influence
NOTES
an x has on Y because the854
other x’s have picked up the influence due to their correlation.
www.afterschoool.tk
From a practical point of view multicollinearity could have the
following affect on your research. You reject the null hypothesis
of no relationship between all the x variables and Y with the F test,
but you can not reject some or all of the separate t tests for the
separate slopes. Don’t freak out (yet!).
Let’s think about crop yield. Some farmers have water systems.
The more it rains in a summer the less water the farmers directly
apply. (Okay, maybe I am ignorant here and farmers here can use
all the water they can apply – its an example.) If you included
both inches of rain and water applied there is a correlation between
the two. This may make it difficult to see the separate impact of
either the rain or the water from the system.
If the x’s (the independent variables) have correlations more
extreme than .7 or -.7 then multicollinearity could be a problem
PGPSE NOTES 855
www.afterschoool.tk
PGPSE NOTES 856
www.afterschoool.tk
Problem 4 page 471, problem 14
page 476 and 26 on page 481
On the previous slide I have an Excel printout.
a)The model for the problem is
Cost = Bo + B1(sales) + B2(# of orders) + e and the estimates line
is Ŷ = -2.728 + 0.0471X1 + 0.0119X2.
b) For each unit increase in sales, the mean value of Y
increases by 0.0471, holding constant the # of orders. For
each unit increase in# of orders, the mean value of Y
increases by 0.0119, holding constant the value of sales.
c) While the value for bo = -2.728 we really do not look at it for
much meaning because in the data there are no sales values = 0
and no # of orders = 0. This is like extrapolation we saw before –
PGPSE NOTES 857
this is risky to interpret outside the range of the values of the x’s.
www.afterschoool.tk
d) To predict we use Ŷ = -2.728 + 0.0471X1 + 0.0119X2 and note
the data for sales use 400 because data is in thousands. So, we have
Ŷ = -2.728 + .0471(400) + .0119(4500) = 69.662.
(Not doing e and f)
Prob 14
F
Critical F
F
4.74 here
In our example here the critical F is 4.74. If from the sample we get
an F statistic that is greater than 4.74 we would reject the null and
conclude the x’s as a package have a relationship with the variable
y.
On the previous slide is an example and the F stat is 32.8784 and so
the null hypothesis would be rejected in that case.
F
4.74 here 32.8784
P-value
The computer printout has a number on it that means we do not even
have to look at the F table if we do not want to. But, the idea is
based on the table. Here you see 32.8784 is in the rejection region.
I have colored in the tail area for this number. Since 4.74 has a tail
area = alpha = .05 here, we know the tail area for 32.8784 must be
less than .05. This tail area is the p-value for the test stat calculated
from the sample and on the computer printout is labeled
Significance F. In the example the value is .0003.
PGPSE NOTES 868
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SOOOOOOO,
Using the F table,
Reject the null if the F stat > critical F in the table, or
If the Significance F < alpha.
If you can NOT reject the null then at this stage of the game there
is no relation between the x’s and the y and our work here would
be done. So from here out I assume we have rejected the null.
T tests
After the F test we would do a t test on each of the slopes similar
to what we did in a simple linear regression case to make sure that
each variable on its own has a relationship with y. There we reject
the null of a zero slope when the p-value on the slope is less than
alpha.
PGPSE NOTES 869
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Multicollinearity
Can you say multicollinearity? Sure you can. Let’s all say it
together on the count of 3. 1, 2, 3 multicollinearity! Very good
class, now listen up!
Multicollinearity is an idea that volumes have been written
about. We want to have a basic feel for the problem here.
You and I want x variables that help explain y. The reason is so
that we can predict and explain movement in y. As an example,
if we can predict and explain crop yield maybe we can make
yield higher so that we can feed the world!
So, we want x’s that are correlated with y. This is a good thing.
But, sometimes the x’s will be correlated with each other. This
is called multicollinearity. The problem here is that sometimes
we can not see the separatePGPSE
influence
NOTES
an x has on y because the870
other x’s have picked up the influence due to their correlation.
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From a practical point of view multicollinearity could have the
following affect on your research. You reject the null hypothesis
of no relationship between all the x variables and y with the F test,
but you can not reject some or all of the separate t tests for the
separate slopes. Don’t freak out (yet!).
Let’s think about crop yield. Some farmers have water systems.
The more it rains in a summer the less water the farmers directly
apply. (Okay, maybe I am ignorant here and farmers here can use
all the water they can apply – its an example.) If you included
both inches of rain and water applied there is a correlation between
the two. This may make it difficult to see the separate impact of
either the rain or the water from the system.
If the x’s (the independent variables) have correlations more
extreme than .7 or -.7 then multicollinearity could be a problem
PGPSE NOTES 871
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r square
r square on the regression printout is a measure designed to
indicate the strength of the impact of the x’s on y. The number
can be between 0 and 1, with values closer to 1 meaning the
stronger the relationship.
r square is actually the percentage of the variation in y that is
accounted for by the x variables. This is also an important idea
because although we may have a significant relationship we may
not be explaining much. From the yield example the more
variation we can explain then the more we can control yield and
thus feed the world, perhaps. Or maybe in business setting the
more variation we can explain the more profit we can make.
4) surplus = Qs - Qd.
$
90
30
Total demand
Q
This
height is
called the x
intercept.
Here I show three different lines with the same
intercept. But, different lines could have different
intercepts. Intercepts can even be negative.
PGPSE NOTES 894
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y 2 Say we move from a dot
1 one unit away in the x
The dot direction. The slope
on the then tells us how far we
line is have to go in the y
represented ? direction to get back to
by an x 1 the line.
value and
a y value.
3 x
Note on the upward sloping (to the right) curve when we went over to
the right on x we have to go up on the y variable. On the flat line we
wouldn’t move in the y direction at all, and on the downward sloping
line we would move down toPGPSE
the line.
NOTES 895
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Now, in algebra, we might have a specific line with the form
y = 60 + 5x. Then we can say, when
x= y=
0 60
1 65
2 70
3 75 and so on. In algebra every point fits exactly on the
line.
Sales in $1000's
9 22 149
100
10 26 202
50
Now, for an each value of x we have data values, called y’s, and
we have the one value of the line, called y hat.
X x
0 .8
passengers
c o m p la i n ts
0 .6
0 .4
0 .2
0
65 70 75 80 85
% o n t im e
The scatterplot suggests higher the % on time the lower the number of
complaints per 100,000 passengers.
PGPSE NOTES 920
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SUMMARY OUTPUT
Regression Statistics
Multiple R 0.882607408
R Square 0.778995837
Adjusted R Square 0.747423814
Standard Error 0.160817904
Observations 9
ANOVA
df SS MS F Significance F
Regression 1 0.638118768 0.638118768 24.67361157 0.001624211
Residual 7 0.181036788 0.025862398
Total 8 0.819155556
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
For the Input y range put b1:b6, the cells the data is in.
(y is the dependent variable – the variable I am most interested
in understanding.)
For the Input x range put a1:a6.
(x is the variable we think will help us predict and explain y.)
Check labels box. (Only check the labels box if you have a label
in the data set like I do.)
Check output range and a9 in open box. (I like to have the output
next to the data set. You can go to a new worksheet if you
want.)
PGPSE NOTES 931
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When you say ok to the regression dialog box Excel will do its
thing and have the results highlighted. Keep the results highlighted,
but you will need to adjust the column widths to be able to read the
output. Open the Format menu, choose ‘column’ and select ‘autofit
selection.’
If you print the results you may want to change the page to
landscape.
Sometimes in the output you will see a number followed by E and
some other stuff. E-06 means take the number given and move the
decimal place six places to the left. Similarly, E+06 means move
the decimal 6 places to the right.
Highest
temperature on the
day
PGPSE NOTES
Day of 939
JFMAMJJAS the year
Owww.afterschoool.tk
ND
Notes about graph:
1) The long term we see the highest temperature occurred
sometime in July or August.
2) When you look at any three or four day period (a shorter
time frame than the whole year) you see ups and downs of
the highest temperature.
Why does the highest temperature each day follow the
pattern I have shown?
The accepted answer comes from the science areas of
astronomy and physics. In these sciences there are
theories about how the earth is tilted and how it rotates
around the sun. These ideas provide us with our
understanding of the pattern of daily high temperatures.
Quantity, Q
Quantity, Q
Quantity, Q
D2
D1
Quantity, Q
D2
1) Note here that when the D1
demand shifted we would
say it shifted because of a
change in demand Quantity, Q
But, If the price was lower than P1 you see there would be
movement down the demand curve. Some folks would say
that since they do not have to give up as much other stuff
to get more units here, they are happy to demand a greater
quantity.
So, the price of the product is a major determinant of how
much of a product consumers want. But there are other
PGPSE NOTES 950
things that have an influence as well.
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P
A few slides back I mentioned
that we need to pay attention to
P1
the position or location of the
demand curve and that maybe
the location could change.
D
Q1 Q
What I now want to make explicit is that Q1 was
demanded at P1 with the understanding that other things
that influence demand are held constant. If these other
things should change then at P1 the amount people want
could change and the demand would shift.
Let’s go back to our CD example. We said if the price
was P1 folks would demand Q1 units. But, if people get
more income it is likely they can afford more things and
PGPSE NOTES 951
thus the demand for CD’s would shift to the right.
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So, on the previous slide we see the demand curve would
shift right when a people’s income would go up. Similarly we
would expect the demand curve would shift left if people’s
income should fall.
People’s income is a factor that leads the demand curve to
be in a certain location. This means if income should
change the demand curve will shift to a new location.
Other factors that lead to a shift in the demand include the
price of related goods, consumer taste and preference, and
the number of consumers in the market.
On the next slide is a table that will list how the demand
curve will shift given a change in a factor of demand. Note
the table does not include the price of the product itself. If
the price changes there is a movement along the demand
curve and we say there isPGPSE
a change
NOTES
in the quantity 952
demanded. www.afterschoool.tk
Factor of demand change demand shifts to
Income increase for normal good right
Income decrease for normal good left
Income increase for inferior good left
Income decrease for inferior good right
Complementary good price increase left
Complementary good price decrease right
Substitute good price increase right
Substitute good price decrease left
Increase in consumers in market right
Decrease in consumers in market left
But, If the price was higher than P1 you see there would be
movement up the supply curve. Some producers would
say that since they get more for producing this item they
give up doing other stuff and they are happy to supply a
greater quantity of this good.
So, the price of the product is a major determinant of how
much of a product producers want to make. But there are
other things that have anPGPSE
influence
NOTES as well. 956
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P
A few slides back I mentioned
that we need to pay attention to
the position or location of the S
supply curve and that maybe the P1
location could change. What I
now want to make explicit is that
Q1 was supplied at P1 with the Q
Q1
understanding that other things that influence supply are
held constant. If these other things should change then at
P1 the amount producers want to make could change and
the supply would shift.
As an example, say the company is making candy and the
price of sugar, a major input to the product, goes up. Then
at P1, since it costs more to make a unit of candy, the
producer will make less because there is less profit to be
made per unit. Producers would
PGPSE NOTES rather
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do something else.
957
So, on the previous slide we see the supply curve would
shift left when the price of an input to the production process
went up. Similarly the supply curve would shift right when
the price of an input falls.
Now that we
S have considered
supply and
demand
separately we
will bring the two
together and
see how buyers
and sellers
interact in a
market.
D
Quantity, Q
Notice at this
S1 price P1 the
quantity
demanded
equals the
quantity
P1 supplied.
D1
Quantity, Q
Q1
Notice that
S1 when you look
at any price
above where the
Pa curves cross,
like at Pa, the
quantity
supplied is
greater than the
quantity
demanded – a
D1 surplus
Quantity, Q
Qd Qs
Notice that
S1 when you look
at any price
below where the
curves cross,
like at Pb, the
quantity
supplied is less
Pb than the quantity
demanded – a
shortage
D1
Quantity, Q
Qs Qd
D1
Quantity, Q
Q1 Qd
P1
D1
Quantity, Q
Q1
D1
Quantity, Q
Q1 Qs
P2
D1
Quantity, Q
Q1 Qs
Q2 NOTES
PGPSE 974
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Let’s summarize what is on the last 4 slides.