1、Chapter One,The Market,The Theory of Economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions - John Maynard Keynes,Economi
2、c Modeling,What causes what in economic systems? At what level of detail shall we model an economic phenomenon? Which variables are determined outside the model (exogenous) and which are to be determined by the model (endogenous)?,Modeling the Apartment Market,How are apartment rents determined? Sup
3、pose apartments are close or distant, but otherwise identical distant apartments rents are exogenous and known many potential renters and landlords,Modeling the Apartment Market,Who will rent close apartments? At what price? Will the allocation of apartments be desirable in any sense? How can we con
4、struct an insightful model to answer these questions?,Economic Modeling Assumptions,Two basic postulates: Rational Choice: Each person tries to choose the best alternative available to him or her. Equilibrium: Market price adjusts until quantity demanded equals quantity supplied.,Modeling Apartment
5、Demand,Demand: Suppose the most any one person is willing to pay to rent a close apartment is $500/month. Then p = $500 QD = 1. Suppose the price has to drop to $490 before a 2nd person would rent. Then p = $490 QD = 2.,Modeling Apartment Demand,The lower is the rental rate p, the larger is the quan
6、tity of close apartments demanded p QD . The quantity demanded vs. price graph is the market demand curve for close apartments.,Market Demand Curve for Apartments,p,QD,Modeling Apartment Supply,Supply: It takes time to build more close apartments so in this short-run the quantity available is fixed
7、(at say 100).,Market Supply Curve for Apartments,p,QS,100,Competitive Market Equilibrium,“low” rental price quantity demanded of close apartments exceeds quantity available price will rise. “high” rental price quantity demanded less than quantity available price will fall.,Competitive Market Equilib
8、rium,Quantity demanded = quantity available price will neither rise nor fall so the market is at a competitive equilibrium.,Competitive Market Equilibrium,p,QD,QS,100,Competitive Market Equilibrium,p,QD,QS,pe,100,Competitive Market Equilibrium,p,QD,QS,pe,100,People willing to pay pe for close apartm
9、ents get close apartments.,Competitive Market Equilibrium,p,QD,QS,pe,100,People willing to pay pe for close apartments get close apartments.,People not willing to pay pe for close apartments get distant apartments.,Competitive Market Equilibrium,Q: Who rents the close apartments? A: Those most willi
10、ng to pay. Q: Who rents the distant apartments? A: Those least willing to pay. So the competitive market allocation is by “willingness-to-pay”.,Comparative Statics,What is exogenous in the model? price of distant apartments quantity of close apartments incomes of potential renters. What happens if t
11、hese exogenous variables change?,Comparative Statics,Suppose the price of distant apartment rises. Demand for close apartments increases (rightward shift), causing a higher price for close apartments.,Market Equilibrium,p,QD,QS,pe,100,Market Equilibrium,p,QD,QS,pe,100,Higher demand,Market Equilibriu
12、m,p,QD,QS,pe,100,Higher demand causes higher market price; same quantity traded.,Comparative Statics,Suppose there were more close apartments. Supply is greater, so the price for close apartments falls.,Market Equilibrium,p,QD,QS,pe,100,Market Equilibrium,p,QD,QS,100,Higher supply,pe,Market Equilibr
13、ium,p,QD,QS,pe,100,Higher supply causes a lower market price and a larger quantity traded.,Comparative Statics,Suppose potential renters incomes rise, increasing their willingness-to-pay for close apartments. Demand rises (upward shift), causing higher price for close apartments.,Market Equilibrium,
14、p,QD,QS,pe,100,Market Equilibrium,p,QD,QS,pe,100,Higher incomes cause higher willingness-to-pay,Market Equilibrium,p,QD,QS,pe,100,Higher incomes cause higher willingness-to-pay, higher market price, and the same quantity traded.,Taxation Policy Analysis,Local government taxes apartment owners. What
15、happens to price quantity of close apartments rented? Is any of the tax “passed” to renters?,Taxation Policy Analysis,Market supply is unaffected. Market demand is unaffected. So the competitive market equilibrium is unaffected by the tax. Price and the quantity of close apartments rented are not ch
16、anged. Landlords pay all of the tax.,Imperfectly Competitive Markets,Amongst many possibilities are: a monopolistic landlord a perfectly discriminatory monopolistic landlord a competitive market subject to rent control.,A Monopolistic Landlord,When the landlord sets a rental price p he rents D(p) ap
17、artments. Revenue = pD(p). Revenue is low if p 0 Revenue is low if p is so high that D(p) 0. An intermediate value for p maximizes revenue.,Monopolistic Market Equilibrium,p,QD,Low price,Low price, high quantity demanded, low revenue.,Monopolistic Market Equilibrium,p,QD,High price,High price, low q
18、uantity demanded, low revenue.,Monopolistic Market Equilibrium,p,QD,Middle price,Middle price, medium quantity demanded, larger revenue.,Monopolistic Market Equilibrium,p,QD,QS,Middle price,Middle price, medium quantity demanded, larger revenue. Monopolist does not rent all the close apartments.,100
19、,Monopolistic Market Equilibrium,p,QD,QS,Middle price,Middle price, medium quantity demanded, larger revenue. Monopolist does not rent all the close apartments.,100,Vacant close apartments.,Perfectly Discriminatory Monopolistic Landlord,Imagine the monopolist knew everyones willingness-to-pay. Charg
20、e $500 to the most willing-to-pay, charge $490 to the 2nd most willing-to-pay, etc.,Discriminatory Monopolistic Market Equilibrium,p,QD,QS,100,p1 =$500,1,Discriminatory Monopolistic Market Equilibrium,p,QD,QS,100,p1 =$500,p2 =$490,1,2,Discriminatory Monopolistic Market Equilibrium,p,QD,QS,100,p1 =$5
21、00,p2 =$490,1,2,p3 =$475,3,Discriminatory Monopolistic Market Equilibrium,p,QD,QS,100,p1 =$500,p2 =$490,1,2,p3 =$475,3,Discriminatory Monopolistic Market Equilibrium,p,QD,QS,100,p1 =$500,p2 =$490,1,2,p3 =$475,3,pe,Discriminatory monopolist charges the competitive market price to the last renter, and
22、 rents the competitive quantity of close apartments.,Rent Control,Local government imposes a maximum legal price, pmax pe, the competitive price.,Market Equilibrium,p,QD,QS,pe,100,Market Equilibrium,p,QD,QS,pe,100,pmax,Market Equilibrium,p,QD,QS,pe,100,pmax,Excess demand,Market Equilibrium,p,QD,QS,p
23、e,100,pmax,Excess demand,The 100 close apartments are no longer allocated by willingness-to-pay (lottery, lines, large families first?).,Which Market Outcomes Are Desirable?,Which is better? Rent control Perfect competition Monopoly Discriminatory monopoly,Pareto Efficiency,Vilfredo Pareto; 1848-192
24、3. A Pareto outcome allows no “wasted welfare”; i.e. the only way one persons welfare can be improved is to lower another persons welfare.,Pareto Efficiency,Jill has an apartment; Jack does not. Jill values the apartment at $200; Jack would pay $400 for it. Jill could sublet the apartment to Jack fo
25、r $300. Both gain, so it was Pareto inefficient for Jill to have the apartment.,Pareto Efficiency,A Pareto inefficient outcome means there remain unrealized mutual gains-to-trade. Any market outcome that achieves all possible gains-to-trade must be Pareto efficient.,Pareto Efficiency,Competitive equ
26、ilibrium: all close apartment renters value them at the market price pe or more all others value close apartments at less than pe so no mutually beneficial trades remain so the outcome is Pareto efficient.,Pareto Efficiency,Discriminatory Monopoly: assignment of apartments is the same as with the pe
27、rfectly competitive market so the discriminatory monopoly outcome is also Pareto efficient.,Pareto Efficiency,Monopoly: not all apartments are occupied so a distant apartment renter could be assigned a close apartment and have higher welfare without lowering anybody elses welfare. so the monopoly ou
28、tcome is Pareto inefficient.,Pareto Efficiency,Rent Control: some close apartments are assigned to renters valuing them at below the competitive price pe some renters valuing a close apartment above pe dont get close apartments Pareto inefficient outcome.,Harder Questions,Over time, will the supply
29、of close apartments increase? rent control decrease the supply of apartments? a monopolist supply more apartments than a competitive rental market?,Chapter Two,Budgetary and Other Constraints on Choice,Consumption Choice Sets,A consumption choice set is the collection of all consumption choices avai
30、lable to the consumer. What constrains consumption choice? Budgetary, time and other resource limitations.,Budget Constraints,A consumption bundle containing x1 units of commodity 1, x2 units of commodity 2 and so on up to xn units of commodity n is denoted by the vector (x1, x2, , xn). Commodity pr
31、ices are p1, p2, , pn.,Budget Constraints,Q: When is a consumption bundle (x1, , xn) affordable at given prices p1, , pn?,Budget Constraints,Q: When is a bundle (x1, , xn) affordable at prices p1, , pn? A: When p1x1 + + pnxn m where m is the consumers (disposable) income.,Budget Constraints,The bund
32、les that are only just affordable form the consumers budget constraint. This is the set (x1,xn) | x1 0, , xn 0 and p1x1 + + pnxn = m .,Budget Constraints,The consumers budget set is the set of all affordable bundles; B(p1, , pn, m) = (x1, , xn) | x1 0, , xn 0 and p1x1 + + pnxn m The budget constrain
33、t is the upper boundary of the budget set.,Budget Set and Constraint for Two Commodities,x2,x1,Budget constraint is p1x1 + p2x2 = m.,m /p1,m /p2,Budget Set and Constraint for Two Commodities,x2,x1,Budget constraint is p1x1 + p2x2 = m.,m /p2,m /p1,Budget Set and Constraint for Two Commodities,x2,x1,B
34、udget constraint is p1x1 + p2x2 = m.,m /p1,Just affordable,m /p2,Budget Set and Constraint for Two Commodities,x2,x1,Budget constraint is p1x1 + p2x2 = m.,m /p1,Just affordable,Not affordable,m /p2,Budget Set and Constraint for Two Commodities,x2,x1,Budget constraint is p1x1 + p2x2 = m.,m /p1,Afford
35、able,Just affordable,Not affordable,m /p2,Budget Set and Constraint for Two Commodities,x2,x1,Budget constraint is p1x1 + p2x2 = m.,m /p1,Budget Set,the collection of all affordable bundles.,m /p2,Budget Set and Constraint for Two Commodities,x2,x1,p1x1 + p2x2 = m isx2 = -(p1/p2)x1 + m/p2so slope is
36、 -p1/p2.,m /p1,Budget Set,m /p2,Budget Constraints,If n = 3 what do the budget constraint and the budget set look like?,Budget Constraint for Three Commodities,x2,x1,x3,m /p2,m /p1,m /p3,p1x1 + p2x2 + p3x3 = m,Budget Set for Three Commodities,x2,x1,x3,m /p2,m /p1,m /p3, (x1,x2,x3) | x1 0, x2 0, x3 0
37、 and p1x1 + p2x2 + p3x3 m,Budget Constraints,For n = 2 and x1 on the horizontal axis, the constraints slope is -p1/p2. What does it mean?,Budget Constraints,For n = 2 and x1 on the horizontal axis, the constraints slope is -p1/p2. What does it mean? Increasing x1 by 1 must reduce x2 by p1/p2.,Budget
38、 Constraints,x2,x1,Slope is -p1/p2,+1,-p1/p2,Budget Constraints,x2,x1,+1,-p1/p2,Opp. cost of an extra unit of commodity 1 is p1/p2 units foregone of commodity 2.,Budget Constraints,x2,x1,Opp. cost of an extra unit of commodity 1 is p1/p2 units foregone of commodity 2. And the opp. cost of an extra u
39、nit of commodity 2 is p2/p1 units foregone of commodity 1.,-p2/p1,+1,Budget Sets Income and Price Changes,The budget constraint and budget set depend upon prices and income. What happens as prices or income change?,How do the budget set and budget constraint change as income m increases?,Original bu
40、dget set,x2,x1,Higher income gives more choice,Original budget set,New affordable consumption choices,x2,x1,Original and new budget constraints are parallel (same slope).,How do the budget set and budget constraint change as income m decreases?,Original budget set,x2,x1,How do the budget set and bud
41、get constraint change as income m decreases?,x2,x1,New, smaller budget set,Consumption bundles that are no longer affordable.,Old and new constraints are parallel.,Budget Constraints - Income Changes,Increases in income m shift the constraint outward in a parallel manner, thereby enlarging the budge
42、t set and improving choice.,Budget Constraints - Income Changes,Increases in income m shift the constraint outward in a parallel manner, thereby enlarging the budget set and improving choice. Decreases in income m shift the constraint inward in a parallel manner, thereby shrinking the budget set and
43、 reducing choice.,Budget Constraints - Income Changes,No original choice is lost and new choices are added when income increases, so higher income cannot make a consumer worse off. An income decrease may (typically will) make the consumer worse off.,Budget Constraints - Price Changes,What happens if
44、 just one price decreases? Suppose p1 decreases.,How do the budget set and budget constraint change as p1 decreases from p1 to p1”?,Original budget set,x2,x1,m/p2,m/p1,m/p1”,-p1/p2,How do the budget set and budget constraint change as p1 decreases from p1 to p1”?,Original budget set,x2,x1,m/p2,m/p1,
45、m/p1”,New affordable choices,-p1/p2,How do the budget set and budget constraint change as p1 decreases from p1 to p1”?,Original budget set,x2,x1,m/p2,m/p1,m/p1”,New affordable choices,Budget constraintpivots; slope flattensfrom -p1/p2 to-p1”/p2,-p1/p2,-p1”/p2,Budget Constraints - Price Changes,Reduc
46、ing the price of one commodity pivots the constraint outward. No old choice is lost and new choices are added, so reducing one price cannot make the consumer worse off.,Budget Constraints - Price Changes,Similarly, increasing one price pivots the constraint inwards, reduces choice and may (typically
47、 will) make the consumer worse off.,Uniform Ad Valorem Sales Taxes,An ad valorem sales tax levied at a rate of 5% increases all prices by 5%, from p to (1+005)p = 105p. An ad valorem sales tax levied at a rate of t increases all prices by tp from p to (1+t)p. A uniform sales tax is applied uniformly
48、 to all commodities.,Uniform Ad Valorem Sales Taxes,A uniform sales tax levied at rate t changes the constraint from p1x1 + p2x2 = m to (1+t)p1x1 + (1+t)p2x2 = m,Uniform Ad Valorem Sales Taxes,A uniform sales tax levied at rate t changes the constraint from p1x1 + p2x2 = m to (1+t)p1x1 + (1+t)p2x2 = m i.e. p1x1 + p2x2 = m/(1+t).,Uniform Ad Valorem Sales Taxes,
