Quiz 5 due Tuesday Oct 31st

Quiz 5 – Consumer Theory
Professor Matthew Festa
Due in Class Tuesday Oct 31st



1) State the law of diminishing marginal utility. Reproduce the Total Utility Graph and Marginal Utility graph from the chapter and explain why Total Utility begins to decline after the 6th unit consumed (2 points).



2) State and explain all 4 theories of consumer behavior (1 points).



3) The marginal benefit Joe gains from going to watch the Mets is $200 dollars while the marginal Utility he gets from going to the Movies is $80 dollars. A met game costs $100 dollars (this is the playoffs) while the movie of the week, which his girlfriend wants to see, costs $10. Given a choose between the 2,which one would he choose that night? (2 points).



4) Consumer theory states that consumers will always manage their consumption so that the marginal benefit of one product equals the marginal benefit of another product. Explain why this is the case.

For reference, explain why MU/$ of A = MU/$ of B (1 points).


5) Joan has $14 in income and she can spend the money on either pizza or ice cream. The price of pizza is $2 dollars and the price of ice cream is 1$. What combination of pizza and ice cream will she purchase given the following MB (which are not converted into MB per dollar terms!!!)

Pizza
1) 24
2) 20
3) 18
4) 16
5) 12
6) 6
7) 4

Ice cream
1) 10
2) 8
3) 7
4) 6
5) 5
6) 4
7) 3

Class Handout for Production Theory

Lecture VII – Production Theory Chapter 9
Professor Matt Festa



I) Economic Costs
a. Opportunity cost- the cost of a resource used is the next best option you could have used the resource for
b. Explicit costs – costs the firm must make (like monetary payments for labor and supplies
c. Implicit costs – are the opportunity costs of using the resources.
d. Economic costs therefore include both explicit and implicit costs (even if you made a profit, the resources could in theory have been used for something else that was even more profitable. That alternative is a cost to economists that must be added in.
e. Economic profit = total revenue – economic cost
f. Accounting Profit = total revenue – total explicit costs.
g. Key graph on Page 153 (big time key graph!!!)


II) Short run Production costs
a. Fixed costs
b. Variable Costs
c. Total Cost = fixed + variable costs.
d. Average Fixed Costs
e. Average Variable Costs
f. Average Total Costs
g. Marginal Cost = change in total cost/change in q


III) Long run production Costs - Figure 9.7
IV) Economies of Scale
a. Labor specialization
b. Managerial specialization
c. EfficientCapital
d. Other factors
e. Note the first portion is the name of the blog, increasing returns (to scale).

Class handout for Consumer Theory

Lecture VI – Consumer Theory Chapter 8
Professor Matt Festa

I) Demand Curve slopes down. Why?
a) Income effect
b) Substitution effect
c) Diminishing marginal utility
d) Remember Utility is the satisfaction or enjoyment you gain from a product


II) Total vs Marginal Utility
a) Focus on graph on Page 130
b) Economics works on the Margin, whether the consumer will consume the extra good rather than something else (whether another good or leisure).
c) Relation to elasticities, the further out on the demand curve you are, the more elastic is the demand curve. This is because you are more sensistive to a product if you have already consumed a large quantity of it!

III) Theories of consumer behavior
a) Rational behavior
b) Preferences
c) Budget Constraint
d) Prices


IV) Marginal Unit per Dollar
a) The rule is that consumers will maximize her satisfaction when she allocates her money income so that the last dollar spent on product A, the last on product b, yield equal amount of marginal benefit.
b) If this does not hold then the consumer can attain more satisfication changing their behavior. Since they are rational they will do so.
c) Further explanation of substitution and income effect.

Interesting application of economics

How to turn a red paper clip into a home? Click here

Pollution taxes in the Washington Post

Remember that one way to solve an externality problem is to institute a tax. This Washington Post article discusses both the existence of the externality and the reasons why a tax has not been used to correct it, a classic case of government and market failure.

Test Averages

The mean and median for the test grades are as follows:

7pm

average = 70.6
median = 66.3

8pm

average= 75.0
neduab = 76

An Economist wins the Nobel Peace Prize

If you haven't heard, the Nobel Peace price has gone to an economist this year. Muhammad Yunus is an economist who developed micro credit. This bloomberg article provides a good background into exactly what microcredit actually is.

Essentially the problem Muhammad solved was the following. If you want to go to the bank and take out loan--for a new business, home, or whatever--the bank needs to be confident that you will pay them back the money they lent plus the interest rate they charge you. You and I can put up collateral in order to acquire the loan. So, for instance, if you buy a home your home is the collateral on the loan. If you don't pay, the bank gets your home. In poor countries this is not possible because people either don't have anything to offer as collateral or the property rights are so poor the ownership of the collateral is essentially meaningless. How to solve such a conundrum? Risk pooling, which you can read about in the article.

Adam Smith and limits of sympathy

This article is a good summary of the moral theory behind Adam Smith's economics. Essentially,

"This analysis might seem cynical, suggesting that apathy, not compassion, lies in the heart of man. But this is not what Smith means. He is emphasizing that humans are limited in the ability to sympathize - or empathize - in today's language. Smith was telling us that as much as we might feel sorry for unfortunate people halfway around the world, our genuine sympathy might not reach that far"

Samuelson on energy independence

Here is a good article that discusses both a social cost (i.e. too much use of imported oil) combined with the complications of fixing it (i.e. government failure, rational ignorance).

Test Reminder

Just a friendly reminder that the first test is Tuesday Oct 12th, 2006. I hope the studying is going well.

Books economist's should read

Marginal Revolution points us to this list. These are books good economic students should read.

Note: I have read about half of them

Mankiw on externality taxes

Harvard Professor Greg Mankiw has a good post here on Pigovian taxes on oil production in California.

Quiz 4 (Due in Class Oct 12th)

EC208 - Intro to MicroEconomics Quiz 4 (Review for Test 1).

Professor Matthew Festa

Due in Class Thursday Oct 12th

1) Draw the supply and demand curve for orange sweatshirts. Paris Hilton and Nick Lachey begin wearing the orange color sweatshirts and Vogue magazine begins calling "orange the new green." (note that green was the previous in color, which was preceded by lavender). Show any shifts in the supply/demand curves and any change in price or output (2 points).

2) Draw the supply and demand curve for the Auto industry. The US and Japan (a big producer of steal) get into a huge fight and Japan cuts off trade (and thus steal supplies). Steal is needed to build cars. Show any shifts in the supply/demand curves and any change in price or output. (2 points).

3) Explain in words what the price elasticity of demand is. If the price of coffee rises 2% and the quantity demanded falls 0.5% is this in elastic or inelastic good. Show the calculation. (2 points).

4) Explain in words what the cross price elasticity of demand is. What three types of goods are there? If the price of tea falls 3% and the quantity demanded of coffee increases 6%, what type of good is this (2 points).

5) Draw the supply and demand for the shrimp fishing industry. A government study shows that the shrimp boats pollute the water which damages the water supplies for a neighboring village. What type of externality is this? Show what shift is needed to bring about the optimal output and price of Shrimp (2 points).

Quiz 3 (due in class Oct 10th)

EC208 - Intro to Microeconomics: Quiz 3 - Market and Government Failure

Professor Matthew Festa

Due in Class Oct 10th, 2006

1) Explain the two differences between a private and public good. Provide one example of a public good that the market will under provide (1 point).

2) Draw a supply and demand curve for fishing. Fishing requires the use of motor boats. Neither the fisher nor the consumer of the fish he catches care about the pollution this causes to the water. This pollution, in turn, damages the property values of homes. What type of externality is this? Should the optimal output and price be higher or lower? Show what shift in any curve should occur to bring about this possibility. Finally, provide two ways the government can bring about this optimal output and price . (3 points).

3) Draw a supply and demand durve for English teachers. Most parents recognize the value of learning to read and write but do not much care if their kids learn anything about great books. However, great books are known to open people's minds up to new and interesting ideas that improve their understand and critical thinking. What type of externality is this? Should the optimal output and price be higher or lower? Show what shift in any curve should occur to bring about this possibility. Finally, provide two ways the government can bring about this optimal output and price . (3 points).

4) Explain the difference between moral hazard and adverse selection with one example for each. Use your notes and/or textbook if you have problems coming up with examples. (2 points).

5) Explain the concept of rational ignorance (1 point).

NYC bans fatty foods

This post is covers both market failure and government failure. Andrew Samwick, an economist at Darthmouth, discusses how NYC is banning Trans fatty foods (like French Fries). He discusses the tradeable permit to pollute system we discussed in class in a joking way here

Of course, this is probably closer to an example of government failure that it is market failure. Do we really think that taxpayer money is best spent....banning French Fries? What about all the jobs that will be lost in the restaurants whose food now tastes like manna?

The Potato Cartel?

Greg mankiw shows how Potato farmers are restricting supply of their crop by......destroying it

Also note his update. They don't understand basic supply and demand! The correct explanation is that by destroying the crop they are shifting the supply curve to the left. This in turn lowers output and creates a shortage. The price level is increased and the Quantity demand decreases as a result until the new equilibrium is reached!

Do you see the importance of these words now?

Class Handout for Government Failure

Lecture V(Based on Text provided free on Internet.)

Government Failure

I) Rational Ignorance
a. Overall negative costs to society but individually the costs are dispersed in society while the benefits are concentrated
b. Example $1,000,000 cost to society with $800,000 benefits to 5 farmers
c. Rational ignorance on government programs
d. Rational ignorance on voting

II) Median Voter Theory
a. Median voter theory resembles bell curve
b. Politicians running towards the middle
c. Shifts in the Median vote
d. What if the best program lies to the right or left of the curve?

III) Bureaucracy
a. The Iron Triangle (Government, Bureaucracy and voters).
b. Capture Theory
c. Lack of accountability in government
d. Rent Seeking - asking the government for economic profit above and beyond what the market will yield (restricting competition)
e. Logrolling – a liberal and conservative senator both vote for the same bill. Why? Because they trade votes.
f. Earmarks – The Alaskan Bridge to Nowhere

IV) Government as Public Goods
a. Some Public choice theorists suggest that Government itself is a public good.
b. Limitations to Public Choice Theory.

Readings for Government Failure (Public Choice Economics)

Since the textbook does not provide a good discussion of Government Failure, the following free links will be used as the textbook for Government failure, often called Public Choice Economics.

http://en.wikipedia.org/wiki/Rational_ignorance This link talks about how it may be rationale for you to remain ignorant, which of course is sub-optimal for the perspective of the overall society.

http://en.wikipedia.org/wiki/Public_choice_theory Is an overview of Public Choice theory, which takes as its basis rational ignorance. The main claim, government is an underprovided public good. (Theory and Claims are the most important sections to look over for the purposes of this class).

http://en.wikipedia.org/wiki/Median_Voter_Theory. The median voter theory discusses how some politicians will "run to the middle" in order to maximize the possibility of being elected. But what if the optimal policy lies somewhere else besides the middle?

Update: This article does an excellent job of explaining public choice economics. http://www.econlib.org/library/Enc/PublicChoiceTheory.html

Class Handout for Market Failure

Lecture V(Based on Chapter 17 in the textbook).

Government and Market Failure

I) Public Goods
a. Contrasted with Private Goods
i. Non Rivalry
ii. Non excludability
b. Problems this causes for private markets
c. Examples of defense and vaccines
d. Counter-example of Broadcast Television
e. Marginal Benefit vs Marginal Cost Rule

II) Spillover effects
a. Externalities
b. Spillover costs (environmental pollution)
c. Spillover benefits (education, basic scientific research).

III) Ways to correct Spillover effects
a. Taxes and Subsidies
b. Coase Theorem
c. Direct Control
d. Market Based Approach
i. “Tragedy of the Commons”
ii. Creating a market for externality rights (i.e. property rights to pollute).

IV) Information Failures (i.e. asymmetrical information).
a. Supply and Demand, and the Perfect Competition model we will discuss later, assume perfect information about the product among buyers and sellers.
b. If not, and one party has more relevant information than the other, then resources may not be allocated efficiently.
c. Health care example.
d. Moral Hazard Problem.
e. Adverse Selection.

Next Class: The flip side of this problem, government failure. There is no good chapter in the textbook on this so I will be providing all relevant textbook material you will need free online.

How can you tell if your house will lose value?

Kevin Hassett has a good piece on the housing market here. He is attempting to offer guidance as to whether there is "arbitrage" opportunities to move out of your home and buy it back after the housing market goes "poof."

He makes the following two criticisms of such a move.

1) Transaction costs are high. You have to higher a broker, put your home on the market and basically hope someone is dopey enough to buy it at its 3 year high. Then you have to buy it back--probably from the same person--when the market bottoms out. Hmmmm.

2) Then we have to consider whether prices are going to decline in the first place. He gives some useful guide posts, all of which are based on supply and demand.

a) Look for an increase in supply (an increase in supply lowers price and increases output). If a bunch of McMansions popped up in your town recently, be wary.

b) Take a look at inventories. If a lot of homes are on the market but are not selling (i.e. those real estate stickers on the lawn), that suggests there is a supply and demand imbalance. That is, the quantity supplied is in excess of the quantity demand. In order to correct, prices have the fall and the quantity supplied has to decline.

A caveat: The housing market is peculiar in that it is not liquid. People don't flip their homes left and right, despite the recent demand for investment homes in recent years. Therefore, in anticipation of a price decline, home owners may just decide to sit this one out for a few years and wait to move into a bigger McMansion. Whether this move will be enough to prevent prices declining is something we are, unfortunately, going to have to wait for in upcoming data. The increase in home purchases purely for investment purchases means that some people may have purchased a home they are not living in. They do not face the same contraint in selling the home(since they live somewhere else), but they will be concerned whether they make a profit (hence getting rid of it now in order to make sure them come on top). The main question is: how many are in each camp?