Economics Winter 14 March 5 th, 2014 Lecture 19 Ch. 9 Ordinal Utility: Indifference Curve Analysis

Substitution Effect and Income Effect

Income and substitution effects: sign of an effect Effect is negative, if price and quantity move in opposite directions; Effect is positive, if price and quantity move in the same direction

Income and substitution effect with an inferior good: substitution effect: opposite of price movement income effect: same direction as price movement

U1U1 U2U2 E F G Good Y Good X Is good X inferior or normal? Substitution effect Income effect

A Giffen Good

Giffen good: good for which a decrease in its price causes the quantity demanded to fall Basketball, Tickets per year Movies, Tickets per year L 1 L* Total effect Income effect Substitution effect L 2 e 1 e 2 e* I 1 I 2

Upward-Sloping Demand Curve: The Giffen Good When food is an inferior good, and when the income effect is large enough to dominate the substitution effect, the demand curve will be upward-sloping. The consumer is initially at point A, but, after the price of food falls, moves to B and consumes less food. Because the income effect EF 2 is larger than the substitution effect F 1 E, the decrease in the price of food leads to a lower quantity of food demanded. A Special Case: The Giffen Good ●Giffen good Good whose demand curve slopes upward because the income effect is larger than the substitution effect.

Is Cola normal good or inferior good?

True or False

Ch. 10: up to p. 231

Some useful terminology: Plant – a physical establishment (factory, mine, store) that performs one or more functions in fabricating and distributing goods and services Firm – a business organization that owns and operates plants. A firm: –Organizes factors of production. –Produces goods and services. –Sells produced goods to individuals, businesses or government. Industry – a group of firms producing the same, or similar, product.

Firms Maximize Profit Profit is the difference between total revenue and total cost. Profit = Total revenue – Total cost Profit = Total revenue –Economic cost

Economic costs ECONOMIC COST of any resource is the value or worth it would have in its best alternative use FIRM’S ECONOMIC COST – those payments a firm must make, or incomes it must provide, to resource suppliers to attract the resources away from alternative production opportunities. Economic costs are the sum of Explicit Costs Money payments a firm must make to non-owners of the firm for the resources they supplied. Implicit Costs Opportunity costs of firm’s own resources or money payments the self-employed resources could have earned in their best alternative use.