Index of the cost of purchasing certain bundles of goods. 

Set at 100 (So 106.5 = Inflation rate of 6.5)

Absolute VS Relative

Prices

Absolute Price Changes: Change in the whole economy's general price level

Relative Price Change: Differing increases / decreases in the prices of two differenct goods

CPI of Future Year DIVIDED BY CPI of Past Year

= X

X MUPTIPLIED BY Past price = adjusted current price

The law of demand placed a qualitative restriction on the demand slope

but does not place a quantitative restriction on the demand slope. 

Explain.

Qualitative: Demand slop is negative

Quantitative: Law does not say to what degree slope is negative (steepness)

Slope Formula for Demand Equation

Price       Quantity

4            5

10          1

y1 - y2

x1 - x2

10 - 4   =  6   =  -2

  1-5        -3 

(Lower quantity on bottom, higher quantity on top)

Remember, slope is always NEGATIVE for demand

Change in quantity of demand

vs

Change in demand

Change in quantity of demand: Movement ALONG the demand curve

Change in demand: Demand curve shifts to the right (incr) or left (decr)

Lateral sum of individual demand curves

Shows total amount demanded by ALL consumers at a given price

1. They switch to a substitute  w/ lower cost

2. They simply cannot afford it

P = a + bQd

P = price

a = intercept (At this price, Q=0)

b = slope (always negative in demand curve)

Qd = quantity demanded. 

You are given two points on a demand curve

(1, 10) and (3, 6)

Use demand formula to determine quantity demanded when P = $4

(3, 6) and (1, 10) means: (Q1, P1) (Q2, P2)

P    Q

6    3

10  1

Slope (B)

10 - 6   =  4   =  -2

  1-3     -2 

Intercept(A)

 10=a-2(1)   =   12

Solve for when P=4

P = a +bQd

4 = 12 -2(Qd)     4  = 12 -2         Qd = 12 - 2 (4)     Qd =  4

                      Qd

Intercept Formula for Demand Equation

Use one of the given points used to find slope

Input P and Qd

Solv

Intercept Formula for Demand Equatation

Suppose P = 10, B = -4, 

After finding slope...         P=a+bQd

Use one of the points you used to find slope and plug in P and Qd

Change in quantity of supply

vs

Change in supply

Jane has choice of two jobs. She values variety at $400.

Job #1: Pays $1000 a week, w/o variety

Job #2: Pays $800 a week, with variety

Which job will she choose?

Job #1: 

$1000 benefit

$400 opp cost (of variety forgone)

Job # 2:

$800 benefit

$400 benefit (of utility)

She will choose job #2 b/c it has a higher total value to her

Normal good:

When income increases, demand increases. 

When income decreases, demand decreases.

        (most goods)

Inferior good

When income increases, demand decreases. 

When income decreases, demand increases.

        (Goods purchased b/c of income restraints,

         like ramen)

How do the affects of

"increase in price of a substitute"

and

"Expectation of higher prices in future"

relate?

Buying a good today 

is a SUBSTITUTE for

Buying a good tomorrow

Law of Supply

Year A --> Year B

 If CPI rises 10% and income rises 10%

What is the expected outcome?

No constraints have changes, so we would expect no change in behavior

Year A --> Year B

If CPI increases 10%

and

The price of a good A increases 6%

What happens to the real/relative price of good A?

Explain how money is a good

What is the price of money?

If a pizza is $5, what is the price of money for that good

Money is a good b/c it is useful. It lowers the cost of transacting

Price of money: amount of other goods consumer is willing to give up in order to retain 1 unit of currency ($1)

If a pizza is $5, price of money is 1/5 pizza

Explain inflation in terms of the

marginal value of money

When a government prints more money

in greater amounts than goods available

the consequence is a decreased

marginal value of money, 

and equivalenty,

increase in prices of all goods. 

What is the cost of holding onto wealth from

year A --> year B

The percent of inflation from year A --> year B

Inflation rate from year A --> year B

is 10%

what is the cost of holding onto $100 of wealth

from year A --> year B

Cost is $10

With $100, you will only be able to purchase $90 worth of goods next year

As inflation increases, cash holdings decrease

(b/c of increased cost of inflation on stored money)

What does this postulate, then, infer about the velocity of money

The velocity of money, or the # of transactions

a given amount of money will support

will INCREASE

Define Elasticity

and

Elastic vs Inelastic vs Unit Elastic

Elasticity: Responsiveness of quantity demanded/supplied as price changes

Elastic: When % change in quantity is GREATER than % change in price 

Inelastic: When % change in quantity is LESS than % change in price.

Unit Elastic

E = P  x      1   

      Q     |slope|

(Point A is higher on demand curve than point B)

Slope =  Qb – Qa

                  Pb - Pa

The more alternative goods, the more elastic

The less alternative goods, the more inelastic

What is perfectly elastic?

When does this hapen?

Perfectly elastic: Demand curve is horizontal.

If price is one unit more, no one will buy. If price is one unit less, supply will run out

This happens w/ price takers, who have no influence on price

     Ex: Small company w/in large market

          Indv consumer w/in large market

What is perfect inelasticity?

Demand curve is vertical

With any price change, quantity remains the same

Why are higher-quality goods usually shipped farther away than lower-quality goods?

(assume goods are substituts)

Suppose you ship both a high quality good and a low quality good far away. What happens to the price of the high quality good? 

Qd for high quality good? Overall demand?

The cost of transportation is relatively less for a higher-valued good than a lower-valued good

The same transportation costs applied to both goods, so increasing cost of both goods by same amount decreases difference in prices, so people buy more high-quality goods

Overall demand decreases because overall prices increase

At home, good steak costs $4, so-so steak costs $2

At a resturaunt, good steak costs $24

                       so-so steak costs $20

Where will relatively more good steak be consumed?

At home: 2:1

Cost of good steak is value of TWO so-so steaks

At resturaunt: 12:11

Cost of good steak is FRACTION of a so-so steak

More good steaks will be consumed at the resturaunt

As price increases...

1. People switch to substitutes

2. People can't afford good

Compliment Goods

vs

Subsitute Goods

and affects of price incr/decr of other good's D or Qd

Compliment Goods:

Decr P of good A = Incr Qd of good A

                       = Incr demand of good B

Substitute Goods:

Incr P of good A = Decr Qd of good A

                       = Incr demand of good A

Trade = mutual benefits

so

NO trade = benefits of trades forgone

1. Production more costly

2. New sellers enter market at their min price

A single price at all transactions of a good

Why?

This maximizes mutual benefits from trade

One seller selling good at lower price than all the others

Decrease in...

cost of materials

Increase in...

Labor/other inputs

Improvements in technology/weather

Number of suppliers

& expectation of lower prices in future

If the demand and price of a good increases

What happens to that good's substitute

Define income elasticity

Give Equation

Percent change in consumption due to a percent change in income

= Total Income    x   Change in quantity

   Total quantity        Change in income

Define cross elasticity

Give Equation

How demand for good A changes w/ price of good Y

=  PriceofGoodY  x   %changeQdx

    PriceofGoodX      %changePy

For substitutes: positive, for complementary, negative. 

Income Elastic

vs

Income Inelastic

Income Elastic: Incr in cons greater than incr in income

Income Inelastic: Incr in cons less than incr in income

If price elasticity = X

a Y% decrease in quantity of a good

will result in a ___ decrease in quantity

X times Y = % decrease in Q

If incr in P > decr in Q,

revenue decreases

If Demand is Elastic...

INCREASE in price will ____ total expenditure

DECREASE in price will ____ total expenditure

INCREASE in price will decrease total expenditure

    (Incr P < Decr Q)

DECREASE in price will increase total expenditure

    (Decr P < Incr Q)

INCREASE in price will INCREASE total expenditure

      (Incr P > Incr Q)

DECREASE in price will DECREASE total expenditure

      (Decr P > Incr Q)

       NewP + InitialP

                 2

 _____________________     x         1   

        NewQ + InitialQ                   Slope

                  2

How do substitution possibilities affect elasticity?

More substitutions = more elastic

The more time passes from a price change,

the more elastic. 

(more time to find alternatives)

If supply function passes through origin, price elasticity is....

If supply function does not pass through origin, price elasticity...

Zero along the whole curve

will become more elastic as you move along curve

If inputs can be used in a variety of production, price elasticity will be relatively...

More elastic. 

Options of subsitutes, producers will use inputs for cheapest production

When the cross price elasticity is negative, goods are 

When the cross price elasticity is positive, goods are 

Income elasticity has 3 categories

1)  >1  

     -normal good

     -income elastic

     -luxury good)

2) <1 but <0

      -normal good

      -income inelastic

3) >0

      -inferior good

Elastic: more than 1

Inelastic: less than 1

Unit elastic: 1

How to calculate % change in Q 

and

% change in P

% change in Q

|new Qd - old Qd|

        old Qd

% change in P

|new P - old P|

        old P