We'll do the revision
and then in the last 10 minutes we'll go
over the Kahoot from the previous topic,
Rationality as well. So just a few
reminders, the final reminders, make
sure you bring the following things
tonight to the exam. The scientific
calculator, you want to be able to solve
future value, convert into present value
type questions. If you can't do that, you forget your calculator, it's not going to be
good. so bring that also number two pencil
we're using Scantron to fill out and
finally whether it's on your phone or if
you've got a card just make sure you have
access to your PUID I'm going to instruct
the proctors not to accept any exams from
anyone until you show the the PUID finally
after the next class so between 530 and
730 I booked out Rawls 3082 I'll be posted
up there if you want to come for some
last-minute revision. I'm not going to be
like lecturing anything, but if you have
questions for me or if you just want a place
to hang out before the exam, the capacity
is 70 people, so hopefully some people
find value in that. And yeah, the exam
will be in WAUC 105.5. Any questions regarding any of those logistics? Ah, great. So some
of you may notice my slides look
a little bit different today in
terms of like the style and background
as per usual. To be transparent the
reason is is I got Claude Code to summarize
my four lectures. I did probably like
a 75-80% bang-up job and then I added
on top of that as well. But I want to be
transparent when AI makes my life easier
as well. It should make your life easier
in certain ways too. So we're gonna cover
the fundamentals, market forces, market
values, elasticity. I'm gonna go
pretty fast here. This is meant to
like jolt memory. Yeah, doing four
weeks of content in in 40 minutes is a
challenge for sure. So firstly what
is economics? Essentially it's the
study of decision -making when there
is scarcity. Essentially we're
always facing trade-offs when
making decisions. So if you remember I
talked about no such thing as a free lunch.
So earlier today if I offered for you to
come to lunch with me and pay for your
entire meal, this isn't a free lunch because
you have to spend half an hour, one hour
with me and that time could be better used
for something else. So trade-offs consist
of the entire set of things you might
have done. So whether it's resources like
money or resources like time, you could
have done a hundred things with your
time. You could have gone and hung out
with friends, played ultimate frisbee, studied
for the exam tonight rather than go out
for lunch with me. Whereas the opportunity
cost is the value of the best foregone
alternative. here. So if the best foregone
alternative for you was to study for
an hour rather than go out for lunch
with me, that is the opportunity cost, the
number one ranked thing. So this is the explicit
cost, monetary, plus the implicit
cost, the foregone opportunity, that's
your opportunity cost. So we have these
seven principles of effective managerial
decision making, identify goals and constraints,
the firm wants to maximize profits,
recognize the nature and importance of
profits, I'm going to speak about all
of these in a second. Incentives. Understand the function of markets. Recognize the time
value of money. Marginal analysis
are bloody important. Marginal benefit equals marginal cost
of maximization. And be empirically
minded. Use data -driven decisions.
And don't mistake correlational
effects for causal. So profits and
opportunity cost. We know the profit
is the total revenue minus
the total cost. Accounting profit,
what you'd see on a balance sheet, is
the total revenue minus the explicit
cost. So these are like your cost of inputs,
wages, etc, etc. But there's
also a term we use called
economic profit, which is the same
as the accounting profit, but we
also take away the implicit cost. So
this is just the value of the best foregone
alternative. So an example is you all chose to go to college. Your explicit costs of
going to college are your tuition fees, your
textbook, etc, etc. But the implicit cost
is what you could have done, the best valued
alternative with with its four years three
for some five for others at college and that
would be you know you could have gotten a job
straight out of high school and you know 50
grand a year i don't know if that's low or
high probably low 50 grand a year so adding
all that together would be the opportunity
cost of going to college then we talk
about this five forces framework so these are
the five forces that determine profitability
so the entry barriers how hard or easy is it
for other firms to enter the harder it is the
more power you will the more profitable it
is the power of input supplies the more power
your input suppliers have the higher they
can charge for your inputs can be more
expensive to produce lowers profitability the power
of buyers how much power to buyers have
you remember I gave that example with Ryanair
how they can be like really sassy towards
their customers because they offer a product
that no one else can really replicate so
even though they're rude to their customers
there's no buyer power so they won't switch
away to something else. Industry rivalry, the idea if you've got
intense competition without differentiated
products there's going to be a lot
of competition that lowers the price
you sell out, lowers profitability and
then substitutes and complements which
we've discussed a lot. Incentives matter, people act differently
when the marginal benefit is greater
than the marginal cost. So an example
for the exam tonight your current
incentive is to do as well as you can but
if I offered $300 to anyone who failed
tonight, they might distort some incentives
for people who think they're on
the cusp of failure. They might bomb
the exam on purpose so they
can give it $300. So incentives matter.
People act when they determine the
marginal benefit of an action is greater than
the marginal cost. But be careful. If you
remember, we looked at a number of research
papers showing how incentives can be
misapplied. So in the daycare example, where
they put in a $5 fine for parents who picked
up their kids late, and this actually
doubled the amount of lateness pickups this
is because a fine is considered a price five
dollars is really low as a price for an extra
hour of childcare so you've got to be
careful in that regard and also incentives
can crowd out intrinsic motivations so if you
take a test you have this intrinsic motivation
to do well but if I pay you one cent per
correct answer then your incentive is the
financial incentive very low incentive
this crowds out your intrinsic motivation,
and you might do worse, as we saw in the Nisi
and Rastachini paper. It also affects
people in terms of things like donating
blood versus giving blood for a
price, etc., etc. Finally, we looked at
perverse incentives. These are poorly
designed incentives that can backfire. My
favourite of the three that we looked at is
the Hanoi Rat Massacre, where they paid rat
captures $1 for every rat they killed, but
there's evidence when killing of the rat,
all they had to do was put in the tail, so
the rat captors were catching the rats,
cutting off the tails, and leaving them back
into the public so they could breed, create
more rats, so these incentive screams
actually created more rats rather than exterminating
the population. Okay, the big
one here, time, value, money, and
net present value. So $100 today is not
worth $100 in one year. It's worth more
than $100 in a year. That's because you
can invest $100 today at a safe rate with
some interest on it. So for example, if you
can get an interest rate of 7% if you
put $100 in the bank, $100 today is going to be worth $107 in one year. So you get what you
currently have, your principal plus the
interest rate in one year. And that's how we find
out the future value. The future value is
essentially our present value multiplied
by one plus the interest rate plus how
many years it's been in the bank essentially.
If we left it in for another year,
this would be larger. But what we're really
interested in is decisions when we
get cash streams in the future, how do
we compare that to something where we
only get cash today? We want to convert
the future value of these cash flows
to present value. So all we do is take
this to the other side and we get
the present value equals future value
divided by one plus interest rate
divided by the years. When you think about this, this is intuitive. $100 in the future
should be worth less than $100 today, just
as we talked about. And this number
here, because the interest rate is
positive, is going to make the future
value smaller. So the higher the
interest rate or the larger the
end, the smaller the present value
is going to be. So if the future
value is $107, we know if you leave it in for
a year at a rate of 7% interest, the
present value will be $100. We've just
said that. But if the interest rate increases,
if it's up at 20%, you don't need to put
$100 in to get $107, you only need to put
it like 90 months. So this is why
the present value is going to get
smaller when interest rates increase,
same with the amount of years
you leave it in. The net present
value is just the present value of
your benefits minus the present value
of your costs. If it's greater
than zero, good investment, less than
zero, bad investment. Also, sometimes you
get different cash flows at certain
times. Your uncle might give you $50 at the
end of this year, $70 at the end of
next year, $25 at the end of the year after
that. And we know a simple way to
calculate that is all you need to figure
out is when are you getting your cash
flows in the future, what year are they
occurring, and you just add this
formula in. So if you got whatever
I said, $70 in the first year, you'd
plug $70 in here. Say the interest rate is 3%, end of first year, $50 at the end of the
second year, $50, $2, $3 as per usual. then
this could be 20 etc so you just want to
add up all these cash flows when they occur in
the future so use this formula okay marginal
analysis is really important so what we
want to do is we want to maximize the net
benefits of the firm and the net benefits of the
firm are the benefits as a function of the
quantity produced minus the cost as a function
of the quantity produced so much you
decide to produce is going to impact your net
benefits. So the optimal amount of quantity to
produce is when your marginal benefits equal
your marginal cost or your marginal net
benefits equal to zero. So the idea behind
this essentially is if your marginal benefits
are greater than your marginal cost that
means the next unit you produce you'd be making
more by producing and selling that, then
it will cost you to produce it. So you're
leaving money on the table if you're not producing
when your marginal benefits are greater
than your marginal costs. If your marginal
costs are greater than your marginal benefits,
you're overproducing. The last unit you
produce costs more to produce than the benefits
you produce. Does anyone know what
that sound is? Do you want to tell
me? I've got no idea. I guess it's
a low-fine military. Low-fine military.
Okay, interesting. Really disrupted my
flow there. Okay, so if your marginal
costs are greater than your marginal
benefits, You're overproducing. The
last unit you produced cost too much. You
didn't reap the revenue back on selling
it, so you should strip back how much
you're producing. So when you're equal
to each other, the marginal benefit
equals the marginal cost, this is Goldilocks'
phone, just right, you're maximizing
your net benefits. So we care how much
the next unit gives us in terms of benefits and
costs, not the average. The average is
misleading. And this is for everything, not
just producing quantity. So if you
remember, we talked about this example
with pizza. If I said to you, a person has an
average of 50 units of happiness when they
eat 7 slices of pizza, is this the
optimal decision? The answer is,
you don't have enough information
to determine. It could be the
case I got 300 units of
happiness from the first slice, so
on and so forth, and the 7th slice
actually gives them negative units of
happiness. So they should have stopped
at 6. So we want to know how much
the next thing gives us in terms of
benefits and costs. Whether it's eating
pizza, whether it's producing, whether
it's an extra hour of studying for
this exam tonight. Benefits minus costs. Marginal benefits
minus costs. Finally, we looked at this idea of regression. So our output y equals
a plus b multiplied by x plus e. and
this is essentially saying a one unit
increase in x will change y by b and this
is a prediction how much do we predict
y will change if x changes so this is a
correlation between x and y, it's not necessarily
causal, and this is a big thing that
I focused on, I think I went on a rant for
like 20 minutes about this but the idea behind
this is two things the first is a bit of
variable bias so if you remember I talked
about this situation, we found all this
data on the amount of glasses of wine
people drink and how long they live.
We see that wine says people live
two years longer. Is this a causal
effect? The answer is no, we've let down
a ton of variables. Well, a really
important one, correlates with
the amount of wine people drink and
health outcomes. Simple example. In fact, on Twitter
last night I saw some influencer
promoting a study that coffee causes
you to live longer. and yeah, I should
have found it and showed you.
It's a good chuckle. Secondly, selection
effects as well. So this is the
idea if I wanted to measure how much of
this class increased pecking score on
the exam tonight, I could get everyone's
attendance who didn't rock up today,
get your exam scores and see if there's an
effect. However, I'm dealing with selection
effects here. So the people who rocked
up to class today, people who rocked up
to class today are more likely to have higher
work ethic putting effort by coming to class
rather than skipping higher effort and work
ethic probably leads to high scores on
the exam so what I'm teaching today could be
absolute bullshit have no effects but it
might show an effect because of these selection
effects so be very careful in interpreting
causal effects now supply and demand law
of demand is price increases quantity
decreases as this inverse relationship. Quantity
can change for two reasons, the movement
along the demand curve, this only occurs when
the price of that product changes, or a shift
of the demand curve entirely, and this is
due to other factors. So things that can
shift demand are a change in income,
this depends if the good is
normal or inferior, the prices of
related goods, substitutes and
complements, advertising can change
consumer tastes, can also give people more
information about products, but we We
looked at changing consumers' tastes, we
watched that Nathan for You video about the
doinket as the extreme example of changing
preferences and tastes. Population effects.
The more people there are, the more
people there are to buy the products.
So demand will shift up and to the right
if there's more people being born.
And the demographics of the population
matter as well. So if I could do a
Thanos thing and snap my fingers and move a
bunch of baby boomers to Gen Z, there's probably
going to be a high demand for for twitch
subscriptions and a lower demand for hip
replacements that's how the demographics of
the population matter finally consumer
expectations if you think things are going to
be more expensive in the future you're
more likely to buy it today demand increases
today if you think it's going to be cheaper
in the future think about you know these
amazon deals for like black friday tvs two
months out you're not going to buy a tv
you'll wait until the cheaper price so demand
reduces now when you think things will be
cheaper in the future. Finally, we have the
linear demand function. So quantity can be
predicted by all these things. Price of the
own good, price of other goods, income,
and other things etc. Whereas the inverse
demand function is when we have P, the price
of the good on the left hand side, quantity
on the right. That's how we graph our demand
function as you can see here. So here is
our demand function. A change in price of
that product alone will result in a movement
along the curve from a to b increase in
demand shifts it up and to the right decrease
in demand shifts it down and to the left
supply law of supplies the price increases
the quantity produced increases firms can
make more of a profit when prices are high
so they're willing to produce it even a higher
cost like demand a movement along the
curve only occurs if there's a change in
the price of the good otherwise there can be
a shift in the curve due to other factors so the
change in your input prices where they
decrease or increase will change how much
you're willing to sell something for technology
improvements or regression will matter
a lot as well government regulation will make
things more costly too the number of firms
so if a new firm enters the market there's
going to be more produced at the same
price point so this shifts supply down into the
right substitutes in production the example
we talked about was if a firm is producing
both cars and tractors, and there's a spike
in the price of tractors, if they can,
they'll move production from cars to tractors,
so this will result in a decrease in supply
in the car market. Taxes, as you
can see, there are two types of taxes. The excise tax, which is a fixed dollar per unit, so a 50 cent tax. It doesn't matter if
it's something that costs a dollar or a
million dollars, it will increase it by 50
cents. so 50 cent tax on a one dollar price
will be a dollar fifty on a million dollar
price will be a million dollars and fifty
cents add valorum tax on the other hand is
a percentage tax so it increases the price
by whatever percent and this means there'll
be absolute differences between prices at
a higher and prices at a lower when there's
an add valorum tax included finally like
consumers producer expectations about the
future matter a lot as well we also have our
linear supply function which is cut off at
the end here actually let's see if we can
yeah there we go so you can see supply
is based on all these things as well where
we can figure out the quantity supplied we
have the price of the good the price of the
inputs and and labor technology etc similarly
we'll move along the supply curve when
there's just a change in price otherwise
an increase in supply for these other factors
will shift it down to the right decrease
up and to the left. So we're at market
equilibrium when the quantity demanded equals
the quantity supplied. So we want to solve for
P and Q at equilibrium. And the intuition,
the idea behind this is if quantity demanded
is greater than quantity supplied, that
means there's going to be a shortage of goods.
There's gonna be a lot more people wanting
it than being supplied, so what will happen
is prices will increase, and as prices
increase two things will happen. More producers
will be willing to make units because that
can offset the higher cost of producing the
next unit and less people will demand the
good as prices increase and it goes above the
most they're willing to pay. So this will
continue to happen until we get to equilibrium
and the opposite effect will happen if
quantity supplied is greater than quantity
demanded. There's a surplus of goods and
prices will continue to fall until this surplus
or excess. I prefer the word excess here.
They use the word surplus a lot but the excess
will be eliminated. then we have our
consumer surplus and producer surplus so if
you remember we looked at this in actually
a few different ways so consumer surplus
this is simply the idea what is your
willingness to pay for a good minus the price
you actually pay so in class we had that
coffee game where's Michael I think Michael
won that one but we looked at what
everyone was willing to pay and how much the
actual price was to determine consumer
surplus for producer surplus we did the
Vegemite task how much would you be willing
to accept and if that is lower than the
price you receive for the good then you'll
sell it essentially. So if you essentially
said the lowest amount I'd be willing
to accept a Vegemite is you know two
dollars and I offered you two dollars
fifty you'll produce a surplus there
would be fifty six. Finally we did the the
trading game in class the the the the pit
market game if you remember that was the
whole idea we're trying to maximize our producer
or consumer surplus depending on what
role you are so if you get confused put yourself
back in your shoes and what your incentives
were there so the total surplus is just
our consumer surplus and producer surplus
added together this is how we measure efficiency
in economics how much gains there were
for producers and consumers so this is the
idea that if there is a shortage so if you
know the price is five dollars we have a shortage
of goods we demand at 750 units supplies
only 250 the prices will continue to increase
so more producers produce less consumers
demand until we're at eight equilibrium
and the same sort of situation applies when
there's overproduction as well the incentives
will drive back to the equilibrium at eight
so here's our consumer surplus so here's
our demand curve this is the price at equilibrium
here so when you think about it the
demand curve is just people's individual
willingness to pay for a product added together
so this person's willing to pay up here they're
only paying here so this strip here is
their consumer surplus and we just add all
that together so it's the area under the
demand curve above the price they pay okay you
get this triangle so it's just the the
difference in the the width which is the quantity
equilibrium minus zero multiplied by the
the length which is the maximum price a person
is willing to pay minus the price paid
multiply that together divided by two area of
the triangle divided by two that gives you
consumer surplus same sort of idea with producer
surplus the supply curve is the minimum
amount a producer is willing to accept
for a good and this is the price here so if
an individual seller here is you know willing
to accept just above 133 here but they
get paid 400 this is going to be their
producer surplus add it all together calculate
the area of the triangle width times
length divided by 2. Okay then we looked
at price controls how does that affect the
free market equilibrium the government can put
in either price ceiling or a price floor the
price ceiling when it is binding create
shortages and dead weight loss some examples
are rent control gas price caps and price
gouging laws a price floor on the other hand
creates surplus plus head weight loss so the
examples of this are minimum wage and the
one I want to focus on here is actually
the agricultural price subsidies and supports
so binding versus non -binding is only binding
if the controls affect the market so the
the intuition I gave here is not in the free
market equilibrium is like a point or a ball
if it's between the price floor and the
price ceiling it's in the house it's non
-binding but if it's above the ceiling or below
the floor or the floor is higher than the
market equilibrium and the ceiling is below
the market equilibrium it's binding and when
we have you know a binding equilibrium
it's going to change the full economic price which
is the current price of the good plus the
opportunity cost of waiting this is the
non-pecuniary price so as i'll show you the
full economic price of the price floor of
ceiling it's going to the market equilibrium
so this is our price ceiling our free market
equilibrium would be here where supply and
demand intersects but we have a ceiling below
the market equilibrium so it's binding at
price c so this results in a quantity demanded
of qd and a quantity supplied at only qa
lower price so people aren't producing it
but everyone wants it so we have a shortage
of between these two points qd minus qs and
when we want to calculate the economic price
we calculate how much it's actually going
for pc plus the opportunity cost of waiting
that's our dead weight loss here if you
remember when there was a price cap on gas
in the 70s there were queues of like five
hours to wait for gas so this person up here
would be willing to pay more than the current
price to make sure they don't have to wait and
get the gas so this is determined by where
the current production is qs as you can see
how much are people willing to pay at
this point which is pf minus the actual price
which is pc so that's the opportunity cost
of waiting pf minus pc and then you add that
to the economic price and that will give you
the full um sorry the the actual price that
will give you the full economic price whereas
if we were at market equilibrium there is
no opportunity cost of waiting the amount
people are willing to pay is the exact same
as what the price is. So that's why
it's always going to be greater when
we introduce a price ceiling or
a price floor. For the price floor it's
a little bit different than the price ceiling.
This is a binding price floor at PF. So
you can see production at QS, only QD
demanded. It's very expensive, not a lot of
people want to buy. So we have the same dead
weight loss in the blue triangle area but we
also have this dead weight loss in the red
triangle area. Only if there's something
being produced so this is a minimum wage this
red area wouldn't exist because it doesn't
really cost anything for more people to
supply their labor but if more agricultural
companies are producing food that's you know
actual inputs that are costly so there's gonna
be extra cost which is determined by this
red area under the supply curve so how
much it costs that isn't sold so from QD to QS
the government can offset this red area by
paying the price floor price so pf multiplied
by what isn't sold which is the excess qs
minus qd so they can pay that to offset the dead
weight loss however there are cases where
you know the government can't use these
resources that they bought for use and then
it'll still be considered dead weight loss so
that's a little bit technical there okay
finally comparative statics the study of
the movement from one equilibrium to another
so if supply is constant and demand increases
this will shift the demand curve up and
to the right so the equilibrium price and the
quantity both increase if supply increases
this will shift the supply curve down and
to the right holding the demand curve constant
equilibrium price decreases and quantity
increases and if they both change the answer
is well it depends so if you look at this table
on 2.2 what it shows is depending on how
supply and demand both shift one thing will
be known for sure and the other is going
to be ambiguous The example we gave was if
demand increased and supply decreased we can
see his demand increasing but supply can increase
to S1 or S2. So if it increases to S1
it intersects with D1 of B, quantity and
price both increase but if it increases from
SO to S2 we can see price still increases
but quantity decreases. So an increase in
demand decreases supply will always increase
price, but the effect on quantity at
equilibrium is ambiguous. If you don't know
what to do, if you get a question
like this, draw it up, it'll
help you out. Okay, so we just
talked about the good parts of free markets
that can be efficient, but we also discussed
market failures, market power, so things
like monopolies and monopsonies, we'll
speak about that later, externalities,
public goods and incomplete
information. So an externality
is a cost or benefit to a
third party not involved in the
transaction. So a negative
externality is an overproduction of
the gourd because you're not taking
into account these external costs.
So the most common example
is pollution. So when a buyer and a
seller are interacting, they only really
care about their own willingness to pay
and own willingness to accept. You're
not taking into account how this
affects society at all. So no one's taking
into account how this pollution affects
third parties, so we overproduce in other words
the social cost which is the internal plus
external cost together is going to be
greater than just the internal cost of the
private cost there are a number of solutions
governments can you know enact for this
taxes one of the best ways to solve it they
actually call Pigoubian taxes so you heard
this in another class it's the same thing
permit submissions trading schemes regulation
congestion pricing positive externalities
have the same sort of flavor but in this
case is under production. There's a social
benefit for third parties, but no one's
taking this into account in their private value,
which is what they determine to enter
into the transaction. So the social benefit,
the internal benefit, plus the external
benefit is greater than just a private benefit,
which is the internal benefit, solutions,
subsidies to increase output to the socially
efficient level. We spoke about the Coase
theorem for negative externalities. So
if property rights are well defined and
there's low transaction costs then people
can come to solutions on their own so the
example we talked about is if your
neighbor's playing loud music you can come up
with some sort of deal pay them 50 bucks to
stop playing music for example depending
on people's values that can lead to both
parties being better off and solving the
negative externality finally the optimal
amount of a bad thing is not zero i asked what's
the optimal amount of car deaths on the
road the answer is not zero to get zero we
need to ban cars or you know set the the the
speed limit at zero or one mile an hour
wouldn't be good for anyone so what we want to
do is reduce the marginal cost of something
until it's equal the marginal benefit once
the marginal cost of something is greater
than the marginal benefit it's not worth abating
anymore whether it be pollution or even
you know people's lives on the road how we
value a life the value of a statistical
life another question entirely so this is our
negative externality you can see the internal
the private benefit here this is what the
free market equilibrium says but when you
take into account the external costs as you
can see here this is what the social optimum
is so the deadweight loss is between the
two supply curves above the demand curve and
where the excess is between the two equilibria
so that's this triangle here and the tax
can shift it up till we get to this point
similarly we're underproducing the free market
equilibrium for a positive externality
you can put in a subsidy as a result this shifts
demand up and to the right or you can do
it for the the supply curve as well i guess
as a result you get the social optimum here
go back to the notes to figure out the the
deadweight loss areas all right then we talked
about four types of goods based on two
terms rivalry and exclusionary so something's
rival it means your use of it affects the
quality of use of someone else or if they can
even use it at all excludability is
essentially you can exclude someone from accessing
the good and based on the four combinations of
these we have four types of goods private
goods rival and excludable you can't buy a
sandwich without paying for it and there's only
a limited number of sandwiches at the
starbucks club goods non -rival but excludable
paying for a streaming service but once you've
paid millions of people use at the same time
without being affected this holds for the most
part common resources rival but non-excludable
general in the ocean anyone can go and
fish you can't exclude anyone from doing that
there's only a limited number of fish in the
sea so if too many people go and fish
there'll be no fish left rivalry is there
finally public goods non -rival non-excludable
so national defense is is is a common example
use so for citizens my use of the national
defense doesn't affect your use and you can't
exclude a citizen from benefiting from
national defense so we had two types of market
failures as a result of this the first was a
tragedy of the Commons this is the idea that
individuals overuse common resources what's
individually optimal is not socially
optimal so we looked at do you invest in a bond
or purchase a cow to go graze in the field
we showed the private incentives for an
individual was to actually defect from the group
and go buy a cow, graze the field, even
if it made everyone else worse off. So
everyone has an incentive to go and fish in
the ocean, a private incentive. This will result
in overfishing, which has no fish left in
the future. This has happened multiple times,
so it's a big issue. This is a type of a
negative externality. Your action
has a negative effect on someone else, a third party. Then we talked
about some solutions don't worry so
much about that. Finally public goods
result in the free -rider problem where
individuals under contribute to the public
good. So we gave the example of streetlights,
how much would you be willing to
pay for streetlights? The thing is you
don't have to say how much you actually
value them because if other people
contribute to having them built you can
still access them. No one can exclude
you from using the streetlights and and
my use of the lights doesn't affect your
use of the lights we all get the same amount
of light from it. So this means people
always have an incentive to lie about their true
value and contribute nothing towards the
public good the other example i gave was
group projects you've probably all been in
the group project with it with a shitty group
member who's done nothing and got the same
grade as you this is because group projects
are a public good you can't exclude anyone
from getting the grade and your grade doesn't
affect their grade so everyone technically
has a incentive to free ride on their
group members hope their group members put in
the work they put in zero effort and get
the same grade there's a number of solutions
so government provision via taxes is a big one
and then there were some mech design things
we spoke about as well finally incomplete
and asymmetric information markets only
work if parties have you know sufficient
information and equal information so we spoke
about the market for lemons akaloff's famous
paper about the car market if buyers don't
know whether a car's high quality or a dud
slash lemon but sellers know for sure what it
is what will happen is buyers won't pay
full price for a quality car because they don't
know if the car is quality or not sellers
of the highest quality cars then won't sell
they're not getting enough value they leave
the market and this continues to happen
more and more quality sellers leave the market
until there's only lemons left so this
market untangles due to incomplete information
finally elasticity so we did a lot of math
in elasticity but at the end of the day
elasticity just measures the percentage change
in one variable given the percentage change
in another variable. So the elasticity
of exam score given attendance is how much
does someone score on the exam tonight
change in percentage terms given they
attended 1% more classes. That's just
all elasticity is. The main thing we
looked at was the own price elasticity of demand.
How does the quantity of a good change in
terms of percentage demanded if the price
changes in terms of percentage. So there's
two ways to calculate this. The first is
our basic elasticity equation, the percentage
change in quantity divided by the percentage
change in price. Sometimes you don't
get the percentage changes, but we can
find out through the slopes of the demand
function. So the change in quantity
given a change in price multiplied by price
divided by quantity. This is always going
to be negative by the law of demand as price
increases, quantity decreases. For elasticity,
we're interested in the absolute value. So
if the absolute value of the elasticity is
greater than 1, it's elastic, which means
there'll be a larger change in quantity than
there is the price. A 1% price increase will
result in more than a 1% decrease in quantity.
At unitary elastic, a 1% price increase
results in exactly a 1% price decrease in
quantity. And if it's inelastic, a 1% price
increase in price will resulting less than a one
percent price increase in quantity and the
three main determinants of elasticity are
one the substitutes how many substitutes
are available the more they are the more elastic
it is and that's why for those of you that
looked at it with Big G cereal and the Lucky
Charms Big G cereal is cereal as a whole
less substitutes for cereal but Lucky Charms
has a lot of different types of cereal can
be substituted with so Lucky Charms will always
be more elastic than big g cereal or cereal
as a whole share of the budget so if you
have something that's 80 of your budget
like rent if the price increases you have to
change something you don't have any other wiggle
room you'll need to downsize get a roommate
etc so the more share of a budget it takes
up the more elastic it is and finally is
time horizon you finish your exam at 9 30
tonight you walk out and gas prices have doubled
you need to get home you don't have time
to adjust you're going to just pay the double
price and get home but if you know the prices
are going to you know be that much in a
year's time you've got time to adjust you can
choose to take the bus buy a bicycle motorcycle
that uses less gas etc more the time
horizon the more elastic it is all right so this
is our demand curve here and as you can see
the elasticity changes along the demand
curve this is because our elasticity formula
is a change in quantity given the change in
price our demand curve is just the inverse
of that the inverse of that one over this however
this slope is always constant no matter
what so why is the elasticity changing at
every point because this is only one half of
our elasticity equation the slope the other half
is the price divided by quantity and this
is changing at each point so when you have
a very low price and high quantity this
is going to be a very small number so this
will be less than one and as price increases and
quantity decreases as you'll see if we move
up the curve here there will become more
and more elastic until it hits unitary elastic
then it hits the elastic zone that's why
it changes I'll get back to the marginal revenue
in a second so total revenue equals price
times quantity so we can figure out if
something will increase revenue or decrease
revenue by how much the price and quantity
changes. So if demand is elastic, if demand is
elastic, if we go here, demand is elastic,
then at $6, if we lower the
price to $5, so let's say we
lower the price by 1%, this is going
to result in more than an increase
of 1% in quantity. Price times
quantity, this increases your
revenue overall. When it's unitary
elastic, a 1% change in price results in a 1%
change in quantity so there'll be no difference
once you hit here and once you're in the
inelastic zone if you decrease price by 1%
you're going to get less than 1% of new customers
so that decision of the lower the price
won't pay off there. So as you can see
marginal revenue of low in your price is positive
while we're in the elastic zone and it
equals zero the marginal revenue equals zero
it's maximized at the unitary elastic point
and then it's negative if you're still lowering
the price in the inelastic zone and then
we can calculate the marginal revenue based
on price and elasticity it's just price times
one plus elasticity divided by elasticity
finally the marginal revenue curve is always
below the demand curve because when you change
the price it applies to all units not just
the next unit so if you lower your price
from six to five it's not just the second unit
you're selling at five now the first unit which
you originally sold at six you've got to
sell at five now as well okay so we can
do these elasticity calculations for the cross
price elasticity changes in the the price
of a substitute or complement and also for
income as well it's the exact same type of idea
so i'm not going to go over it again but this
helps us a to determine if something's a
substitute or a complement and whether it's
elastic or inelastic same for income with a
normal good and inferior good so finally we can
have a linear demand function that looks
like this quantity equals a function based
on the price of the own good price of other
good income etc and we can calculate all the
elasticities based on this slope multiplied
by the these other things so px divided
by qx the slope is just the alpha in front of
the relevant variable so for own price it's alpha
one for cross price it's alpha two for
income it's alpha three that's the slope how
does quantity change when there's a one unit
change in income or one unit change in price
of the other good one a unit change in price
of one good then we want to multiply it in
this case by px which we're given and quantity
of x which you can calculate for cross
price we want to we will get given py and
you need to figure out qx and then income
divided by qx for income elasticity if you get
the inverse demand function so px is on the
left hand side quantities on the right just be
aware the slope in front of quantity is
not gonna be the slope here it's gonna be 1
divided by the alpha just be aware of that so
just going back to here this slope here is
the change in P given the change in Q we want
the change in Q given the change in P so if
you do 1 divided by this slope it will give
you that just be aware of that finally if we
transform this linear equation by logs this
gives us the elasticity straight up so when
you transform by log what this means is
what happens if there's a one percentage change
in in the price of x how does that increase
or decrease the percentage change in
in in quantity so b1 b2 b3 are the elasticities
they are the elasticities you don't
need to do any calculations if you get the log
transform linear equation all right
great that's all i have for the revision
four weeks of content in 40 minutes is is
no joke um i got to do this again one more
time but let's finish up with the kahoot on
rationality so we're going to transport
back to last week if you can remember for
those of you that haven't attended those
lectures just guess um remember you still
get points for towards extra credit for
being wrong and i'm going to have a sip
of coke and water yeah daniel Could
you, is that the division of the
Bryce case? It's not, it's literally
just our slides. Like there's nothing
new on there, you can access it
everywhere else. I'm still trying
to decide how to upload it up in the
next class or not. I mean the exam is
in about four and a half hours, so
I'll think about it. Thoughts, exactly. Okay, are we waiting on anyone still? We all logged in. Brilliant, let's get
started. So let's get back into our
rationality mindsets. Persons' preferences are complete and transitive. They are rational. True or false? Hopefully a bit of a softball to get
us started. I wonder if there's
a setting that just ends it when
everyone answers, because I think
everyone's answered. Okay, great. That's
just a definition of rationality
in economics. Most people
got that right. Brilliant. Next question. Which of the following
binary relations for the set of all people
is not transitive? not transitive is taller
than is in love with his siblings with is
an ancestor of five seconds left take a
crack if you don't know hey brilliant most
people got that right remember transitivities
if A is related to B B is related to C A
is related to C that's correct for all them
except is in love with so for example
if Daniel's in love with me and I'm in love
with Eric that does not mean Daniel is
in love with Eric transitivity doesn't apply
in that situation. In most cases it doesn't
apply I should say. New leader. Okay,
third question. The binary relation is
taller than the set of all people is complete.
True or false? I don't know if anyone
else had those height walls growing up but
that were good fun. Alright, most people
got that right. False. Remember
this is why the weak preference relation
is so important. If two people are
the same height you can't compare
them in any way if you use is taller
then so at least as tall as would be a
complete relation fourth question
what is the expected value of the following
lottery win 10 bucks with 50 chance
win four bucks with 50 chance the
expected value quick match everyone got that one
right that's that's great but for those of
you that didn't remember expected value is
just an outcome times the probability of
that outcome occurring and add them all together
so you've got a 50 percent chance of
winning $10, 0.5 times 10 is 5. 50% chance of
winning $4, 0.5 times 4 is 2. Add it together,
5 plus 2 equals 7. That's the expected
value of this lottery. Hey, penultimate
question. I'm not going to
pick on the leader. It's way too close
up the top until the last question. So
penultimate question. The next $1 gain
provides less utility than the previous $1
gauge. True or false? $2.50. See how we do? Okay, so this was
half and half. So yes, remember, we have this
idea of diminishing marginal utility. The
next dollar is always worth less than the
previous dollar to you. It could be with anything
really. We actually showed with Ivan and
Christian, are your shoulders still
hurting from last week? No, I feel great.
Oh, you feel great. That's awesome. But
we saw, as they were doing push ups, they
started off fast, but then they fatigued
heavily as we went along. so it's the
same idea with money the first bit of money
is worth a lot to you but then it slows
down over time same with eating food as
well the first bite of a cake gives you
a lot of enjoyment then that enjoyment
slightly decreases for the next extra
piece of cake you eat ok, final question ok, this
isn't a clear leader so I don't want to
call anyone out here ok, final question which indifference
curve provides the highest utility? Which
indifference curve in the picture provides
the highest utility? No, it's not
the best worded question in the
world, so, yeah. Most people
got that right. Up and to the right gives you the higher
utility. Okay, let's see who
our winner is. Okay, who's
Apple Pie Deer? Congratulations. Is this, uh, how
many wins now? First. First win.
Congratulations. What do you want? A guy. Yeah, yeah. The classic. I mean,
it's a kangaroo with a pie. Exactly.
All right, remember, 5.30, probably a
little bit after 5.30 because of the walk,
I'll be in Rawls, so feel free to come
out and hang out there. Otherwise,
I'll see you all tonight. Best of luck
with your studying. Sir, quick question.
Hey, what's up? So, the blue is
deadweight loss or the red is deadweight loss?
So, they both are. So, yeah, so this is the
deadweight loss from the opportunity cost,
but this deadweight loss, all up here, is
because it costs to produce all the goods
that aren't sold so the government will buy
yeah so at the price of the of the floor they'll
buy this amount yeah okay yeah that's how
they try and offset that but there's
still dead weight loss because you still have
the opportunity to call it yeah another one
is if I do the capital wrong so do I still
get the extra point or if you want if you
didn't do it yeah if I did it wrong oh yeah
you still get half a point for a wrong answer
you could get every question wrong with
my semester and you'll still get an extra credit
point okay yeah and you only need to get
I think 50% correct to get two extra credit
points oh really well if you think about
this is a 75% threshold so 50% from just working
like doing it what about 50% hmm that's
for me to incentivize the people higher I
think it's I think it's 80% 80 or 90 is a 90
percent correct to get there the thresholds
90% but that means you can get 50% of the
points from wrong so you only need to get
80% or higher I believe to get the she's
doable she's definitely doable yeah I have a
question so what's that on the practice exam
you don't include the the company growth
rate like the one plus art yeah no that's
not on the exam I said that's not on the exam
oh you said that yeah I said anything that
I'm not giving you a formula for won't be on
the exam so that won't be on the exam and
that crazy cross price elasticity equation
which you saw in the homework won't be on
the exam either so the