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To do today: Finish cross elasticity and income elasticity Inequality Efficiency: Marginal costs and benefits See my email for the reading assignments from Akerlof and Schiller for the discussions starting next Wednesday. No homework this weekend. Next due date February 17th. © 2011 Pearson Education Income elasticity of demand A measure of the extent to which the demand for a good changes when income changes, other things remaining the same. Income elasticity of demand = % change in Qd % change in income Income elasticity of demand for chocolate: Who has the biggest sweet tooth? Total consumption l USA 0.79 l Germany 0.39 l United Kingdom 0.44 l France 0.60 l Japan 0.08 l Switzerland 1.06 Reference: Henri Jason Trends in cocoa and chocolate consumption with particular reference to developments in the major markets. Malaysian International Cocoa 100000 Singapore Hong Kong China Airline travel (000) per capita 10000 New Zealand Australia Switzerland US Netherlands Canada Denmark UK Ecuador Norway France Spain Japan Finland Malaysia Belgium Greece Ireland Saudi Arabia Germany Sweden Portugal Austria Thailand Korea Rep Panama Dominican Rep Italy S. Africa Lebanon Chile Costa Rica Brazil Mexico Peru Venezuela Philippines TunisiaHungary Argentina Sri Lanka Colombia Czech Rep KenyaZimbabweBulgaria Turkey Uruguay Croatia Cote D'Ivoire Slovenia SyriaLithuania Pakistan Poland Paraguay Romania VietnamChinaAlgeria Iran Cameroon Belarus India Ukraine Nigeria Bangladesh Israel 1000 100 10 0 5000 10000 15000 20000 GNP per capita ($ PPP) 25000 30000 35000 Cross Elasticity Suppose that when the price of a burger falls by 10 percent, the quantity of pizza demanded decreases by 5 percent. Cross elasticity of demand = – 5 percent – 10 percent = 0.5 Cross Elasticity of Substitutes vs. Complements Cross elasticity of demand for a substitute is >0 • Fall in the price of Pepsi: decrease in consumption of Coke • Qd of coke and P of its substitute change in the same direction. • Make sure you know why for complements the QD and P change in opposite directions. What determines fairness? Equal opportunity Equal outcomes Inequality and efficiency Main concern of neoclassical theory is efficiency Efficiency defined by marginal cost and marginal benefit What about inequality? Inequality Inequality Income share by income group Inequality in opportunity as well as outcomes Efficiency: Marginal benefits (MB) MB: what people are willing to forgo to get one more unit of the good. MB decreases as the quantity of the good increases— the principle of decreasing marginal benefit Marginal Cost (MC) MC increases as more of the good is produced. MC curve shows the amount of other goods and services that we must give up to produce one more pizza. Another look at the demand curve A demand curve (D) is a marginal benefit curve. D shows the value the consumer places on each pizza. This is equal to MB. MB and consumer surplus Consumer surplus is the MB from a good or service minus the price paid for it, summed over the quantity consumed. Consumer Surplus (CS) and total benefit CS from the 10,000 pizzas = MB – P for all the pizzas. CS = $ The total benefit is expenditure on pizza + consumer surplus = $ From the Production (Supply) Side of the Market Supply and Marginal Cost Sellers distinguish between cost and price. • Cost is what a seller must give up to produce the good. • Price is what a seller receives when the good is sold. The cost of producing one more unit of a good or service is its marginal cost (MC). Cost, Price and Producer Surplus A supply curve (S) is a MC curve. S tells us the dollars worth of other goods and services that firms must forgo to produce one more pizza. That is, the S shows the seller’s cost of producing each unit of pizza. Producer Surplus Producer surplus is the price of a good minus the opportunity cost of producing it, summed over the quantity produced. Cost, Price and Producer Surplus (PS) PS = P - MC P = $10 PS is the triangle equivalent to CS (upside down)