INTERMEDIATE MICROECONOMICS 1 BY SAMIRAN BANERJEE CONTENTS 1

INTERMEDIATE MICROECONOMICS (1) BY SAMIRAN BANERJEE

CONTENTS 1. MARKETS 1. 1 MARKET DEMAND SUPPLY 1. 2 DETERMINANTS OF DEMAND SUPPLY 1. 3 MARKET INTERVENTIONS 1. 4 ELASTICITIES 2. BUDGETS 2. 1 COMMODITY SPACE 2. 2 COMPETITIVE BUDGETS 2. 3 CHANGES IN PRICES OR INCOME 2. 4 NON-COMPETITIVE BUDGETS 2

CONTENTS 3. PREFERENCES 3. 1 BINARY RELATIONS 3. 2 PROPERTIES OF BINARY RELATIONS 3. 3 UTILITY REPRESENTATION OF PREFERENCES 3. 4 TYPES OF PREFERENCES 3. 5 THE NOTION OF UTILITY 3. 6 UTILITY, PREFERENCES AND PROPERTIES 3. 7 SPECIAL TOPICS 4. INDIVIDUAL DEMANDS 4. 1 PREFERENCE MAXIMIZATION ON BUDGETS 4. 2 CALCULATING INDIVIDUAL DEMANDS 4. 3 TWO PROPERTIES OF DEMAND FUNCTIONS 3

CONTENTS 5. CONSUMER COMPARATIVE STATICS 5. 1 PRICE AND INCOME CONSUMPTION CURVES 5. 2 INDIVIDUAL ELASTICITIES OF DEMAND 5. 3 DECOMPOSING PRICE EFFECTS 4

CHAPTER 1 MARKETS 5

1. 1. MARKET DEMAND SUPPLY ASSUMOTIONS: • A SINGLE PRODUCT (SAY, THE MARKET FOR STEEL) • A SPECIFIC GEOGRAPHICAL AREA • RELATIVELY SHORT TIME PERIOD, SUCH AS A FEW MONTHS. 6

1. 1. 1. PLOTTING A MARKET DEMAND FUNCTION • 7

… 1. 1. 1. PLOTTING A MARKET DEMAND FUNCTION • 8

… 1. 1. 1. PLOTTING A MARKET DEMAND FUNCTION Figure 1. 1 Marketdemand Law of Demand’: keeping all other factors fixed, as the price of a product increases, its quantity demanded decreases. 9

… 1. 1. 1. PLOTTING A MARKET DEMAND FUNCTION • 10

• 1. 1. 2 AGGREGATING DEMAND FUNCTIONS 11

… 1. 1. 2 AGGREGATING DEMAND FUNCTIONS 45 ≤ p < 60: 0 ≤ p < 45: Figure 1. 2 Aggregate demand 12

… 1. 1. 2 AGGREGATING DEMAND FUNCTIONS Figure 1. 2 Aggregate demand 13

… 1. 1. 2 AGGREGATING DEMAND FUNCTIONS 250 − 5 p if 0 ≤ p < 45 100 − 5/3 p if 45 ≤ p ≤ 60 inverse aggregate demand: Figure 1. 2 Aggregate demand 14

1. 1. 3 PLOTTING A MARKET SUPPLY FUNCTION • 15

… 1. 1. 3 PLOTTING A MARKET SUPPLY FUNCTION Figure 1. 3 Market equilibrium 16

1. 1. 4 MARKET EQUILIBRIUM 17

… 1. 1. 4 MARKET EQUILIBRIUM Stable equilibrium: Any deviation from equilibrium will be automatically redressed by market forces to restore the price back to its equilibrium level 18

… 1. 1. 4 MARKET EQUILIBRIUM Figure 1. 3 Market equilibrium 19

… 1. 1. 4 MARKET EQUILIBRIUM Figure 1. 3 Market equilibrium 20

1. 1. 5. CONSUMER AND PRODUCER SURPLUS In any voluntary transaction between a buyer and a seller, trade takes place at some price between the maximum price a buyer is willing to pay and the minimum price a seller is willing to accept • INDIVIDUAL CONSUMER SURPLUS: Thedifferencebetweena buyer’s maximum price and the actual price paid • INDIVIDUAL PRODUCER SURPLUS: The difference between the price received by a seller and the minimum price this seller is 21 willing to accept

. . . 1. 1. 5. CONSUMER AND PRODUCER SURPLUS The sum of consumer and pro- ducer surpluses is a measure of the gains from trade in this market and re- garded as an index of market efficiency Figure 1. 4 Consumer and producer surplus 22

1. 2 DETERMINANTS OF DEMAND SUPPLY • The market demand for any product depends on several variables other than the price of that product • (A) The income levels of potential buyers, • (B) The prices of other goods, • (C) The tastes or preferences of buyers, and • (D) The number of buyers • A change in any of these couses a shift in market demand curve 23

. . . 1. 2 DETERMINANTS OF DEMAND SUPPLY • A good with a positive income effect is called a normal good • A good with a negative income effect is called an inferior good. • An increase in the price of a substitute good would make consumers buy more of the good • An increase in the price of a complement is likely to cause a decrease in the demand for this product 24

1. 3 MARKET INTERVENTIONS 1. 3. 1 PRICE CEILINGS • Is a maximum price imposed on a particular product • The sellers have to engage in rationing • Leads to a market disequilibrium • Aria C shows the deadweight loss of a price ceiling 25

. . . 1. 3 MARKET INTERVENTIONS 1. 3. 2 PRICE FLOOR • Is a minimum price imposed on a particular product • Leads to a market disequilibrium • Aria C shows the deadweight loss of a price floor 26

. . . 1. 3 MARKET INTERVENTIONS 1. 3. 3 QUOTAS • A quota is a maximum quantity limit imposed on a particular product • For a quota to be effective, the quantity limit has to be less than the original market equilibrium quantity. 27

. . . 1. 3 MARKET INTERVENTIONS 1. 3. 4 TAXES • Taxes may be either per-unit or ad valorem, and imposed on either sellers or buyers. • Per-unit tax: Fixed dollar amount for each unit traded. • Ad valorem: Tax on the value of a sale. 28

. . . 1. 3 MARKET INTERVENTIONS A PER-UNITTAX TAXON ON SELLERS • Sellers earned $10 on each • Suppose a tax, t, of $6 per unit sold previously, but now unit is imposed on sellers. they earn 14 − 6 = $8 net of • taxes, i. E. , $2 less than Then, each seller will raise before. the minimum price she is • This $2 is the incidence of willing to accept by the tax on sellers. amount of this tax, thereby shifting the inverse supply • The price difference of 14 − 10 = $4 is called the curve up by $6 at each incidence of the tax on point 29

. . . 1. 3 MARKET INTERVENTIONS TAX ONON BUYERS A PER-UNIT TAX BUYERS • Suppose the tax of $6 had been • imposed on buyers instead of Buyers have to pay 8 + 6 = sellers. $14 to purchase one unit of • Since buyers have to pay the good, while sellers tax after they purchase the product, each buyer will lower receive $8 for each unit her maximum price by the sold. amount of the tax • • Thus the incidence of the Thereby shifting the demand tax on buyers is still $4 curve down by $6 at each point. while that on sellers is still $2. T.

. . . 1. 3 MARKET INTERVENTIONS Subsidies A subsidy is a negative tax subsidies may be per-unit or ad valorem Suppose a per unit subsidy: per-unit subsidy moves every point on the original supply down vertically by this amount the consumer surplus after the subsidy increases substantially to area A the producer surplus shown by area B is also larger. this is not the aggregate gains from trade since this surplus of A + B ($147) does not include the cost of the subsidy to the

. . . 1. 3 MARKET INTERVENTIONS Subsidies Subtracting the cost of the subsidy from A+ B we obtain the new gains from trade after the subsidy to be equal to $63, which is less than the original gains from trade of $75 by $12. the aggregate gains from trade are smaller than the original gains from trade by the triangle C which is the deadweight loss of the subsidy

1. 4 ELASTICITIES Demand Elasticities measure the responsiveness of the quantity demanded to changes in different determinants of demand, such as • THE PRICE OF THE PRODUCT • INCOME • PRICES OF OTHER GOODS. 33

1. 4. 1 PRICE ELASTICITY OF DEMAND • 34

1. 4. 1 PRICE ELASTICITY OF DEMAND • 35

1. 4. 1 PRICE ELASTICITY OF DEMAND we say that the demand is elastic or responsive to price changes because the percentage change in the quantity demanded is greater than the percentage change in price in absolute terms |ε| > 1: elastic ε = -1: unit elasticity |ε| < 1: inelastic different points on a linear demand have different price elasticities: from −∞ at the vertical intercept, the price elasticity shrinks in absolute value to − 1 at the halfway point, to zero at the horizontal intercept 36