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Slides to Accompany Microeconomics Lecture Notes 1 through 6
1
Food Stamps Versus Cash All other goods per month
Budget line with cash
Y + 100
Y
f C
e
I3
d
I2 I1 B Budget line with food stamps
A
0
Original budget line 100
Y
Y + 100 Food per month
2
Substitution and Income Effects with Normal Goods Wine, Gallons per year 12.0
L2
L1
e2
5.5 L*
I2 e1 e* I1
0
26.7 30.6 58.9 Substitution Income effect effect Total effect
Beer, Liters per year
3
Giffen Good Football, Tickets per year
L2 L1
e2
I2
L* e1
e*
Total effect
Substitution effect
I1 Movies, Tickets per year
Income effect
4
Income and Substitution Effects of a Wage Change Y, Goods per day
Time constraint
I2
L2 I1
L*
e2
e*
L1 0 24
e1 N* H*
N1 N 2 H1 H 2
24 0
N , Leisure hours per day H, Work hours per day
Substitution effect Total effect Income effect
5
Labor Supply Curve That Slopes Upward and Then Bends Backward (a) Labor-Leisure Choice Y, Goods per day
L3
Time constraint
I3
I2 I1 L2
e3 e2
L1 24
e1 H2
H 3 H1 0 H, Work hours per day 6
The Decision to Insure B
¶ ) U (M
MU declines as income rises.
C A
M1
¶ M M
M2
Income
7
Risk Aversion Utility, U
c
U ($70) = 140 0.1U ($10) + 0.9U ($70) = 133
0.5U ($10) + 0.5U ($70) = U ($26) = 105
U($10) = 70
0
f
d
U ($40) = 120
U (Wealth)
e b
a
10
26
40
64
70 Wealth, $
Risk premium
8
Risk Neutrality Risk-Neutral Individual Utility, U
c
U ($70) = 140 0.5U ($10) + 0.5 U($70) = U ($40) = 105
U ($10) = 70
0
U (Wealth)
b
a
10
40
70
Wealth, $
9
Risk Preference Risk-Preferring Individual Utility, U U (Wealth) c
U ($70) = 140
0.5 U ($10) + 0.5U ($70) = 105 U ($40) = 82 U ($10) = 70
0
b
a
10
e
d
40
58 70
Wealth, $
10
Decision Trees A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting, B) Construct new facilities. C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management ranks the respective probabilities as .10, .50, and .40. A cost analysis that reveals the effects upon returns is shown in the following table. 11
Payoff Table
A B C
0.1 Low 10 -120 20
0.5 Medium 50 25 40
0.4 High 90 200 60
12
Then add our possible states of nature, probabilities, and payoffs High demand (.4) Medium demand (.5) Low demand (.1)
A
High demand (.4)
B
Medium demand (.5) Low demand (.1)
C
High demand (.4) Medium demand (.5) Low demand (.1)
$90k $50k $10k $200k $25k -$120k $60k $40k $20k
13
Determine the expected value of each decision High demand (.4)
$62k
Medium demand (.5) Low demand (.1)
$90k $50k $10k
A
EVA=.4(90)+.5(50)+.1(10)=$62k We can determine the EV for B and C 14
Solution High demand (.4)
$62k A B
$80.5k
Medium demand (.5) Low demand (.1) High demand (.4) Medium demand (.5) Low demand (.1)
C
High demand (.4)
$46k
Medium demand (.5) Low demand (.1)
$90k $50k $10k $200k $25k -$120k $60k $40k $20k
15
1
Food Stamps Versus Cash All other goods per month
Budget line with cash
Y + 100
Y
f C
e
I3
d
I2 I1 B Budget line with food stamps
A
0
Original budget line 100
Y
Y + 100 Food per month
2
Substitution and Income Effects with Normal Goods Wine, Gallons per year 12.0
L2
L1
e2
5.5 L*
I2 e1 e* I1
0
26.7 30.6 58.9 Substitution Income effect effect Total effect
Beer, Liters per year
3
Giffen Good Football, Tickets per year
L2 L1
e2
I2
L* e1
e*
Total effect
Substitution effect
I1 Movies, Tickets per year
Income effect
4
Income and Substitution Effects of a Wage Change Y, Goods per day
Time constraint
I2
L2 I1
L*
e2
e*
L1 0 24
e1 N* H*
N1 N 2 H1 H 2
24 0
N , Leisure hours per day H, Work hours per day
Substitution effect Total effect Income effect
5
Labor Supply Curve That Slopes Upward and Then Bends Backward (a) Labor-Leisure Choice Y, Goods per day
L3
Time constraint
I3
I2 I1 L2
e3 e2
L1 24
e1 H2
H 3 H1 0 H, Work hours per day 6
The Decision to Insure B
¶ ) U (M
MU declines as income rises.
C A
M1
¶ M M
M2
Income
7
Risk Aversion Utility, U
c
U ($70) = 140 0.1U ($10) + 0.9U ($70) = 133
0.5U ($10) + 0.5U ($70) = U ($26) = 105
U($10) = 70
0
f
d
U ($40) = 120
U (Wealth)
e b
a
10
26
40
64
70 Wealth, $
Risk premium
8
Risk Neutrality Risk-Neutral Individual Utility, U
c
U ($70) = 140 0.5U ($10) + 0.5 U($70) = U ($40) = 105
U ($10) = 70
0
U (Wealth)
b
a
10
40
70
Wealth, $
9
Risk Preference Risk-Preferring Individual Utility, U U (Wealth) c
U ($70) = 140
0.5 U ($10) + 0.5U ($70) = 105 U ($40) = 82 U ($10) = 70
0
b
a
10
e
d
40
58 70
Wealth, $
10
Decision Trees A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action: A) Arrange for subcontracting, B) Construct new facilities. C) Do nothing (no change) The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management ranks the respective probabilities as .10, .50, and .40. A cost analysis that reveals the effects upon returns is shown in the following table. 11
Payoff Table
A B C
0.1 Low 10 -120 20
0.5 Medium 50 25 40
0.4 High 90 200 60
12
Then add our possible states of nature, probabilities, and payoffs High demand (.4) Medium demand (.5) Low demand (.1)
A
High demand (.4)
B
Medium demand (.5) Low demand (.1)
C
High demand (.4) Medium demand (.5) Low demand (.1)
$90k $50k $10k $200k $25k -$120k $60k $40k $20k
13
Determine the expected value of each decision High demand (.4)
$62k
Medium demand (.5) Low demand (.1)
$90k $50k $10k
A
EVA=.4(90)+.5(50)+.1(10)=$62k We can determine the EV for B and C 14
Solution High demand (.4)
$62k A B
$80.5k
Medium demand (.5) Low demand (.1) High demand (.4) Medium demand (.5) Low demand (.1)
C
High demand (.4)
$46k
Medium demand (.5) Low demand (.1)
$90k $50k $10k $200k $25k -$120k $60k $40k $20k
15
