P. 8-11 Utility + demand + supply + indifference curves + elasticities + Cobweb, p119.

Marginal utility or cardinalists' approach (measuring exact utility).

Consumers maximise the utility within their income. They base the purchasing decisions on marginal utility and react to equilibrium when =.

Consumers' expenditure is limited and he must distribute it between different commodities.

Indifference curves or ordinalists' approach (ranking utilities).

The rate at which a consumer is willing to exchange one unit of one product for units of another is termed the marginal rate of substitution. It's given by the slope of the indifference curve. A movement to right is to bigger total utility.

Budget line shows all the combinations of two products that can be purchased with a given level of income. The slope of the line shows the relative prices of the two goods.

At equilibrium the budget line is tangent to indifference curve (relative prices are equal to marginal rate of substitution).

Applications

1.   Price consumption line

If the price of 1 good changes, the budget line pivots. All the new 2 quantities attainable form price consumption line. From this line we can derive the normal demand curve.

2.         Effect of a rise in income - consumer moves to higher indifference curve.

3.         Effects

People buy more of the good if the price of product falls:

      It's cheaper (substitution effect), budget line moves parallel to new budget line in the old indifference curve.

      The fall in price leaves them more income to spend (income effect). Move parallel by consumption line to new indifference curve.

Demand-

various amounts of a good or service that consumers are willing and can by at various prices in a given period of time-

Factors affecting demand:

1.income,2.population,3.seasonal factors,4.tastes and fashion,5.change in the price of substitutes,6.change in the price of complements, advertising, price, government influences, distribution of income

Elasticity of demand:

>1-elastic,price up revenue down<1-inelastic-price up, revenue up=1-unit el.

=0-perfectly in

=oo-perfectly el.

Factors affecting elasticity:

1.     Avail. of substitutes

2.     Proportion of income spent

3.     Durability

4.     Addiction

5.     Economic and human constraints

6.     Time period

7.     number of substitute uses (the more the more elastic)

8.     type of product(luxury)

9.     How closely defined-oil, Esso

change in Q/change in P

Cross El-change in Q prod B/change P in A (+ substitutes -complements)

Income El-change in Q/change in income,  + normal -inferior

Supply-

The various amounts of a good or service producers are willing to put on the market at various prices in a given period of time.

Determinants

1.change in the price of a factor of production 2.change in the state of technology 3.govn intervention 4.new firms entering the industry, price, the price of other commodities, tastes of producers, exogenous factors (weather).

Elasticity Periods (Marshall)

i.     Momentary - absolutely inelastic.

ii.    Short run - with the limit of present fixed costs

iii.    Long run - depends on factors:

       1.         Time

       2.         Factor mobility

       3.         Natural constraints

       4.         Risk taking

Government intervention:

          flat price - any artificially imposed price

Creates black market (e.g. in Russia)

          ceiling price - the maximum price imposed

1.     Wartime controls (coupons)

2.     Rent control (abolished in 1988)

3.     Interest (low interest rates will create a shortage of supply)

          price floor - minimum price

1.     Agricultural prices (CAP)

2.     Minimum wages (creates unemployment)

3.     Exchange rates

          Price stabilisation

Applied to farmers.

Cobweb theorem. Factors modifying:

1.     Producers learn from experience

2.     Distributed time lags

3.     Unplanned variations of supply will modify further (especially in agriculture)

4.     Prices might be inflexible (change too slow to bring about a change)