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1
GOAL OF ECONOMICS FOR THE INDIVIDUAL
MAXIMIZE HAPPINESS: “UTILITY”
SUBJECTIVE AS TO WHAT COMPOSES A PERSON’S “UTILITY FUNCTION”
* RESOURCES* LEISURE* OTHER PERSON’S UTILITY* GLOBAL GOALS
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HOW MUCH SHOULD YOU “SEARCH” FOR HAPPINESS?
TIME LOOKING FOR LOWEST GAS PRICE
TIME LOOKING FOR BEST APARTMENT
TIME LOOKING FOR BEST JOB
TIME LOOKING FOR PERFECT MATE
SEARCH INVOLVES TIME (AND SOMETIMES, MONEY) COSTS
OPPORTUNITY COST OF SEARCH (WEB INFORMATION HAS REDUCED)
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THE DEMAND CURVE
“WANTS” AND “NEEDS” – WHAT YOU’D LIKE TO HAVE NOT RECOGNIZING PRICE
“DEMAND” – HOW MUCH YOU BUY AT A GIVEN PRICE
COMPARE THE SUBJECTIVE VALUE YOU DERIVE TO PRICE
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CONCEPT OF “MARGINAL VALUE” – WHY WE BUY MORE WHEN PRICE FALLS
ADDITIONAL AMOUNTS OF SOMETHING ARE WORTH LESS TO US THAN EARLIER AMOUNTS
AT $3/GALLON, 20TH GALLON IS JUST WORTH $3 TO MARY
TO BUY 21ST GALLON, PRICE WOULD HAVE TO FALL TO $2.90
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ILLUSTRATES THE IDEA OF “MARGINAL DECISION-MAKING”
MOST OR OUR DECISIONS INVOLVE SMALL CHANGES – BUY ONE MORE GALLON OF GAS; SPEND ONE MORE HOUR STUDYING
COMPARE BENEFITS OF BUYING ONE MORE GALLON OF GAS TO BENEFITS OF SPENDING THAT MONEY IN ANOTHER WAY
COMPARE BENEFITS OF STUDYING ONE MORE HOUR TO BENEFITS OF USING THAT HOUR IN ANOTHER WAY
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IDEA OF CONSUMER SURPLUS
IF BUY AT SAME PRICE PER UNIT FOR ALL UNITS, THEN GET A “BARGAIN” ON EARLIER UNITS WHERE WILLING TO PAY MORE
IN EXAMPLE, WHEN PRICE IS $5, CONSUMER SURPLUS IS $4+$3+$2+$1=$10
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SELLERS TRY TO “EXTRACT” CONSUMER SURPLUS
CHANGING FEATURES OF PRODUCT SO NOT SAME TO ALL
DIVIDING BUYERS INTO DIFFERENT GROUPS (MARKET SEGMENTATION – MORE LATER)
ULTIMATE EXAMPLES – HOME AND CAR BUYING – UNIQUE PRICE TO EACH BUYER
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ANOTHER EXAMPLE IS TWO-PART PRICING
FIRST PART – PAY AN ENTRANCE FEE
SECOND PART – PAY FOR NUMBER OF UNITS
EXAMPLES AMUSEMENT PARKS BIG-BOX STORES
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CAUTIONS ON COMPARING PRICES
MOST PRICES INVOLVE TRADE-OFFS
THE ADAGE “TOO GOOD TO BE TRUE” IS OFTEN RELEVANT
FOR PRICES* SAME PRODUCT CHARACTERISTICS?* SERVICE CONTRACTS, DELIVERY?* WARRENTIES?* PAY NOW VERSUS PAY LATER?
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IMPACT OF INCOME ON HOW MUCH WE BUY
“NORMAL GOOD” – HIGHER INCOME PERSON BUYS MORE AT EVERY PRICE
“INFERIOR GOOD” – HIGHER INCOME PERSON BUYS LESS AT EVERY PRICE * SECOND HAND CLOTHES * FAST FOOD * USED VEHICLES
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EXAMPLES OF NORMAL AND INFERIOR GOODS
MIKE MARY ($20,000) ($150,000)Fast food burgers per month 20 3
Pairs of new shoes per year 1 15
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PRICE OF COMPLEMENTS
COMPLEMENTS – PRODUCTS THAT YOU LIKE TO CONSUME TOGETHER - BACON AND EGGS
PRICE OF BACON UP, EAT LESS BACON AND EAT LESS EGGSPRICE OF BACON DOWN – EAT MORE BACON AND EAT MORE EGGS
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PRICE OF SUBSTITUTES
SUBSTITUTES – PRODUCT THAT CAN USE IN PLACE OF ANOTHER - CHICKEN AND BEEF
PRICE OF CHICKEN UP – EAT LESS CHICKEN AND EAT MORE BEEFPRICE OF CHICKEN DOWN – EAT MORE CHICKEN AND EAT LESS BEEF
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IMPORTANCE OF LOCATION TO PRODUCT PRICE
CONSUMERS ARE WILLING TO PAY MORE FOR PRODUCTS SOLD IN MORE CONVENIENT LOCATIONS-- HOUSING-- GAS MORE EXPENSIVE AT CONVENIENTLY LOCATED STATIONS
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GREAT EXAMPLE – IMPACT OF SCHOOLS ON HOME PRICES
HOMES IN NEIGHBORHOODS WHERE STUDENTS PERFORM BETTER ACADEMICALLY SELL FOR MORE, AFTER ADJUSTING FOR ALL OTHER FACTORS THAT AFFECT HOME VALUES
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BUYING VERSUS RENTINGADVANTAGES OF OWNING:
• FREEDOM OF USE• SECURITY OF POSSESSION• FOR SOME, POTENTIAL FOR INVESTMENT
GAINS - POSSIBLE FOR HOMES - RARELY FOR VEHILCES• OFTEN LOWER COST OVER LONG-RUN
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BUYING VERSUS RENTING, IIRENTING ADVANTAGES:
• EASIER TO CHANGE• NO RISK OF LOSS• POSSIBLE SHORT-RUN SAVINGS SINCE DON’T PAY FOR DEPRECIATION
HAS THERE BEEN A PERMANENT CHANGE IN THE ECONOMICS OF OWNING VERSUS RENTING?
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PREFERENCES PERSONAL “LIKES” AND “DISLIKES”
I’LL BUY MORE TIES THAN YOU AT ANY PRICE
YOU’LL BUY MORE FLIP-FLOPS THAN ME AT ANY PRICE
ROLES OF ADVERTISING, AGE, PEERS
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POTENTIAL USE OF “BROKERS” TO ACQUIRE INFORMATION
WHEN INFORMATION IS TIME-CONSUMING TO ACQUIRE, OR DIFFICULT TO UNDERSTAND, BUYERS SOMETIMES USE A BROKER
BROKER COLLECTS THE INFORMATION AND ANALYZES FOR THE BUYER
PAID FOR SERVICESQUESTION: WHO PAYS THE BROKER?
INTERNET HAS REDUCED THE COST TO BUYERS OF ACQUIRING INFORMATION
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CREDIT AND BUYING USING CREDIT (BORROWING) CAN INCREASE YOUR ABILITY TO SPEND TODAY
EFFECTIVELY BORROWING AGAINST FUTURE INCOME
CONCERN – ABILITY TO REPAY IN FUTUREWILL ALWAYS PAY MORE DUE TO INTEREST CHARGES
BEST USED FOR “DURABLE” PRODUCTS AND INVESTMENTS – SOMETHING THAT HAS FUTURE BENEFITS
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SEE EVERYDAY ECONOMICS
CHAPTER 12: HOW MUCH IS TOO MUCH DEBT?
CHAPTER 13: HOW TO GET OUT OF DEBT
BEWARE OF “DEBT CONSOLIATION AND PAYMENT” SCHEMES
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SMART BUYING
CONSIDER WHAT CAN BUY WITH SAME MONEY (OPPORTUNITY COST)
CONSIDER CURRENT AND FUTURE COSTS - VEHICLE – PURCHASE PRICE AND ANNUAL OPERATING COSTS
PAY MORE NOW TO SAVE LATER? – HOW JUDGE (MORE LATER)
BUY “OFF-PEAK” (OUT-OF-SEASON) TO SAVE
WAIT – PRICE LOWER IN FUTURE?
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SMART BUYERS ALSO IGNORE “SUNK COSTS” IN THEIR DECISIONS
COSTS THAT YOU’VE PAID AND CAN’T GET BACK
IRRELEVANT TO THE FUTURE
EXAMPLE: PAID $200 FOR PLANE TICKET TO WASHINGTON FOR A JOB INTERVIEW; CHANCE TO HAVE AN INTERVIEW HERE FOR A BETTER JOB – DO THE INTERVIEW HERE AND FORGET THE $200
24
TIME AND MONEY
VALUE OF MONEY DEPENDS ON AMOUNT AND WHEN IT’S PAID OR RECEIVED
USUALLY, PRICES ARE HIGHER IN THE FUTURE AND LOWER IN THE PAST
SO DOLLARS IN PAST ARE WORTH MORE – GREATER PURCHASING POWER THAN DOLLARS TODAY
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DEFINITIONS
“NOMINAL DOLLARS” - “ACTUAL” DOLLAR AMOUNTS, UNADJUSTED FOR PURCHASING POWER
“REAL DOLLARS” – DOLLARS ADJUSTED FOR PURCHASING POWER
CONVENTION – EXPRESS DOLLARS IN THEIR PURCHASING POWER OF THE CURRENT YEAR (2014)
26
USE PRICE INDICES TO SHOW HOW PURCHASING POWER OF DOLLAR HAS CHANGED
EXAMPLE: CONSUMER PRICE INDEX VALUE OF 100 IN 1983 VALUE OF 218 TODAY (2014) MEANS TAKES $2.18 TODAY TO PURCHASE WHAT $1.00 BOUGHT IN 1983 THEREFORE, IF EARNED $10,000 IN 1983, WOULD BE THE SAME AS EARNING $21,800 TODAY. SAYING THE SAME THING, THE “PURCHASING POWER” OF $10,000 IN 1983 IN “2014 DOLLARS” IS $21,800
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WAYS FOR CALCULATING THE PURCHASING POWER - IN TODAY’S DOLLARS – OF PAST DOLLARS
1. PAST DOLLAR X (CPI TODAY/CPI PAST YEAR) AMOUNT
RUSS EARNED $50,000 IN 2000; WHAT’S THE PURCHASING POWER TODAY – IN 2014 – OF THAT SALARY? CPI 2000 = 172 CPI 2014 = 218$50,000 X (218/172) = $63,372 $50,000 IS THE “NOMINAL” SALARY $63,372 IS THE “REAL” SALARY
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CALCULATING PURCHASING POWER IN TODAY’S DOLLARS - CONTINUED
2. HAVE A TABLE WITH (CPI TODAY/CPI PAST YEAR) ALREADY CALCULATED CALLED “PURCHASING POWER CONVERTERS” (Everyday Economics, page 4).
SAME EXAMPLE: RUSS EARNED $50,000 IN 2000; WHAT’S HIS PURCHASING POWER IN 2014?
$50,000 X 1.2674419 = $63,372
TABLE OF PURCHASING POWER CONVERTERS MUST BE UPDATED EACH YEAR
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CALCULATING PURCHASING POWER IN TODAY’S DOLLARS - CONTINUED
3. HAVE TOTAL INFLATION RATE BETWEEN THE TWO YEARS
Example: Inflation rate between 2000 and 2014 was 26.7%
26.7% = 0.267 Then add 1.00 and multiply: $50,000 x 1.267 = $63,350 (rounding difference)
30
PRICES ALSO VARY GEOGRAPHICALLY: STATE TO STATE OR CITY TO CITY
CHAPTER 2, EVERYDAY ECONOMICS
COST-OF-LIVING INDEX FOR NORTH CAROLINA: 96.9
COST-OF-LIVING INDEX FOR NEW YORK: 132.7
COST-OF-LIVING IN NEW YORK IS ((132.7/96.9)-1)*100 = 36.9% HIGHER THAN IN NORTH CAROLINA
SO NEED $1.37 IN NY TO EQUAL $1.00 IN NC FOR SAME PURCHASING POWER
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MULTIPLE APPLICATIONS
CONVERT SALARIES, PRICES, COSTS, PROFITS, ETC.
CAN CONVERT AND COMPARE NOMINAL $ THAT START AT DIFFERENT YEARS
SEE WWW.BLS.GOV FOR CPI VALUES 1913, CPI = 9.8, SO A DOLLAR THEN WOULD BE WORTH (238/9.8) OR $24