Changes

=== For Honors Students Only: Giffen Goods ===

=== For Honors Students Only: Giffen Goods ===

Last class, we mentioned an odd type of good known as an “inferior” good.  You may recall that the demand for an “inferior” good actually increases when income decreases.  Examples are margarine (because people with declining income can less afford butter).  Bankruptcy services are “inferior”, because when income declines, more people file for bankruptcy, and the greater the demand for bankruptcy services.   

Last class, we mentioned an odd type of good known as an “inferior” good.  You may recall that the demand for an “inferior” good actually increases when income decreases.  Examples are margarine (because people with declining income can less afford butter).  Bankruptcy services are “inferior”, because when people's income declines, more of them file for bankruptcy, and then there is a greater demand for bankruptcy services.   

'''''Question''''': If a good is inferior, does a decrease in its price cause an increase in quantity demanded?

'''''Question''''': If a good is inferior, does a decrease in its price cause an increase in quantity demanded?

Finally, at 4 o'clock in the afternoon, you see the golden arches of McDonalds appear on the horizon.  You drive closer and the arches appear bigger.  It’s not a mirage!

Finally, at 4 o'clock in the afternoon, you see the golden arches of McDonalds appear on the horizon.  You drive closer and the arches appear bigger.  It’s not a mirage!

When you arrive, you run in and order its famous french fries.  You’re famished.  When the food arrives, you take your first handful of french fries.  Wow, it is really satisfying to to eat that first bunch of french fries with an empty stomach.  Your marginal utility is extremely high.  You might have even been willing to pay $5 for that first mouthful of french fries because you are so hungry.  Then you eat your second handful of french fries.  Your marginal utility is still high, but not quite as high as the first one.  You wouldn’t have paid as much for the second handful either.  By the time you finish all the french fries, the last few bites were not so satisfying.  In fact, you’ve gotten sick to your stomach.  The marginal utility of that last french fry was very low.  Perhaps even less than zero!

When you arrive, you run in and order its famous french fries.  You’re famished.  When the food arrives, you take your first handful of french fries.  Wow, it is really satisfying to eat that first bunch of french fries with an empty stomach.  Your marginal utility is extremely high.  You might have even been willing to pay $5 for that first mouthful of french fries because you are so hungry.  Then you eat your second handful of french fries.  Your marginal utility is still high, but not quite as high as the first one.  You wouldn’t have paid as much for the second handful either.  By the time you finish all the french fries, the last few bites were not so satisfying.  In fact, you’ve gotten sick to your stomach.  The marginal utility of that last french fry was very low.  Perhaps even less than zero!

You have just experienced the '''''Law of Diminishing Marginal Utility''''': the marginal utility of each additional unit (e.g., french fry) always declines (in a given period).  This is similar to the "Diminishing Returns" experienced by a '''''producer''''' of goods.

You have just experienced the '''''Law of Diminishing Marginal Utility''''': the marginal utility of each additional unit (e.g., french fry) always declines (in a given period).  This is similar to the "Diminishing Returns" experienced by a '''''producer''''' of goods.

Let's take a simple example.  Suppose you like chocolate and peanut butter equally well, and you are "indifferent" between receiving one chocolate bar and one peanut butter candy bar.  Plotting the good for a chocolate bar on the x-axis and the good for a peanut butter candy bar on the y-axis, the indifference curve will be a straight line with a negative slope of 1.  Give up a chocolate bar but receive a peanut butter bar, and you're on the same indifference curve:  your overall utility has not changed.  But give up a chocolate bar and receive TWO peanut butter bars, and you've increased your overall utility and you've left that original indifference curve.  You're better off with that deal and are not "indifferent" to it.  You want the improvement in utility in the 2-for-1 deal.

Let's take a simple example.  Suppose you like chocolate and peanut butter equally well, and you are "indifferent" between receiving one chocolate bar and one peanut butter candy bar.  Plotting the good for a chocolate bar on the x-axis and the good for a peanut butter candy bar on the y-axis, the indifference curve will be a straight line with a negative slope of 1.  Give up a chocolate bar but receive a peanut butter bar, and you're on the same indifference curve:  your overall utility has not changed.  But give up a chocolate bar and receive TWO peanut butter bars, and you've increased your overall utility and you've left that original indifference curve.  You're better off with that deal and are not "indifferent" to it.  You want the improvement in utility in the 2-for-1 deal.

Let’s take another example that illustrates the usefulness of an indifference curve.  Suppose you are working on the homework for this course with three friends - Chris, Stephanie and Kevin.  Someone says they are hungry and go to look for snacks.  You see a half-eaten bag of potato chips and you pop a bag of popcorn.  However, there is not enough food for everyone, so have to ration who receives what.

Let’s take another example that illustrates the usefulness of an indifference curve.  Suppose you are working on the homework for this course with three friends - Chris, Stephanie and Kevin.  Someone says they are hungry and go to look for snacks.  You see a half-eaten bag of potato chips and you pop a bag of popcorn.  However, there is not enough food for everyone, so you have to ration who receives what.

You count 24 potato chips and 40 kernels of popcorn.  Uh oh.  There are four of you.  On average, that’s only 6 potato chips and 10 kernels of popcorn per person.  You tell everyone that.

You count 24 potato chips and 40 kernels of popcorn.  Uh oh.  There are four of you.  On average, that’s only 6 potato chips and 10 kernels of popcorn per person.  You tell everyone that.

“Consumer surplus” is a concept that illustrates the power of the free market as it drives down the price of goods.  When we buy goods and services, most of us would pay at a higher price if we had to.  For example, our families would pay twice the cost of milk because we would still want to drink milk even if the price were higher.  We may not buy as much milk at a higher price, but we would still buy some.  We get extra value when we can buy milk at a price lower than what we would really pay if we had to.

“Consumer surplus” is a concept that illustrates the power of the free market as it drives down the price of goods.  When we buy goods and services, most of us would pay at a higher price if we had to.  For example, our families would pay twice the cost of milk because we would still want to drink milk even if the price were higher.  We may not buy as much milk at a higher price, but we would still buy some.  We get extra value when we can buy milk at a price lower than what we would really pay if we had to.

The "consumer surplus" is the net benefit (in dollars) a consumer obtains from buying a good.  Thus (consumer surplus) = (total benefit) - (total cost).  The "consumer surplus" is never negative, because people would not purchase goods or services if their total benefit is less than their total cost.  They would be better off keeping their money and not making the purchase.

The "consumer surplus" is the net benefit (in dollars) that a consumer obtains from buying a good.  Thus (consumer surplus) = (total benefit) - (total cost).  The "consumer surplus" is never negative, because people would not purchase goods or services if their total benefit is less than their total cost.  They would be better off keeping their money and not making the purchase.

To illustrate how powerful the concept of the "consumer surplus" is, let’s define another term: “demand price.”  That is the most someone is willing to pay for something.  When you go to see a movie, there is a maximum amount you are willing to pay for a ticket.  It varies for different consumers.  It also depends on what the movie is.

To illustrate how powerful the concept of the "consumer surplus" is, let’s define another term: “demand price.”  That is the most someone is willing to pay for something.  When you go to see a movie, there is a maximum amount you are willing to pay for a ticket.  It varies for different consumers.  It also depends on what the movie is.

The consumer surplus is the demand price (the most a consumer would pay) minus the price paid (the amount the consumer actually has to pay).  Suppose you were effusive (i.e., very enthusiastic) about a particular movie, and wanted very much to see it.  You were so excited that you were willing to pay $20 to see that movie.  But if the theater charges you only $8, then your consumer surplus is $20 - $8 = $12.

The consumer surplus is the demand price (the most a consumer would pay) minus the price paid (the amount the consumer actually has to pay).  Suppose you were effusive (i.e., very enthusiastic) about a particular movie, and wanted very much to see it.  You were so excited that you were willing to pay $20 to see that movie.  But if the theater charges you only $8, then your consumer surplus is $20 - $8 = $12.

Consumers stop buying a good when the demand price falls slightly below the price paid.  For movies, the demand price falls the longer it keeps playing in a theater.  After you’ve seen the movie once or twice, you’re not willing to pay so much to see it again.  Over time people stop paying to see the same movie, and the theater stops playing it and begins showing a new movie instead.

Consumers stop buying a good when the demand price falls slightly below the sales price.  For movies, the demand price falls the longer it keeps playing in a theater.  After you’ve seen the movie once or twice, you’re not willing to pay so much to see it again.  Over time people stop paying to see the same movie, and the theater stops playing it and begins showing a new movie instead.

Almost every time someone buys something, he benefits from the consumer surplus of that transaction because he would probably pay a little more than he did.  If you value a chocolate candy bar at $1.05 but can buy it for $1, then you acquired extra wealth of 5 cents as your consumer surplus.  You would have paid $1.05 for it, but paid only $1 and then had both the candy bar and the 5 cents.  You became wealthier from the transaction by an amount equal to your consumer surplus.  And you became fatter too!

Almost every time someone buys something, he benefits from the consumer surplus of that transaction because he would probably pay a little more than he did.  If you value a chocolate candy bar at $1.05 but can buy it for $1, then you acquired extra wealth of 5 cents as your consumer surplus.  You would have paid $1.05 for it, but paid only $1 and then had both the candy bar and the extra 5 cents.  You became wealthier from the transaction by an amount equal to your consumer surplus.  And you became fatter too!

==Charity==

==Charity==

A force perhaps even stronger than the “invisible hand,” or perhaps a variation of the invisible hand, is charity.  The desire to give something of benefit to others, without demanding as much in return, is enormous.  “Give and ye shall receive” is advice from the Bible.  The giving may be in one form (money), and the receiving may be in another form (heavenly reward, which could be described as part of an overall "utility").  Look around, and you will notice numerous important charitable acts by others and yourself.

A force perhaps even stronger than the “invisible hand,” or perhaps a variation of the invisible hand, is charity.  The desire to give something of benefit to others, without demanding as much in return, is enormous.  “Give and ye shall receive” is advice from the Bible.  The giving may be in one form (money), and the receiving may be in another form (heavenly reward, which could be described as part of an overall "utility").  Look around, and you will notice numerous important charitable acts by others and yourself.

An immense advantage of charity is that it has no transaction costs.  One person simply gives money, or goods, or services, to someone else (or to a church), and the recipient of the donation then uses it in the best way possible.  A person giving $10 in a collection basket at church does not fill out any paperwork or require any commitments on how the church uses the donation.  It is assumed that the church will use the money as best it can, perhaps even in an unexpected way during the following year.  Pure charity is often purely efficient, with little waste in terms of transaction costs.  Charitable transfers are not taxed either, so none of it goes to support the government.

An immense advantage of charity is that it has no transaction costs.  One person simply gives money, or goods, or services, to someone else (or to a church), and the recipient of the donation then uses it in the best way possible.  A person giving $10 in a collection basket at church does not fill out any paperwork or require any commitments on how the church uses the donation.  It is assumed that the church will use the money as best it can, perhaps even in an unexpected way during the following year.  Pure charity is often purely efficient, with little waste in terms of transaction costs.  Charitable transfers are not taxed either, so none of it is spent on harmful government programs.

America’s health care system, by far the greatest in the world, was built on a foundation of charity.  People and religious organizations giving time, money and expertise to care for individuals who could never afford to pay all the costs.  Education, too, was developed in this country largely through charity.  In recent years, both health care and education have lost their charitable identities and been taken over in significant ways by the government, and the results of government involvement have not been positive.  Costs have gone up and quality has gone down.

America’s health care system, by far the greatest in the world, was built on a foundation of charity.  People and religious organizations giving time, money and expertise to care for individuals who could never afford to pay all the costs.  Education, too, was developed in this country largely through charity.  In recent years, both health care and education have lost their charitable identities and been taken over in significant ways by the government, and the results of government involvement have not been positive.  Costs have gone up and quality has gone down.

The first private medical clinic in the United States was the Mayo Clinic, established by the Mayo family of physicians in 1889.  Their sponsor was the Sisters of St. Francis, which built St. Mary’s Hospital in Rochester, Minnesota.

The first private medical clinic in the United States was the Mayo Clinic, established by the Mayo family of physicians in 1889.  Their sponsor was the Sisters of St. Francis, which built St. Mary’s Hospital in Rochester, Minnesota.

Likewise, the successful American colonies were initially more religious and charitable than commercial.  Pennsylvania was founded on religious principles by the Quaker William Penn, who in turn established Philadelphia as the City of Brotherly Love.  Within merely a few decades it grew to become the second most populated city in the British Empire, after London.

Likewise, the successful American colonies were initially more religious and charitable than commercial.  Pennsylvania was founded on religious principles by the Quaker William Penn, who in turn established Philadelphia as the City of Brotherly Love.  Within merely a few decades it grew to become the second most successful city in the British Empire, after London.  Another successful city, Boston, was built on the religious values of Puritans.

It was only on the solid foundation of the brick houses of hardy Quakers and their strict moral rules that the flower of free enterprise blossomed there.  The same could be said for Boston, where Puritans served as the anchor.

It is primarily on the solid foundation of religious values and charity that the flower of free enterprise blossoms.

==Assignment==

==Assignment==

Read and, if necessary, reread the above lecture.  Complete the homework assignments through the level in which you choose to enroll in this course:

Read and, if necessary, reread the above lecture.  Answer any six out of the following seven questions, and the extra credit question at the end can be answered by anyone (honors questions can also be completed):

1. A consumer's overall satisfaction is expressed in economics as his  _________________.

1. A consumer's overall satisfaction is expressed in economics as his  _________________.

3.  Suppose your favorite hobbies are reading books and hiking, and imagine that they have the following values for marginal utility.  The first hour that you hike gives you lots of utility:  10 units.  But as you start to tire, you enjoy and benefit from it less.  The next hour of hiking is worth only 8 units of utility (in other words, it has a marginal utility of 8 units rather than 10), and the next hour of hiking is worth only 5 units, and then 3, then 1, and then zero for the next hours, in that order.  Your marginal utility for reading books does not decline so quickly.  In the first hour, reading a book gives you utility of 6 units; the next hour is worth 5 units; the next hour is worth 4 units; and then 3, 2, 1 and 0.  Suppose that you have 5 extra hours today.  How should you spend those hours on hiking and reading in order to maximize your utility, and what will be your total utility for those 5 hours?  Explain your answer.

3.  Suppose your favorite hobbies are reading books and hiking, and imagine that they have the following values for marginal utility.  The first hour that you hike gives you lots of utility:  10 units.  But as you start to tire, you enjoy and benefit from it less.  The next hour of hiking is worth only 8 units of utility (in other words, it has a marginal utility of 8 units rather than 10), and the next hour of hiking is worth only 5 units, and then 3, then 1, and then zero for the next hours, in that order.  Your marginal utility for reading books does not decline so quickly.  In the first hour, reading a book gives you utility of 6 units; the next hour is worth 5 units; the next hour is worth 4 units; and then 3, 2, 1 and 0.  Suppose that you have 5 extra hours today.  How should you spend those hours on hiking and reading in order to maximize your utility, and what will be your total utility for those 5 hours?  Explain your answer.

4.  Suppose you plan to buy a brand new car for $25,000.  When you do to the car dealership to make your purchase, you notice that there is a car on the lot that looks brand new but not longer has the sticker price on it.  The dealer says it was returned by someone after driving it only 100 miles.  You like the color and ask if you can buy it.  The dealer, seeing that you’re so interested, says he’ll sell it to you for the same price as a brand new car that has never been sold.  You’re willing to buy it at full price, and do not mind one bit that someone else used it briefly and returned it.  But you notice that other people (the “market”) would not pay full price for a returned car.  Relying on the “market” rather than your personal preferences, what should you tell the dealer in order to maximize your benefits from your purchase?

4.  Suppose you plan to buy a brand new car for $25,000.  When you go to the car dealership to make your purchase, you notice that there is a car on the lot that looks brand new but no longer has the sticker price on it.  The dealer says it was returned by someone after driving it only 500 miles.  You like the color and ask if you can buy it.  The dealer, seeing that you’re so interested, says he’ll sell it to you for the same price as a brand new car that has never been sold.  You’re willing to buy it at full price, and do not mind one bit that someone else used it briefly and returned it.  But you notice that other people (the “market”) would not pay full price for a returned car.  Should you pay the price of a brand new car for this car that has been driven 500 miles? Explain.

5. Explain why the shape of an indifference curve for two goods that are perfect substitutes is a straight line going from the upper left down to the lower right.  Extra credit:  why must its slope be negative 1?

5. Explain why the shape of an indifference curve for two goods that are perfect substitutes is a straight line going from the upper left down to the lower right.  Extra credit:  why must its slope be negative 1?

6.  Describe either the "income effect" or the "substitution effect."  Take your pick.

6.  Describe either the "income effect" or the "substitution effect."  Take your pick.

7.  Charity is based on the foundation of a successful free market.  Or is a successful free market based on a foundation of charity?  Describe and explain which is the cart, and which is the horse (in other words, which comes first or is most important, charity or the free market).

7.  Charity is based on the foundation of a successful free market.  Or is a successful free market based on a foundation of charity?  Describe and explain which is the "cart", and which is the "horse" (in other words, which comes first or is most important, charity or the free market).

===Honors===

===Honors===