Thursday, September 5, 2013

The effect of a tax - curve shifting

Vu asked:

Dear professor Arvani have a questionWhy when a unit tax is levied directly on consumers, this make the demand curve shifts downwards? and what could be the causes of this shift ?
Thank you very much

My response:

The tax is levied in some market for a good or service.  Typically, buyers pay some of it and sellers pay some of it as well.  The tax creates a wedge between what the buyer pays and what the seller receives, with the difference being the tax.  If in the diagram the price represented is the seller's price (so the supply curve remains the same) then the demand curve shifts down by the amount of the tax.  In this way if you add the tax to the seller's price, you get the price really does pay so the quantity demanded should be exactly what it was before at this higher price.

Monday, July 8, 2013

Comparative Statics of Consumer Choice

Judy asked:

using well labele diagrams show the total effect,income effect and substitution effect due to a price fall of good x1 assuming that the consumer baskets has only good x1 and x2. The price of good x2 remains constant.

My Response:

I encourage you to watch my video on income and substitution effects.  There the goods are labeled x and y (instead of x1 and x2) and it is for a price increase rather than a price decrease.  I suspect you covered something similar in your class and now your instructor wants you to think through what happens when the price change is in the opposite direction.

From my video in the description there is a link to the spreadsheet.  Go to the tab labeled Income and Substitution Effects. There is a button called Raise Price of Good X.  Push on that and look at the cell next to the button.  It has positive values.  If you type into that cell a negative value, say -15, you will get the graph for a price reduction of Good X.  Note that because this was designed for a price increase, the new budget line doesn't extent all the way to X axis.  It should.

Also, your instructor may feel I'm doing your homework for you and not be happy about it.  So if you pose another question of this sort to Ask The Prof, please also include what you've tried to do in response.  This way I can help you without giving away the answer to the question.

Tuesday, April 30, 2013

Produce or Not in the Short Run?

Joe R. asks:

Working on  a question with a full chart to reference but am lost where to get the date for the answer. The question ask about the product price of $56, will this firm produce in the short run.?

My response:

There is a fairly complete analysis of the general issues in the video Short Run Cost.  The question is asking, in effect, whether there is any output level were Average Variable Cost is below $56.  If the answer is yes, then producing at that output level nets some producer surplus (the difference between revenue and variable cost), so it makes sense to produce.  If not, then it is best not to produce.

Note that the fix cost is not relevant for this calculation.  It is sunk in the short run and therefore must be paid regardless of whether production occurs.  

Your chart that you refer to may not have Average Variable Cost broken out, in which case you must compute it by dividing Total Variable Cost by Output.  If it is broken out, then it is simply a matter of eyeballing it to see if it ever is below $56.

Thursday, April 18, 2013

On the Weak and General Axiom of Revealed Preference

John asked the following:

"I have two related questions on Choice. 
I know that we can satisfy WARP but have nevertheless a violation of GARP. My question is if we can have a situation where WARP is violated, but GARP is satisfied? 
Secondly, from the definition of GARP it is always spoken of a bundle being revealed preferred to another bundle through a chain or ""sequence"" of revealed preferences. My question is, if this defined ""sequence"" can consist of only two observations, so that we have actually a direct revealed preference after all?  In other words, does ""revealed preferred"" include the case of ""direct revealed preferred""?"

My response:

The quick answers are, to the first question, no, and to the second question, yes.  In other words, GARP implies WARP and the chain can have only two elements, which is WARP directly.

A longer response would include making a comparison between revealed preference and the usual assumptions made about preference.  These are about a preference relation, R.  xRy is then read as, x is preferred to or indifferent to y.   So from R one can also define P and I by:

  • xPy if xRy and not yRx.
  • xIy if xRy and yRx.

There are three "logical" assumption about preference orderings.

R is complete.  For every x and y in the Consumption set (the set of possible consumption bundles) either xRy or yRx.  This means comparisons can be made between any two consumption bundles.  Note that neither P nor I are complete.

R is reflexive.  For every x in the Consumption set xRx.

R is transitive.  For every x, y, and z in the Consumption set, if xRy and yRz then xRz.

These properties allow one to define a choice, provided the choice set is closed.  In this case if the choice set is C then x in C is a choice (a maximal element under R) if xRy for all y in C.  Note that there is no greatest number less than 100.  If you posit it is 99, then 99.9 is greater and you can always add an additional 9 to the right.  So for a choice to exist, the choice set must be closed.  100 is the greatest number less than or equal to 100.  The choice set being closed means it includes its boundary.

To these logical assumptions, one usually adds an economic assumption - monotonicity or more is preferred to less.  This assumption rules about satiation points as well as "thick indifference curves,"  The upshot of this assumption is that when the choice problem is given by a budget set, the choice will always be on the budget line, never inside the line.

A further assumption that is frequently made is that preferences are Convex, which gives indifference curves their usual shape.  This is done do when the Budget environment changes in a small way, the choice also changes at most in a small way.  Or, if you prefer, the demands are continuous function of the budget environment.

Now, with all this machinery, what does WARP get you?  In this way of thinking, WARP is equivalent to completeness, reflexivity, and monotonicity.  You need GARP to bring in transitivity.  There is also something called SARP, the strong axiom.  It is WARP plus the assumption that preferences are strictly convex, so the choice is always unique.

I hope that helps.