Economics Dr.

Sauer

Chapter 3 Lecture Handout 3.1.3 Solving 3 equations and 3 unknowns Solve the equations: 2x +y z = 4 x +yz=3 2x + 2y + z = 12

(PE 3.1 page 110) __________________________________________________________________ 3.2.1 Equilibrium A. Goods Market In the goods market, equilibrium is achieved when Qd = Qs Example: Pd = 100 0.5Qd Ps = 10 + 0.5Qs

and Pd = Ps.

B. Labor Market In the labor market, equilibrium is achieved when Ld = Ls Example: wd = 9 0.6Ld ws = 2 + 0.4Ls

and wd = ws.

C. Government Controls of Price 1. Price Ceilings are legal maximums on the price. Example: Suppose there is a price ceiling of $40 in the goods market. Pd = 100 0.5Qd Ps = 10 + 0.5Qs

2. Price Floors are legal minimums on the price. Example: Suppose the government imposes a minimum wage of $6 on the labor market. wd=9 0.6Ld ws = 2+0.4Ls

(PE 3.2 page 116) _______________________________________________________________________ 3.2.2 Equilibrium for Substitutes and Complements A. Good X and Y are substitutes Example: Qdx = 82 3Px + Py Qsx = 5 +15Px Qdy = 92 + 2Px - 4Py Qsy = 6 + 32Py

B. Good X and Y are complements Example: Qdx = 190 2Px 2Py Qsx = 10 +2Px Qdy = 240 - 2Px - 4Py Qsy = 40 + Py

_____________________________________________________________________ 3.2.4 Taxes and Subsidies A. Taxes Example: Pd = 100 0.5Qd Ps = 10 + 0.5Qs Suppose the government imposes a $6 tax per unit sold.

B. Subsidies Example: Pd = 450 2Qd Ps = 100 + 5Qs Suppose the government provides a subsidy of $70 per unit sold.

3.2.5 Break Even Analysis If Total Revenue = Total Cost, a firm is breaking even. Example: TR = 3Q TC = 10 + 2Q

(PE 3.3 page 125) ______________________________________________________________________ 3.3 Consumer and Producer Surplus Example: P = 60 - 0.6Q P = 20 + 0.2Q

(PE 3.4 page 131) _______________________________________________________________________ 3.4 National Income Model and IS-LM Model National Income Model Equilibrium occurs when aggregate national income is equal to aggregate (planned) expenditure. Y=E E = C + I + G + NX in equilibrium: Y = C + I + G + NX

Household consumption is typically modeled as: C = C0 + bY

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Example: Suppose G = 0 and NX = 0 Suppose C0 = $50 million I = $100million

b = 0.5

General Equations: Y = (C0 + bY) + I

_______________________________________________________________________ IS-LM Model The IS schedule relates all possible values of national income and interest rates for which equilibrium exists in the goods market. So far, investment has been assumed to be autonomous. In reality, investment is influenced by interest rates. I = I0 dr (d is a constant) The equilibrium condition for the three-sector economy (no foreign sector) is,

Rewriting in the form, r = f(Y) gives the equation for the IS schedule.

The LM schedule relates all possible combinations of national income and interest rates) for which equilibrium exists in the money market. Money Supply:

Money Demand: Transactionary demand, M dT , facilitates the everyday purchase of goods. Precautionary demand, M dP , facilitates unforeseen expenses that may occur. Assuming that the sum of both these demands (L1) is proportional (k) to national income, L1 ! M dT  M dP and L1 = kY (0 < k < 1) Speculative demand, M dS , facilitates speculations (investments) in other assets such as government bonds. The level of speculations is negatively to the interest rate. Letting L 2 ! M dS , then L2 = a hr where a and h are constants

Overall, the total demand for money is given as, Md = MdT + MdP + MdS = Therefore, money market equilibrium is given by,

Rewriting in the form, r = g(Y) gives the equation for the LM schedule.

Equilibrium Y and r 2 equations and 2 unknowns: r = f(Y) r = g(Y)

Example: Calculate the equilibrium level of national income and the equilibrium interest rate given the following information on the goods and money markets: C ! 40  0 . 8Yd I ! 200  20r G 0 ! 400 t ! 01 Yd = (1-t)Y . Goods market: Money market:
L1 ! 0 . 3Y L 2 ! 60  120r M 0 ! 300

where M d ! L1  L 2 and M s ! M 0 .
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(PE 3.6 page 136) ____________________________________________________________________ Complete the Test Exercises 3 page 144-145. Here are the ones not contained in the text.
5. The demand and supply functions for a good are given by the equations P = 80 - 2 Q and P = 20 + 4Q respectively. (a) Calculate the equilibrium price and quantity (b) Calculate the consumer and producer surplus at equilibrium

6.

See Q.5: the supplier pays an excise tax of 12 per unit sold. (a) Write down the equation for the supply function when the excise tax is imposed (b) Calculate the equilibrium price and quantity (c) Calculate the tax paid by (i) the consumer (ii) the producer (d) Calculate the consumer and producer surplus at equilibrium

7.

The demand and supply functions for complementary goods, X and Y are given by the equations: Qd , X ! 200  4 PX  PY Qd ,Y ! 80  PX  PY Qs , X ! 65  6 PX Qs ,Y ! 20  4 PY

Calculate the equilibrium price and quantity for each good. 7