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LUBS1950

Semester I - LECTURE IV.

1.

Lecture IV. Supply Custom Text: ch. 14, pp. 229-31.

Ob ect!"es: to analyse household su ly o! a "ommod#ty held as a !#$ed sto"%& to determ#ne 'hether a household '#ll "hoose to su ly more o! #ts sto"% 'hen the mar%et r#"e r#ses& to a ly the analys#s to the household su ly o! la(our& to "om are the determ#nants o! su ly and demand #n a ure e$"han)e e"onomy.

#. $e% &rou'( )ules *or the #'+lys!s o* Supply l. So !ar 'e ha*e assumed that the "onsumer has a !#$ed (ud)et #n money and #n#t#ally holds no other "ommod#t#es. +e then sho'ed that she 'ould e$"han)e her money !or a (undle o! "ommod#t#es and sho'ed 'h#"h (undle o! "ommod#t#es she 'ould (uy.

y(

y , -ya. y(/ I1

x , -$a. 0/ a

ya

$a

,!-. 4.1 Suppl!er ./u!l!br!um 0I'ter!or Solut!o'1


0. I no' assume that the "onsumer. or trader. -1Clar#ssa2/ ossesses a !#$ed sto"% o! some "ommod#ty. a. -e.). la(our ser*#"es. r#"e/ and no money. By 3!#$ed sto"%3 I mean to #m ly that no rodu"t#on #s "urrently ta%#n) la"e. The sto"% o! a #s "alled Clar#ssa2s initial endowment. Clar#ssa "an 3)o to mar%et3 and e$"han)e "ommod#ty a !or another "ommod#ty. b. 4. Clar#ssa "an there!ore sell "ommod#ty a !or b u to the l#m#t )#*en (y her sto"%s o! "ommod#ty a.

LUBS1950

Semester I - LECTURE IV.

0.

2. The Tr+(er3s ./u!l!br!um 1. 5n 6#). 7.1 Clar#ssa there!ore starts at o#nt x , -$ a. 0/ '#th sto"% le*el $ a o! a and 8ero o! b. +#th #nd#!!eren"e "ur*es and (ud)et l#ne as sho'n. Clar#ssa '#ll 'ant to mo*e to o#nt y , -ya. yb/. Th#s #m l#es sell#n) $ a - ya o! a #n e$"han)e !or yb o! b. +e say the 9uant#ty suppl!e( (y Clar#ssa #s $a - ya at the r#"e sho'n. +e say the 9uant#ty ya #s Clar#ssa3s o%'-(em+'( !or the "ommod#ty a at the r#"e sho'n.

BL1 BL4 BL0 %

y(

"

5 I1 x

ya

8a

$a

,!-. 4.2 Sep+r+t!'- I'come 4 Subst!tut!o' .**ects

0. The e9u#l#(r#um o#nt y #s an interior solution -Le"ture III. :art I. B. 5/. ;t the e9u#l#(r#um o#nt y the slo e o! Clar#ssa2s #nd#!!eren"e "ur*e #s e9ual to the slo e o! her (ud)et l#ne. +e %no' the slo e o! the #nd#!!eren"e "ur*e #s the same as the Marginal Rate of Substitution of b for a -Le"ture II. :art II. </ and the slo e o! the (ud)et l#ne #s the same as the r#"e o! a d#*#ded (y the r#"e o! b. So #! the t'o slo es are e9ual #t !ollo's that: 6)S o* b *or a 7 pa 8 pb =ust as 'e had !or #nter#or solut#ons #n the analys#s o! demand.

C. 9o% (o :r!ce Ch+'-es #**ect the ;u+'t!ty Suppl!e(< 1. Su ose the r#"e o! "ommod#ty a !alls. +#ll Clar#ssa su ly more or less o! a>

I! the r#"e o! a !alls. Clar#ssa3s (ud)et l#ne mo*es !rom BL 1 to BL0 as #n 6#). 7.0. Th!s mo"eme't !s (!**ere't *rom %h+t you m!-ht expect +*ter Lecture III o' =em+'(. The re+so' *or the (!**ere'ce !s the 'e% &rou'( )ules >sect!o' #, +bo"e?. 0. To se arate out #n"ome and su(st#tut#on e!!e"ts. dra' the hy othet#"al (ud)et l#ne BL 4. as #n Le"ture III. Th#s #s !ound (y sl#d#n) BL 1 around #nd#!!eren"e "ur*e I 1 unt#l #t #s arallel to BL 0. Bud)et l#ne BL4 has the same slo e as BL0 and there!ore sho's the same relat#*e r#"es as BL0& #t allo's Clar#ssa to rea"h the same #nd#!!eren"e "ur*e as (e!ore and there!ore sho's the same real #n"ome as (e!ore. -See Le"ture III. :art II. C.4 de!#n#t#on o! "onstant real #n"ome

LUBS1950

Semester I - LECTURE IV.

4.

'hen relat#*e r#"es are "han)#n)/. So BL4 )#*es Clar#ssa constant real income, new relative prices. Then ush#n) Clar#ssa o!! BL4 onto BL0 )#*es her a lower real income, at constant relative prices. :ro-ress Chec@: Loo@ +t ,!-. 4.2 +-+!' +'( choose the correct +lter'+t!"es !' these st+teme'ts: I* Cl+r!ss+ mo"es *rom y to % her supply o* a !'cre+ses8(ecre+ses8st+ys the s+me. I* Cl+r!ss+ mo"es *rom y to " her supply o* a !'cre+ses8(ecre+ses8st+ys the s+me. I* Cl+r!ss+ mo"es *rom y to u her supply o* a !'cre+ses8(ecre+ses8st+ys the s+me. >True or ,+lse<? Ae c+' (r+% +' !'(!**ere'ce cur"e t+'-e't to 2L 2 +t %, or ", or u. Th!s me+'s th+t %e c+''ot pre(!ct %h+t %!ll h+ppe' to Cl+r!ss+Bs supply o* a %!thout @'o%!'more +bout her t+stes >!'(!**ere'ce cur"es?. 4. It #s s#m lest to "ondu"t the rest o! the analys#s #n terms o! Clar#ssa3s own demand !or "ommod#ty a. 7. Subst!tut!o' .**ect: 6a"ed '#th BL4. Clar#ssa2s e9u#l#(r#um 'ould mo*e !rom y to a o#nt 'h#"h must (e do'n I1 to the r#)ht o! y. !or #nstan"e o#nt 5. That #s. the su(st#tut#on e!!e"t leads to an increase #n Clar#ssa3s o'n demand !or a !rom ya to. !or #nstan"e. 8a. 5. I'come .**ect: ?o' #! a #s a normal )ood -#n"ome e!!e"t #s os#t#*e/. the redu"t#on #n #n"ome de #"ted (y the sh#!t o! (ud)et l#ne BL 4 to os#t#on BL0 must "ause a decrease #n Clar#ssa3s o'n-demand !or "ommod#ty a !rom 8a to a 9uant#ty 'h#"h "ould (e )reater than or less than ya. -+e "an dra' #nd#!!eren"e "ur*es tan)ent#al to BL 0 'h#"h 'ould )#*e e#ther result./ @. I! Clar#ssa2s o'n-demand de"reases to some'here (et'een 8 a and ya then the net e!!e"t o! the r#"e !all o! "ommod#ty a #s to decrease Clar#ssa2s supply o! "ommod#ty a. I! Clar#ssa2s o'ndemand de"reases to less than ya then the net e!!e"t o! the r#"e !all o! "ommod#ty a #s to increase Clar#ssa2s supply o! "ommod#ty a. A. So the net e!!e"t o! a r#"e !all on Clar#ssa3s o'n-demand !or a normal )ood "ould (e #n e#ther d#re"t#on and th#s means that the net e!!e"t o! a r#"e !all on Clar#ssa3s su ly "ould also (e #n either direction. B. I'come .**ect: I! "ommod#ty a #s an inferior )ood !or th#s trader. the redu"t#on #n #n"ome !rom BL4 to B0 must "ause an increase #n Clar#ssa3s o'n-demand !or the "ommod#ty #.e. a de"rease Clar#ssa3s su ly. Th#s means the net e!!e"t o! a r#"e !all on the su ly o! an #n!er#or )ood '#ll always (e to redu"e su ly. 9. So, !* commo(!ty a !s +' !'*er!or -oo(, + *+ll !' !ts pr!ce %!ll +l%+ys le+( to + *+ll !' supply. 2ut !* commo(!ty a !s + 'orm+l -oo(, + *+ll !' !ts pr!ce coul( le+( to + *+ll or a rise !' supply. 10. ;re the "#r"umstan"es #n 'h#"h a redu"t#on #n r#"e leads to an #n"rease #n su ly unusual> The )ood (e#n) su l#ed must (e normal and the #n"ome e!!e"t o! the r#"e !all must (e (#))er than the su(st#tut#on e!!e"t. So 'e loo% !or )oods 'here the #n"ome e!!e"t '#ll (e o'er!ul. Th#s '#ll o!ten (e the "ase 'hen someone der#*es a lar)e art o! her #n"ome !rom the sale o! one art#"ular "ommod#ty. e.). a easant3s sale o! a)r#"ultural rodu"ts or a 'or%er3s sale o! la(our ser*#"es. In su"h "ases. a redu"t#on #n the r#"e o! a)r#"ultural rodu"ts or #n the 'a)e rate may 'ell "ause an #n"rease. not a de"rease. #n the 9uant#ty o!!ered !or sale (y the #nd#*#dual trader.

LUBS1950

Semester I - LECTURE IV.

7.

=. #' #ppl!c+t!o' to the 9ousehol(Bs Supply o* L+bour 1. Clar#ssa #s "on"e#*ed o! as (r#n)#n) 07 hours o! la(our to the mar%et ea"h day. The 9uest#on #s 1Co' mu"h o! th#s la(our '#ll she sell>2. The o(*erse o! th#s 9uest#on #s 1Co' mu"h '#ll she "hoose to reta#n !or her o'n use>2. #.e. 1+hat #s her o'n-demand !or la(our>2. ; erson2s o'ndemand !or la(our #s o!ten "alled a erson2s demand !or leisure. 0. The !#rst ste #s to 'or% out her (ud)et l#ne. Th#s #s dra'n '#th le#sure on the hor#8ontal a$#s and un#ts o! the only other "ommod#ty. (read. on the *ert#"al a$#s. I am )o#n) to assume that she "an sell any 9uant#ty o! la(our er day !rom 8ero to 07 hours -so there #s no #n*oluntary unem loyment and =o(s are s e"#!#ed '#th !ully !le$#(le hours/. Th#s means the le#sure-a$#s #nter"e t o! the (ud)et l#ne #s at the o#nt -07. 0/. 4. ?o' let2s 'or% out 'here the (read-a$#s #nter"e t #s. The 'a)e rate #s !#$ed at w er hour. Clar#ssa has no other sour"e o! #n"ome. +a)es are used to (uy a s#n)le )ood. (read. 'h#"h "osts ( er loa!. I! she has 8ero le#sure. she 'or%s 07 hours a day and earns 07 w. +#th th#s she "an (uy 07w D ( loa*es o! (read. Th#s means the (read-a$#s #nter"e t o! the (ud)et l#ne #s at the o#nt -0. -07w D (// 7. The slo e o! the (ud)et l#ne #s the same as usual: the rat#o o! the t'o r#"es. Cere. these are the r#"e o! le#sure -the 'a)e rate/ and the r#"e o! (read. and the slo e #s --/ w D (. Th#s #s also the 1real 'a)e2. #.e. the 'a)e rate #n terms o! 'hat #t '#ll (uy. not #n terms o! money. 6or e$am le #! w #s E4 D hour and ( #s E1. the 1real 'a)e2 #s E4 D E1 , 4 -loa*es o! (read/ er hour. 5. So the (ud)et l#ne loo%s l#%e that #n 6#). 7.4.

(read 07'D slo e , --/ ' D


( (

I1

yt

07

Le#sure. t

,!-. 4.3 ./u!l!br!um !' the Supply o* L+bour

:ro-ress Chec@: 2u!l( up + (+!ly bu(-et l!'e *or the *ollo%!'- stu(e't. Steph+'!e h+s -ot + -r+'t o* C3,DEF per ye+r. Th+tBs +bout C1F + (+y. She c+' +lso %or@ *or +s m+'y hours +s she l!@es beh!'( the b+r !' + loc+l pub +t CE per hour. She h+s 'o other source o* !'come. The o'ly commo(!ty she buys !s co**ee +'( !t costs C1 per cup. S@etch Steph+'!eBs bu(-et l!'e. TG)$ OV.)

LUBS1950

Semester I - LECTURE IV.

5.

Hou m!-ht *!'( !t help*ul to *!ll !' th!s t+ble: Le!sure >hours? >o' the x-+x!s? 24 23 22 21 ... F ... 24 ... Aor@ >hours? Aor@ !'come 8 (+y CF CE &r+'t !'come 8 (+y Tot+l !'come Tot+l co**ee >cups? >y-+x!s? 1F 1E

F 1 2

C1F C1F C1F C1F ... C1F

C1F C1E

...

...

4. The se"ond ste #n 'or%#n) out ho' mu"h la(our Clar#ssa '#ll su ly #s to ma%e some assum t#ons a(out her tastes -#nd#!!eren"e "ur*es/. I assume that her re!eren"es !or le#sure and (read "on!orm to all the usual a$#oms o! "onsumer theory -Le"ture II/. Th#s means she '#ll ha*e an #nd#!!eren"e "ur*e l#%e I 1 #n 6#). 7.4. I1 #s the h#)hest atta#na(le #nd#!!eren"e "ur*e. Clar#ssa '#ll there!ore "hoose to (e at y& th#s #s her e9u#l#(r#um. In e9u#l#(r#um she has an o'ndemand !or le#sure o! yt hours and su l#es the rema#n#n) 07 - yt hours er day o! la(our. 7. +e "an use th#s analys#s as a start#n) o#nt !or assess#n) ol#"y ro osals. 6or e$am le. ho' '#ll the #nd#*#dual2s la(our su ly alter #! 'a)e #n"ome #s ta$ed> Fany eo le ta%e #t !or )ranted that

LUBS1950

Semester I - LECTURE IV.

@.

#n"reas#n) #n"ome ta$at#on '#ll redu"e the hours eo le '#ll 'or%. Is th#s true> Su ose all 'a)e #n"ome #s ta$ed at a rate o! 05G. Th#s a!!e"ts the (ud)et l#ne as sho'n #n 6#). 7.7: the (ud)et l#ne !alls !rom BL 1 to BL0& the ma$#mum 9uant#ty o! (read that "an (e a"9u#red #s redu"ed !rom 07w D ( to -0.A5/07w D (. 5. The )eneral analys#s )#*en #n se"t#on C no' a l#es d#re"tly.

a. The su(st#tut#on e!!e"t '#ll ta%e the #nd#*#dual !rom y to some'here l#%e u. #n"reas#n) the#r o'n-demand !or le#sure and hen"e redu"#n) the#r su ly o! la(our. =ust as many eo le e$ e"t. (. But 'hat a(out the #n"ome e!!e"t> Unless le#sure #s an #n!er#or )ood -'h#"h #s not l#%ely/. anyth#n) "an ha en. ;ssum#n) le#sure #s a normal )ood. the #n"ome e!!e"t '#ll redu"e the #nd#*#dual2s o'n-demand !or le#sure and she "ould "hoose to mo*e !rom u to p or / or any'here else on the (ud)et l#ne BL0 to the le!t o! u. and th#s '#ll #n"rease her su ly o! la(our. "ontrary to 'hat most eo le 'ould e$ e"t. ". I! she mo*es to / the net e!!e"t. ta%#n) (oth the su(st#tut#on and #n"ome e!!e"ts #nto a""ount. #s st#ll to #n"rease her o'n-demand !or le#sure and redu"e the su ly o! la(our and the usual o #n#on #s "orre"t. d. I! she mo*es to p. ho'e*er. the net e!!e"t #s to reduce her o'n-demand !or le#sure and increase the su ly o! la(our and the usual o #n#on #s 'ron). e. So the !#rst "on"lus#on #s that eo le2s2 "erta#nty that a r#se #n #n"ome ta$ rates '#ll redu"e hours o! 'or% has no theoret#"al (as#s. It all de ends on 'hether eo le mo*e to la"es l#%e p or la"es l#%e / and th#s de ends on eo le2s tastes.

(read 07'D

BL1

-0.A5/-07'D (/

BL0 p

u I1

07

le#sure. t

,!-. 4.4 I'come T+x +'( L+bour Supply

@. It !ollo's !rom th#s that #! 'e 'ant to !#nd out 'hat the e!!e"t o! an #n"rease #n ta$ rates '#ll (e. 'e ha*e to )o out and !#nd out 'hat eo le2s tastes are.

LUBS1950

Semester I - LECTURE IV.

A.

a. :ro!essor CV Bro'n o! St#rl#n) Un#*ers#ty undertoo% stud#es o! th#s %#nd #n the early 19B0s. The study 9uest#onna#red a sam le o! marr#ed men. I)nor#n) those men 'ho sa#d they 'ere una(le to "han)e the#r hours o! 'or% !or one reason or another. the result 'as that many sa#d they 'ould 'or% lon)er #! ta$ rates 'ere redu"ed and many eo le sa#d they 'ould 'or% shorter hours. (. 5ther stud#es (ased on #n!eren"es !rom eo le2s ast (eha*#our #n the !a"e o! #n"ome ta$ "han)es su))ested the !ollo'#n) est#mates o! the #m a"t o! "han)#n) the rate o! #n"ome ta$ !rom the then-rul#n) standard rate o! 40G. The ta(le su))ests. !#rst. that. em #r#"ally. the e$ e"tat#on held (y many eo le that #n"reas#n) #n"ome ta$ rates redu"es the hours eo le 'or% #s "orre"t (ut that. se"ond. the s#8e o! the e!!e"t #s *ery small. 5ne reason !or th#s #s that the a*era)e e!!e"t #s made u o! the de"#s#ons o! many #nd#*#duals. some o! 'hom rea"t one 'ay and some #n the o os#te 'ay so that mu"h mutual "an"ell#n) out o""urs and the o*erall e!!e"t #s sl#)ht. Ta(le 1 Est#mates o! the e!!e"t on a*era)e hours 'or%ed o! #n"ome ta$ "han)es. UH Fales. 19A1 Ta$ rate 05G G Chan)e #n Cours +or%ed: 0.B4 0BG 0.4A 40G -0.55 45G -1.45

Source: CV Bro'n. Taxation and Labour Supply. Ieor)e ;llen J Un'#n. 19B1. Ta(le 10.0.

,or Hour O%' T!me: .. =em+'( +'( Supply: Comp+r!so' +'( Summ+ry 1. The 9uant#t#es a trader '#shes to (uy or sell #n an e$"han)e e"onomy -'here there #s no rodu"t#on/ de end on only t'o sets o! !a"tors: The trader3s tastes. -Ind#!!eren"e "ur*e ma ./ The trader3s !eas#(le set. -:os#t#on J slo e o! (ud)et l#ne/. 0. Ta(le 0 summar#8es the #m a"t o! r#"e "han)es on demand and su 1 red#"ta(le2 "ases are and #n!er#or )oods #n su ly. normal )oods #n demand ly. ;s 'e ha*e seen. the

In these "ases the #n"ome and su(st#tut#on e!!e"ts o erate #n the same d#re"t#on and the net e!!e"t o! the t'o "an there!ore (e red#"ted. The 1a'%'ard2 "ases are #n!er#or )oods #n demand and normal )oods #n su ly& #n these t'o "ases the #n"ome and su(st#tut#on e!!e"ts o erate #n o os#te d#re"t#ons and the net e!!e"t "annot there!ore (e red#"ted !rom theory alone.

LUBS1950

Semester I - LECTURE IV.

B.

Ta(le 0. Com ar#son o! In"ome and Su(st#tut#on E!!e"ts #n <emand and Su Good ?ormal Demand Su(st#tut#on J #n"ome e!!e"ts 'or% #n thesame d#re"t#on. : K< Su(st#tut#on J #n"ome e!!e"ts e!!e"ts 'or% #n o os#te d#re"t#ons. ELCE:T 65R II66E? I55<S. : K< :r#"e redu"t#ons lead to #n"reases #n the K< '#th the e$"e t#on o! I#!!en )oods. -The 1La' o! <emand2 holds e$"e t !or I#!!en )oods/. Supply

ly

Su(st#tut#on J #n"ome e!!e"ts 'or% #n o os#te d#re"t#ons.: KS or

In!er#or

Su(st#tut#on J #n"ome e!!e"ts 'or% #n the same d#re"t#on. : KS :r#"e redu"t#ons may or may not lead to de"reases #n the KS. -There #s no 1La' o! Su ly2/.

Con"lus#ons

:: :r#"e& K<: Kuant#ty <emanded& KS: Kuant#ty Su

l#ed& : u & : do'n& : #m l#es& results #n.

4. Be"ause eo le ty #"ally "onsume a '#de *ar#ety o! )oods (ut sell only a small *ar#ety o! )oods. #n"ome e!!e"ts are l#%ely to (e small !or )oods #n demand (ut lar)e !or )oods #n su ly. Th#s means that I#!!en )oods are rare -Le"ture III. :art II. </ (ut that )oods 'here a !all #n the mar%et r#"e leads to an #n"rease #n su ly may (e relat#*ely "ommon. So 'e ha*e a 1La' o! <emand2 su(=e"t to the em #r#"ally un#m ortant e$"e t#on o! the I#!!en )ood (ut 'e ha*e no 1La' o! Su ly2 at all.

LUBS1950

Semester I - LECTURE IV.

9.

By the t#me you ha*e 'or%ed throu)h th#s mater#al you should now: the )round rules !or the analys#s o! su ly #n a ure e$"han)e e"onomy& 'hat an #n#t#al endo'ment #s& that a household #n e9u#l#(r#um #n su ly at an #nter#or solut#on has an FRS o! b !or a e9ual to the rat#o o! the r#"e o! a to the r#"e o! b& ho' (ud)et l#nes sh#!t #n the analys#s o! su ly #n res onse to "han)es #n r#"es& that #! a "ommod#ty #n su ly #s a normal )ood then su ly may #n"rease #! the mar%et r#"e r#ses& that the 9uant#t#es a household "hooses to demand and su ly de end on only the household2s tastes and !eas#(le set.

By the t#me you ha*e 'or%ed throu)h th#s mater#al you should understand and be able to explain: 'hy the su ly#n) household2s (ud)et l#ne mo*es as #t does #n res onse to r#"e "han)es& 'hy a household may "hoose to su ly more o! a "ommod#ty 'hen #ts r#"e !alls& 'hy there #s no 1La' o! Su ly2.

By the t#me you ha*e 'or%ed throu)h th#s mater#al you should (e able to: determ#ne a household2s e9u#l#(r#um su ly 9uant#ty )#*en data a(out #ts tastes. #ts #n#t#al endo'ment and the r#"es o! the "ommod#ty #t #s sell#n) and the "ommod#ty #t #s (uy#n)& demonstrate that a household may "hoose to su ly more o! a "ommod#ty 'hen #ts r#"e !alls (y se arat#n) out the #n"ome and su(st#tut#on e!!e"ts o! a "han)e #n the r#"e o! the "ommod#ty& a ly th#s analys#s to household su l#es o! la(our& d#s"uss the em #r#"al e*#den"e on the res ons#*eness o! la(our su ly to ta$ "han)es.

+ant to re are !or ne$t 'ee%> 6or Le"ture V on Su ly J <emand )o to the Custom Te$t. "h. 0 6or Le"ture VI on E$"han)e )o to "h. 1@.1 and 1@.0.

FI

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