lecture05.ppt

Keyissues 1 derivingdemandcurves2 incomeeffect3 effectsofapricechange4 CPIbias5 laborsupplycurve traceoutthedemandcurvebyholdingincomeandthepriceofwineconstant andvaryingthepriceofbeerexample estimatedsetofindifferencecurvesforthetypicalAmericanconsumerarebowedawayfromorigin sobeerandwineareimperfectsubstitutions DerivingDemandCurves DerivinganIndividual sDemandCurve Price consumptioncurve showshowtheoptimalpairsofbeerandwinevaryastherelativepricevaries Howincomechangesshiftdemandcurves holdpricesfixedandvaryincomeincreaseinincomecausesshiftofthedemandcurvemovementalongincome consumptioncurvemovementalongtheEngelcurve EffectofaBudgetIncreaseonanIndividual sDemandCurve Incomeelasticities incomeelasticity normalgood EI 0inferiorgood EI 0 Mimi sincomeelasticities beer Eb 0 88wine Ew 1 38botharenormalgoods Arechildreninferior motherwithrelativelittleeducation EI 0 18motherrelativelywelleducated EI 0 044 Income consumptioncurvesandincomeelasticities shapeofincome consumptioncurvefor2goodstellsussignofincomeelasticitiessomegoodsmustbenormal notallgoodscanbeinferior Income ConsumptionCurvesandIncomeElasticities Incomeelasticitiesmayvarywithincome Gailmayviewhamburgerasanormalgoodatalowincomeaninferiorgoodatahighincome AGoodThatIsBothInferiorandNormal Qualityandincomeelasticities whentheirincomesrise somepeoplebuyhigherqualitygoodsratherthanmoreofwhatthey recurrentlybuyingexamples fanciercarsfancierfoodsdesignerclothing Effectsofapricechange aspriceofonegoodgoesup allelsethesame therearetwoeffects asubstitutioneffectanincomeeffect Substitutioneffect consumerssubstituteother nowrelativelycheaper goodsfortheonewhosepricerosedirectionoftheeffectisunambiguous Incomeeffect priceincrease consumers buyingpowerfalls reducing income opportunityset soconsumerbuyslessofatleastsomegoodsdirectionofincomeeffectdependsonincomeelasticityofeachgood Incomeandsubstitutioneffects SubstitutionandIncomeEffectswithNormalGoods Incomeandsubstitutioneffectwithaninferiorgood substitutioneffect oppositeofpricemovementincomeeffect samedirectionaspricemovementGiffengood goodforwhichadecreaseinitspricecausesthequantitydemandedtofallpotatoesinIreland quininewaterforlabrats GiffenGood Inflation becauseofinflation pricestodayarenotdirectlycomparabletopastpricesinflationharmspeopleonfixedincomes netlenders andothers Cost of livingadjustments manylong termcontractsincludecost of livingadjustments COLAs generalbusinesscontractsrentalalimonypaymentssalariespensions ConsumerPriceIndex CPI manygovernmentsreportacost of livingmeasure CPImeasureofinflation overallriseinpricesovertimeCPIoverestimateshowtruecost of livingchangesovertimeoverestimatehurtsyouifyourlandlordincreasesrentonyourapartmentusingCPI Realvs nominalprices nominalprice currentdollars pricerealprice constantdollar price adjustedforinflation realprice nominalpricedividedbyCPI Governmentcollectsprices on364individualgoodsandservices suchas housingdentalserviceswatchandjewelryrepairscollegetuitionfeestaxifareswomen shairpiecesandwigshearingaidsslipcoversanddecorativepillowsbananasfuneralexpenses Summarystatistics ifgovernmentreportsallpriceincreasesseparately informationisoverwhelminginsteaduseasinglesummarystatistic CPI howpricesroseonaverage Averaging onewaytoaveragepriceincreases weightthegoodequallybutdowereallywanttoweightpriceincreaseofskateboardsasmuchasthatofautomobiles CPIapproach givealargerweighttopricechangeofagood thelargeritsbudgetshareexample supposeCPIconsistsofonlyclothing C andfood F Priceofbundles Calculaterateofinflation CPIadjustment weassumepriceofclothingrosemorerapidlythanthatoffoodCPIovercompensates upwardbias utilityrisesbecauseconsumersubstitutestowardtherelativelycheapergood TheConsumerPriceIndex SourceofBias TotalCPIbias CPICommissionconcludedthatCPIhasatotalupwardbiasofabout1 1percentagepointsperyear substitutionbias 0 4percentagepointsperyearfailuretotakeproperaccountofspreadofdiscountstores 0 1percentagepointfailuretoaccountfullyforqualityimprovementsandnewproducts drugs computers 0 6percentagepoint USPS in2002 atypicalunionemployeeearned 59 900 includingbenefits Substitutionbiasof0 5 ayearcostsUSPS 300extraperemployeemultipliedby860 000employees substitutionbiascostsUSPSover 257millionperyear andbenefitsitsemployeesbysameamount FederalGovernment CPICommissionconcludedCPIisfourthlargest federalprogram afterSocialSecurity healthcare defense 634billionofnationaldebtwouldbeeliminatedin5yearsifCPIrose1 lessrapidlyperyeargaintogovernmentwouldlargelybeatexpenseofSocialSecurityrecipients Howricharedevelopingcountries commonlyusedmeasureofincomeunderstatesthird worldcountryincomesrelativetothoseofindustrialnationsproblem ignoressubstitutioneffects aswithCPI InternationalMonetaryFund IMFusedtoreportcountry sincomebyconvertingnativecurrencyintodollarsatmarketexchangerateIMFswitchedtousingpurchasing powerparities PPP whichtakeaccountofinternationaldifferencesinpricesusedtoreporthowmuchChinesecouldbuyathighUSprices nowuselowerChineseprices Result IMFnowreportsthatthirdworld sshareofworld sincomewentfrom18 to34 fordevelopingcountries9 to11 forEasternEuropeandtheformerSovietUnion7 to18 forAsia73 to54 forindustrializedcountries Moreplausible oldsystem China stotalincomeIndiaimprobableChinahasahighdailyfoodconsumption70 ofChineseurbanhouseholdshavecolorTVs81 havewashingmachinesnewChineseav incomeis 1 950China sshareoftheworldincomerosefrom2 to6 makingitthird biggesteconomybehindU S 22 5 andJapan 7 6 1999U S incomedistribution solid 2001Chinaincomedistribution dashes Derivinglaborsupplycurves useconsumer theorymodeltoderivesupplycurveoflaborbyderivingdemandcurvefortimespentnotworkingtimeconstraint H 24 NH hoursofworkinadayN hoursofleisureornonworkinaday Priceofleisure foregoneearningsaregreaterforalawyerwhoearns 500anhourthanforsomeonewhoworksforminimumwage Utility Laura sutility U I N dependsongoodssheconsumes representedbyherincome Inumberofhoursofleisure N Budgetconstraint Timeconstraint can tincreasehoursinadayverticalconstraintat24hoursofleisure DemandforLeisure Supplycurveoflabor hersupplycurveofhoursworked labor is mirrorimage ofdemandcurveforleisure H 24 Nforeveryextrahourofleisuresheconsumes sheworksonefewerhour SupplyCurveofLabor Solvedproblem originally Laurachosetowork12hoursperdaywhenshecouldworkasmanyhoursasshewantedatawageofwnewlimit shemaynotwork 8hourshowdoesheroptimalchoicebetweenhoursworkedandgoodschange willshebeworseoff havelowerutility Restatement change Laurafacesanadditionalconstraint can tworkmorethan8hours affects numberofhourssheworks goodsshebuys andherutility Solvedproblem Mark sutilityfunctionishisbudgetconstraintis Howmanyhoursadaydoeshechosetoworkifthewageisw Answer Incomeandsubstitutioneffects increaseinwagecausesbothincomeandsubstitutioneffectsthatalteranindividual sdemandforleisureandsupplyofhoursworked IncomeandSubstitutionEffectsofaWageChange Estimatedlaborsupplycurves typicalBritishmaleslightlybackward slopingsupplycurvelaborsupplyelasticitybetween 0 2and 0 05Americanmaleworkersverticalsupplycurveelasticitybetween 0 2and0 15 bestestimatesis0 unmarriedwomenupwardslopingelasticitybetween0and4 Marriedwomen ssupplycurves slightlybackwardbendinginCanadaandU S slightlyforwardslopinginU K andGermany Doanimalsmakerationalchoices animalshavetomakechoicesbetweenscarceresources asdohumansincome leisurechoicesofpigeons job peckingaresponsekeyfora3secondaccesstoafoodhoppercontainingmixedpigeongrains Iassumetheyusedadultpigeons sofarasIknow noonehaseverseenababypigeon Wagesandincome wagescouldbealteredbyvaryingnumberofpecksrequiredforapayofffromabout12to400incomevariedbyprovidingfreeaccessfor3secondstofoodhopperatregularintervalsbyvaryingbothwagerateandincome experimenterscoulddeterminedpure compensated substitutioneffectofawagechangeandincomeeffect Researchersfound compensatedsubstitutioneffectforleisure 0 aspriceofleisurefallsandpigeonscompensatedwithmoreincome consumedmoreleisureleisurenormalgood aspigeons incomeincreased foodwithoutworking pigeonsconsumedmoreleisurebyspendinglesstimepeckingpigeons supplycurveoflaborisbackwardbending IncomeTaxes Incometaxratesandlaborsupply whycareaboutshapeoflaborsupplycurves ifsupplycurvesareupwardsloping incometaxcausespeopletoworkfewerhoursreducinggoodsproducedraisingfewertaxrevenuesifsupplycurvesslopebackward asmallincreaseinincometaxratemayincreasetaxrevenuesandincreasetotalproduction Taxcuts PresidentsJohnKennedyandRonaldReaganarguedthatcuttingmarginaltaxratewouldstimulatepeopletoworkmoreReaganalsoclaimedthat duetoextrawork taxreceiptswouldincreasebecausetaxrateshaveadjustedsubstantiallyovertime wehaveanaturalexperimenttotestthishypothesis Taxrates Kennedytaxcuts loweredtoppersonalmarginaltaxratefrom91 to70 ratefelloverthenextcoupleofdecades ReaganTaxReformActof1986 DuetotheReagantaxcuts themaximumratefellto50 from1982 198638 5 in198728 in1988 1990rateroseto31 in1991 199239 6 from1993 2000 BushAdministration sTaxReliefActof2001 taxcutreducestoprateto38 6 for2001 200337 6 for2004 200535 for2006andthereafterMarginalratesoriginal 15 28 31 36 39 6 proposed 10 15 25 33 after7 2001 15 27 5 30 5 35 5 39 1 InternationalComparison 2001 highestmarginaltaxrateincludingbothcentral federal andsub centralgovernmenttaxes stateandlocal rangedfrom35 6 inTurkeyto65 2 inBelgiumtoprates UnitedStates47 5 Australia48 5 Canada43 2 Denmark63 3 Iceland43 1 Japan49 5 Netherlands52 0 NewZealand39 0 UnitedKingdom40 Effectoftax effectofataxrateof 0 28istoreducetheeffectivewagefromwto 1 w 0 72wtaxreducesafter taxwageby28 sothataworker sbudgetconstraintrotatesdown LaborSupplyCurveThatSlopesUpwardandThenBendsBackward LaborSupplyCurveThatSlopesUpwardandThenBendsBackward Taxrevenueandtaxrate iflaborsupplyisfirstupwardslopingandthenbackwardbendingthen relationshipbetweentotaltaxrevenues wH andtaxrate isbellshaped RelationshipofTaxRevenuetoTaxRates 600 800 400 200 Taxrevenue 50 0 t 79 100 t Marginaltaxrate Taxrevenue EffectsofU S taxcuts estimatesof between79 and85 Kennedyerataxcutfrom91 to70 raisedtaxrevenueandincreasedworkeffortoftop income bracketworkersReagantaxcutshadoppositeeffectsbecauseactualtaxrate wasonlyabouthalfasbigas U S wasinupward slopingsectionofbell shapedcurverapidgrowthofU S deficitduringReaganerapartiallyduetotaxcuts Effectsoftaxcutsinothercountries Sweden 80 marginaltaxrateisgreaterthanthatcountry s Netherlands isabout70 closetoactualrateof67 4 in1985 Solvedproblem canaflattax constantmarginaltaxrate beaprogressivetax richpeoplepayahigheraveragetaxratethanpoorpeople Answer yestaxsystemmayexemptafixedamountofincomefromtaxesperpersonsupposefirst 10 000ofincomeisexemptflat10 rateischargedonremainingincomesomeonewhoearns 20 000 averagetaxrateof5 someonewhoearns 40 000 averagetaxrateof7 5 Stategeneralfundrevenues shareoftotalstategeneralfundrevenues 40billion personalincometax 35 salestax 35 7 bankingandcorporations 12 3 tobacco 0 4 horseracingandliquorare0 7 Intelpaysnotaxcutwelfare lose50 fromfeds WinningtheGoodLife Wouldyoustopworkingifyouwonabiglotteryprizeorinheritedalargesum Imbens Rubin andSacerdote 2001 comparedmajor prizewinnersandotherswhoplayedtheMassachusettsMegabuckslotteryprizesrangedfrom 22 000to 9 7million withanaverageof 1 1million paidinyearlyinstallmentsovertwodecades Results typicalpersonplayinglotteryearned 16 100averagewinnerreceived 55 200inprizemoneyperyearandchosetoworkslightlyfewerhourssothathisorherlaborearningsfellby 1 877peryearthus winnersincreasedtheirconsumptionandsavingsbutdidnotsubstantiallydecreasehowmuchtheyworkedforeverydollarofunearnedincome winnersreducedtheirworkeffortandhencetheirlaborearningsby11 onaverage Demographicdifferences behaviorsamefor menandwomenbigandverybigprizewinnerspeopleofalleducationlevelsdifferencesbyageofthewinnerandbyincomegroups people55to65reducedtheireffortbyaboutathirdmorethanyoungerpeople retiredearly peoplewithnoearningsinyearbeforewinninglotterytendedtoincreasetheirlaborearningsafterwinning Child CareSubsidies increasedemploymentofmothersoutsidethehomeledtoasteepriseinchildcareoverpastseveraldecades6of10U S mothersworktoday twicetheratein19706of10childrenundertheageof6areinchildcare 45 ofchildrenunderageone 8of10employedmotherswithchildrenunder6havesomeformofnonparentalchildcarearrangement Child CareSubsidies cont childcareisamajorburdenforpoor maypreventpoormothersfromworkingChild careexpensesforchildrenunder5absorbed25 oftheearningsforfamilieswithannualincomes 14 400 butonly6 forfamilieswithincomesof 54 000ormore Question Congressmustdecidehowtoaidpoorfamilieschild careprogramcouldprovideanadvaloremoraspecificsubsidyalternatively governmentcouldprovideanunrestrictedlump sumpaymentunderthemajorwelfareprogramthatcouldbespentondaycareoronallothergoodssuchasfoodandhousing Question cont foragivengovernmentexpenditure doesthepricesubsidyorthelump sumsubsidyprovidegreaterbenefittorecipients whichincreasesthedemandfordaycareservicesbymore whichinflictslesscostonotherconsumersofda