Microeconomics for E&BE

Welcome to Lecture 1: Introduction plus Supply and Demand!

 Amos Lee - Supply and Demand

Gert-Jan Romensen
[email protected]

Department of Economics, Econometrics & Finance, University of Groningen

Room 728, Duisenberg Building
Introducing the team: Lecturer and course coordinator

• Gert-Jan Romensen

• Assistant professor of Economics

• Favorite spots in Groningen:

Noorderplantsoen and Kardinge

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Introducing the team: Tutorial teachers

Anouk Schippers Lieke Voorintholt Lotte Swank

Nannette Stoffers Oliver Herrmann Tobias Grohmann 2

Introducing the team: Secretary and teaching assistants

• Helena Lei

• Secretary for Microeconomics for E&BE

• Contact: [email protected]

Teaching assistants:
• Anneke Akkerman, Barnabas Bakucz, Benjamin Goder, Celine van der Wei-
jden, Christian de Vries, Dimosthenis Sampson, Femke de Boer, Isa Sulter,
Lars Boersma, Lucas Vos, Mariska Dommerholt, Mattia Fustinoni, Milan
Mulder, Sharon Langenberg, Stefan Tijink, Thomas Ganzevoort, Wendy
Bijpost and Zalan Varkonyi

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Why this course?

• What are the big economic topics in the upcoming years?

1. Energy transition: From fossil fuels to renewable energy
2. Climate change: Designing policies to address pollution
3. Big data: Personalization of products, prices, and advertisements
4. Aging populations: Savings and consumption over the lifecycle
5. Digitalization of markets: Effects on brick-and-mortar businesses
6. Et cetera

 Goal: To view these kind of challenges through the lens of an economist

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We live in interesting times

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What is economics?

• Economics is concerned with the allocation of scarce resources. It is

the study of how people make decisions, use resources and respond
to incentives

• Economics ranges from the very small to the very large

Microeconomics is the study of individual decisions
Macroeconomics is the study of the economy as a whole

• A microeconomist and a macroeconomist walk into a bar

The microeconomist may ask: “Do I consume more or less Belgium
Trappist beers if the price of Irish stout goes up?”
The macroeconomist may ask: “Is there a relation between economic
growth and the level of alcohol consumption in a country?”

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Is economics useful? Citation rates between the social sciences

1 Source: Angrist et al. 2017 7

Is economics useful? Examples of what economists do

• Designing government policies that account for, and help people over-
come, behavioral biases and errors in everyday decision-making
 Richard H. Thaler (2017 Nobel laureate in Economics)

• Using field experiments to find out what works in improving the lives
of people in developing countries (wealth, health, and education)
 Esther Duflo (2019 Nobel laureate in Economics)

• Creating mechanisms to help patients find the right kidney donors

 Alvin Roth (2012 Nobel laureate in Economics)

• What are the sources and consequences of economic immobility and

inequality of opportunities?
 Raj Chetty (2013 John Bates Clark Medal for economists under 40)

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The focus in this course is on Microeconomics

• Not only have macroeconomists been em-

barrassed by a decade of failed predic-
tions, but they are also losing their edge.
For anyone starting out in economics, the
future is micro

• Microeconomists are a humble bunch.

Rather than seeking a unified theory of
everything, they hone in on a particular
area, often a single type of market or firm,
and try to find out how it works

• The Economist, January 2015

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Microeconomics: The study of individual decisions

• The focus of this course is to explore how rational consumers and

profit-maximizing firms behave in a competitive market

• We look at models; simplified representations of reality that focus on

the aspects of reality that are important for the problem at hand

• We will use math to structure our thoughts about these models

Dani Rodrik (2015): “Math ensures that the elements of a model -
the assumptions, behavioral mechanisms, and main results - are stated
clearly and are transparant. Once a model is stated in mathematical
form, what it says or does is obvious to all who can read it. This
clarity is of great value and is not adequately appreciated.”

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“Economists make unrealistic assumptions”

• Milton Friedman (1953) argues that a theory cannot be tested by

the realism of its assumptions. What matters is the accuracy of the
theory’s predictions
People typically behave as if they are maximizing satisfaction
Firms typically behave as if they are maximizing profits

• Our main purpose in this course is to study how markets function, not
how consumers behave. For that purpose, rationality is a reasonable
assumption

• John H. Cochrane (2015) on his blog The Grumpy Economist:

“People do a lot of nutty things. But when you raise the price of
tomatoes, they buy fewer tomatoes”

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“Economists make unrealistic assumptions”

• This is a highly stylized map of Gronin-

gen. Still, it perfectly allows you to get
around. Better than any more “realistic”
map. Same is true for economic models

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Course disclaimer

• Many new things in the course this year!

1. New course coordinator and secretary
2. New material (lectures, tutorials and practicals)
3. New online environment (Brightspace)

• The course is work-in-progress

Asking for a favor (part I): Have some mercy when you spot a typo in
the material, when the course page on Brightspace has an occassional
error, or when an announcement/email reply is delayed
Asking for a favor (part II): Please give us feedback, both in real-
time as well as afterwards in the course evaluation

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Road map of today’s lecture

• General introduction to the course

A typical week in the course
Contact and communication
Topics discussed
Textbook
Grading and exam dates
How to study in this course?
MicroApp

• Break

• Supply and demand: The basics

Introducing the supply-and-demand framework
When is a market in equilibrium?
Economic welfare in markets: Consumer surplus and producer surplus
Elasticities: Measuring the responsiveness to price changes

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Lecture 1: What you will learn today

1. A lot about the course structure

2. Market equilibrium: Where demand meets supply

3. Elasticities: Measuring the responsiveness to price and income changes

4. Economic welfare: Consumer surplus and producer surplus

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General introduction: A typical week in the course

• Tuesday: Two-hour lecture in which the microeconomic theories of

the material for that week are covered

• Wednesday-Thursday: Two-hour tutorial in which a teacher elabo-

rates on exercises related to the material from the lecture. There will
also be group work in some exercises

• Thursday-Friday: Two-hour practical in which you work in groups

on exercises related to the lecture material (first hour), with feedback
from TA’s. There is a graded quiz in the second hour that tests your
understanding of the material for that week

• Outside the classroom: self-study and practice

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General introduction: Contact and communication

• How to stay up to date with the course information?

1. Course manual
2. Announcement via Brightspace

• Whom should I contact?

Coordinator: Course organization and material as well as urgent issues
Secretary: Enrollment, grades, attendance, Brightspace, et cetera
Tutorial teachers: Questions about the tutorial exercises
 We aim to reply to your question within three working days. You can
send a reminder if we fail to do so

• Office hour by the coordinator: Every Wednesday from 16.00 until

17.00 in room 728 (extra office hours TBA prior to exams)

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General introduction: Topics discussed

• Week 1: The Basic Supply and Demand Model

• Week 2: Economic Policy

• Week 3: Consumer Behavior

• Week 4: Individual and Market Demand

• Week 5: Producer Behavior

• Week 6: Costs and Perfect Competition

• Week 7: Perfect Competition and Monopoly

• Week 8: General Equilibrium and Externalities

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General introduction: Textbook

• Textbook: Goolsbee A., Levitt S. and C. Syverson (2020): Microe-

conomics, Macmillan, 3rd Edition (ISBN: 9781319306793)

The third edition of Goolsbee et al. (2020) is the

reference book for this course. All other editions of
this book are allowed as well, such as the first and
second international edition or US edition. Chapter
numbers may vary across editions

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General introduction: Grading and exam dates

• Components of the final grade in this course

Midterm exam: 30%
Final exam: 60%
Participation: 10%

• Midterm (3 October 2022): Covers the first four lecture weeks

• Final (31 October 2022): Covers all lecture weeks

• Participation: Avg. of six best practical quizzes (out of seven)

 Only awarded if five out of seven tutorials and six out of seven prac-
ticals (not counting the week 1 practical) were attended

• Resit (2 February 2023): Covers all lecture weeks (weight of 100%)

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General introduction: How to study in this course?

• Step one: Familiarize yourself with the course information: what is

expected from you in this course?
Course manual and Brightspace announcements

• Step two: Read the book and slides carefully (really understand it)

• Step three: Solve exercises (tutorials, practicals, and old exams)

• But wait, there is more!

Practice on the MicroApp: A learning platform specifically developed
for this course!

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General introduction: MicroApp

• A learning platform, developed by the course coordinator, on which

you can practice at your own pace and level with the material
• Access via https://www.microapp.nl
• Personal login credentials are made available soon via Brightspace

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General introduction: MicroApp

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Time for a break! Ò

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A note on how the lectures are structured

• During lectures I will not cover everything and focus on selected

topics based on what students from previous cohorts found challenging

• My approach: Spend more time on the core and challenging topics

rather than aiming to discuss everything

• Please refer to the textbook for a more extensive discussion of the

material (including topics not covered in class)

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Supply and demand: Introducing the framework

• Let’s start from the very beginning: What is a market?

A market facilitates exchange and is characterized by a specific:
(1) product or service, (2) location, and (3) point in time
Example: The market for singing lessons in Groningen, today

• Markets have a demand side and a supply side

Demand: Combined amount that all consumers are willing to buy
Supply: Combined amount that all producers are willing to sell

• Four assumptions in the supply-and-demand model of a market

1. We focus on a single market
2. All products sold are identical
3. All products sell for the same price and everyone has full information
4. Many consumers and producers in the market

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Supply and demand: A visit to the Vismarkt in Groningen

Weekly Saturday trip to the Vismarkt to do the groceries:

Eager to buy a tray of kibbeling

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Supply and demand: A visit to the Vismarkt in Groningen

• In the market for kibbeling, consumers (like you and me) and fish
market stalls (“producers”) interact with each other

• Suppose that the quantity demanded and supplied of kibbeling, QKD

and QKS , can be described as follows (with PK being the price):
Demand: QKD = 700 − 50PK + 25PL + 10B
Supply: QKS = 150PK

• Surely other factors affect the market as well? What about the
grocery budget and the price of other products?
Let’s include the grocery budget B and the price of loempia’s (spring
rolls), PL , in the demand function for kibbeling
For now, we assume that: B = 20 and PL = 4

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Supply and demand: Constructing (inverse) demand curves

• Demand
PK
QKD = 700 − 50PK + 25PL + 10B
20
QKD = 1, 000 − 50PK
16
12 • Inverse demand:
PK as a function of QKD
8 PK = 14 − 50
1
QKD + 12 PL + 15 B
4 D PK = 20 − 1
QD
50 K

0
200 400 600 800 1, 000 • PK = 20 is the choke price:
QK
The price at which QKD = 0

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Supply and demand: Constructing (inverse) demand curves

• Demand
PK
QKD = 700 − 50PK + 25PL + 10B
20
QKD = 1, 000 − 50PK
16
12 • Inverse demand:
PK as a function of QKD
8 PK = 14 − 50
1
QKD + 12 PL + 15 B
4 D PK = 20 − 1
QD
50 K

0
200 400 600 800 1, 000 • What happens if PK changes?
QK
Movement along the demand curve

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Supply and demand: Constructing (inverse) demand curves

• Demand
QKD = 700 − 50PK + 25PL + 10B
PK
QKD = 1, 000 − 50PK
22
DPL =8
• Inverse demand:
20
DPL =4 PK as a function of QKD
8 PK = 14 − 50
1
QKD + 21 PL + 51 B
PK = 20 − 1
QD
50 K

⇒
• What happens if PL changes?
0
200 600 1, 000 1, 100 Suppose from PL = 4 to PL = 8
QK
PK = 22 − 1
QD
50 K

Shift of the demand curve

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Supply and demand: Constructing (inverse) demand curves

• Demand
QKD = 700 − 50PK + 25PL + 10B
PK
QKD = 1, 000 − 50PK
22
DB=30
• Inverse demand:
20
DB=20 PK as a function of QKD
8 PK = 14 − 50
1
QKD + 21 PL + 51 B
PK = 20 − 1
QD
50 K

⇒
• What happens if B changes?
0
200 600 1, 000 1, 100 Suppose from B = 20 to B = 30
QK
PK = 22 − 1
QD
50 K

Shift of the demand curve

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Supply and demand: ∆ in income or prices of other goods

• The impact of changes in PL (∆PL ) reveal whether K and L are

substitutes or complements
Substitutes: Goods that can be replaced with one another
• Demand for kibbeling increases if PL increases, and vice versa
Complements: Goods that are consumed together
• Demand for kibbeling decreases if PL increases, and vice versa

• The impact of changes in B (∆B) reveal whether K is a normal good

or an inferior good
Normal good: Goods for which demand increases if income increases,
and vice versa
Inferior good: Goods for which demand decreases if income increases,
and vice versa

• Note: In most exercises in this course, we talk of consumer income (I )

rather than consumer budgets (B)

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Supply and demand: Constructing (inverse) supply curves

PK
• Supply
S QKS = 150PK

12
• Inverse supply:
8 PK as a function of QKS
PK = 150
1
QKS
4

0
600 1, 200 1, 800
QK

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Supply and demand: Determining the market equilibrium

PK • Demand and inverse demand:

20 QKD = 1, 000 − 50PK
S PK = 20 − 1
QD
50 K

• Supply and inverse supply:

PK∗ = 5
QKS = 150PK
PK = 1
QS
D 150 K

0 • Market equilibrium (PK∗ , QK∗ ):

QK∗ = 750 1, 000 QK Demand equals supply: QKD = QKS

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Supply and demand: Determining the market equilibrium

PK
20
• Demand and inverse demand:
S
QKD = 1, 000 − 50PK
PK = 6
PK = 20 − 1
QD
50 K
PK∗ =5
PK = 4 • Supply and inverse supply:
Excess demand
D QKS = 150PK
PK = 1
QS
150 K
0
QK∗ = 750 1, 000 QK
• What if PK < PK∗ or PK > PK∗ ?
QKS = 600 QKD = 800 Excess demand: PK < PK∗

QD S
K > QK

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Supply and demand: Determining the market equilibrium

PK
20
Excess supply • Demand and inverse demand:
S
QKD = 1, 000 − 50PK
PK = 6
PK = 20 − 1
QD
50 K
PK∗ =5
PK = 4 • Supply and inverse supply:
D QKS = 150PK
PK = 1
QS
150 K
0
QK∗ = 750 1, 000 QK
• What if PK < PK∗ or PK > PK∗ ?
QKD = 700 QKS = 900 Excess supply: PK > PK∗

QSK > QD
K

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Supply and demand: Markets and economic welfare

• Consumer surplus (CS): The gain for consumers if the price of a

product is less than consumers’ willingness to pay for that product
 CS is the area between the inverse demand curve and the market price

• Producer surplus (PS): The gain for producers if the market price
of a product exceeds producers’ willingness to sell the product
 PS is the area between the inverse supply curve and the market price

• Total surplus (TS): The sum of consumer surplus and producer

surplus (in the absence of government policies)

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Supply and demand: Consumer surplus and producer surplus

PK
20 • Consumer surplus (CS):
S CS = 21 (20 − 5)(750 − 0) = 5, 625
CS
PK∗ = 5

0
QK∗ = 750 1, 000 QK

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Supply and demand: Consumer surplus and producer surplus

PK
20 • Consumer surplus (CS):
S CS = 21 (20 − 5)(750 − 0) = 5, 625
CS
• Producer surplus (PS):
PK∗ = 5
PS PS = 21 (5 − 0)(750 − 0) = 1, 875
D
• Total surplus (TS):
0 TS = CS + PS = 7, 500
QK∗ = 750 1, 000 QK

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Research intermezzo: Consumer surplus of ride-hailing services

• It can be hard to derive demand curves and consumer surplus in real

markets. For example, how to find consumers’ willingness to pay?

 Solution: Conduct an experiment. Economists and Uber data sci-

entists used Uber’s surge pricing algorithm to estimate the demand
curve for ride-hailing services and the associated consumer surplus

2 Source:Cohen et al. (2016). Using Big Data to Estimate Consumer Surplus: The
Case of Uber. NBER Working papers 41
Research intermezzo: Consumer surplus of ride-hailing services

Ride requests at surge thresholds Estimated demand curve for rides

• The researchers estimated that for 2015 the overall consumer surplus
of Uber’s ride-hailing services in the US was $6.8 billion

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Supply and demand: Elasticities

• Economists are often interested in how consumers and producers

react to changes in prices and income

• For this, we use the concept of elasticity: The percentage change

in one variable (e.g., quantity) divided by the percentage change in
another variable (e.g., price)
Answers the question: What is the percentage change in Q if, say,
the price is changed with one percent?

• Back to the Vismarkt: How responsive is the quantity demanded

and supplied of kibbeling to changes in the price of kibbeling, price of
other goods, and consumer income?

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Supply and demand: Price elasticities of demand and supply

• Price elasticity of demand: Percentage change in the quantity de-

manded due to a one percent change in the price
∆QD
%∆QD QD ∆QD P
ϵD = = ∆P
=
%∆P P
∆P QD

If we assume ∆P to be small, then:

∆QD P ∂QD P
ϵD = ≈
∆P QD ∂P QD

• Price elasticity of supply: Percentage change in the quantity sup-

plied due to a one percent change in the price
∆QS P ∂QS P
ϵS = ≈
∆P QS ∂P QS

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Supply and demand: Price elasticities of demand and supply

• Recall our earlier results from the Vismarkt:

Demand: QKD = 700 − 50PK + 25PL + 10B or QKD = 1, 000 − 50PK
Supply: QKS = 150PK
Market equilibrium: PK∗ = 5 and QK∗ = 750

• Price elasticity of demand at the market equilibrium:

∂QKD PK (5) 1
ϵD = = (−50) =−
∂PK QKD (750) 3
1% price increase reduces QKD with 31 % (opposite for price decrease)

• Price elasticity of supply at the market equilibrium:

∂QKS PK (5)
ϵS = = (150) =1
∂PK QKS (750)
1% price increase increases QKS with 1% (opposite for price decrease)
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Supply and demand: Price elasticities of demand and supply

• How to interpret the magnitude of the elasticities?

Inelastic response (∣ϵ∣ < 1): Q changes with less than 1% in response
to a 1% price change
Unit-elastic response (∣ϵ∣ = 1): Q changes with 1% in response to a
1% price change
Elastic response (∣ϵ∣ > 1): Q changes with more than 1% in response
to a 1% price change

• Note: ∣ ⋅ ∣ means absolute value and refers in math to the distance

from zero. Absolute value is always positive, e.g., ∣ϵD ∣ = ∣ − 31 ∣ = 13

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Research intermezzo: Price elasticities of ride-hailing services

Figure 3: Purchase rate changes of Uber rides at price discontinuity

The vertical line is the point at which the surge price changes from 1.2 to 1.3 times the normal fare

3 Source: Cohen et al. (2016). Using Big Data to Estimate Consumer Surplus: The

Case of Uber. NBER Working papers

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Supply and demand: Price elasticity of demand and revenue

PK
20 ϵD = −∞ (perfectly elastic) • Inverse demand:
PK = 20 − 1
QD
50 K

15 ϵD = −3
• Revenue (PK × QK )
10 ϵD = −1 Maximized when ϵD = −1
(Will be covered in the practical)
5 ϵD = − 13
D ϵD = 0 (perfectly inelastic)
0
250 500 750 1, 000 QK

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Supply and demand: Other elasticities

• Cross-price elasticity of demand: Percentage change in the quantity de-

manded due to a one percent change in the price of another good

∂QKD PL
ϵKL =
∂PL QKD

• Income elasticity of demand: Percentage change in the quantity de-

manded due to a one percent change in household income

∂QKD I
ϵI =
∂I QKD

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Supply and demand: Other elasticities

• Recall our earlier results from the Vismarkt:

Demand: QKD = 700 − 50PK + 25PL + 10B
Market equilibrium: PK∗ = 5 and QK∗ = 750

• Cross-price elasticity of demand at the market equilibrium:

∂QKD PL 4 2
ϵKL = = (25) =
∂PL QKD 750 15
2
1% increase in PL increases QKD with 15
% (opposite for price decrease)

• Income elasticity of demand at the market equilibrium:

∂QKD I 20 4
ϵI = = (10) =
∂I QKD 750 15
4
1% increase in I increases QKD with 15 % (opposite for income drop)
Note: I and B are used interchangeably in this example
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Supply and demand: Other elasticities

• Cross-price elasticity of demand reveals whether goods are substi-

tutes or complements
Substitutes: Positive cross-price elasticity
Complements: Negative cross-price elasticity

• Income elasticity of demand reveals whether goods are normal

goods or inferior goods
Normal good: Positive income elasticity
Inferior good: Negative income elasticity

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Recap of today’s lecture

• General introduction to the course

All information discussed today can be found in the course manual

• Supply and demand: The basics

Introducing the supply-and-demand framework
When is a market in equilibrium?
Economic welfare in markets: Consumer surplus and producer surplus
Elasticities: Measuring the responsiveness to price changes

52
What is discussed in this week’s tutorials and practicals?

• Wednesday-thursday: Tutorials
The tutorials start next week!

• Thursday-friday: Practicals
Selected topics: Market equilibrium, consumer and producer surplus,
the relation between price caps and excess demand and supply, and
(cross-)price elasticities
There will be an ungraded practice quiz. Starting next week, practical
quizzes will be graded and counted toward your participation grade!

53
What’s on the agenda for next week?

• Using the supply and demand model to study the effects of economic
policies on the market equilibrium and economic welfare:
Taxes and subsidies
Price regulations (price floors and price ceilings)
Quantity regulations (quota’s)

• Key question: Do these policies generally increase or decrease eco-

nomic welfare in the market?

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Thank you for joining the lecture!

Gert-Jan Romensen
[email protected]

55