Health Economics- Lecture Ch02

8/3/2019 Health Economics- Lecture Ch02

1/23

Microeconomic Tools

Dr. Katherine Sauer

Metropolitan State College of Denver

Health Economics


2/23

OutlineI. Consumer Theory

II. Elasticity

III. Theory of the Firm

Review on your own:

Production Possibilities Frontier

Supply and Demand

Functions and CurvesIndividual and Market Demands

Market Structure

Welfare Loss


3/23

I. Consumer Theory

examines how rational individuals make consumption

choices when faced with limited resources

2 parts: preferences and budget constraints

1. preferences

- assume consumer can rank goods

- ordinal not cardinal

utility: measure of satisfaction / happiness

marginal utility: extra utility from consuming

one more unit of the good


4/23

The Utility of Wealth

Utility

Wealth in dollars

Utility

MU

$1


5/23

Indifference Curves depict consumers preferences

over two goods

- downward sloping

- cannot cross

- bowed toward origin

U1

U2A

Y

X

E

D

F

C

B

Bundles F, D, A, E all

provide U1 of utility.

Bundle C contains the

same amount of Y as

D, but has more X

higher utility.


6/23

U1

G

When you have a lotof good G, you are

willing to give some

up to get an additional

unit of A.

When you have less of

good G, you are not as

willing to give someup to get an additional

unit of A.A


7/23

The slope of the indifference curve tells how willing to

give up good Y to get good X.- marginal rate of substitution (MRSX,Y)

U1

X

Y

Steep slope (willing to give up Y)

Flat slope (not as willing to give up Y)


8/23

2. Budget Constraint

$20 for entertainment budgetmovie tickets cost $10

coffees cost $4

20 = 10M + 4C

20 10M = 4C5 2.5M = C

M

C

5

2

BC

C intercept is 5.

Slope is -2.5.

M intercept is5 2.5M = 0

5 = 2.5M

2 = M


9/23

Budget constraints in general:

I = px

X + Py

Y

slope = -px/py

Y intercept = I/py

X intercept = I/px

Y = -(px/py)X + I/py

The slope of the budget constraint tells us the markets

rate of substitution between the goods.


10/23

3. Consumer Equilibrium

- a consumer wants to maximize satisfaction /

happiness but is constrained by their income

- a consumer will seek to be on the highest

indifference curve that they can afford

U1

U2

U3

D

B

C

A

At the optimum, the

slope of the budget

constraint is equal tothe slope of the

indifference curve.

Y

XX*

Y*


11/23

II. Elasticity

- measures the responsiveness of a variable to a

change in another variable

- the % change in a dependent variable from a

1% change in the independent variable

q,p = Q/Q

P/P

= Q . P

Q P= Q . P

P Q

q,I = Q . I

I Q


12/23

q,p is always negative so use absolute value.

0 = q,p perfectly inelastic

0 < q,p < 1 inelastic

q,p = 1 unitary elastic

> q,p > 1 elastic = q,p perfectly elastic

q,I could be positive or negative.

> 0 normal good< 0 inferior good

= 0 no response


13/23

Price Elasticities


14/23

The impact of a cigarette tax:

S1

D1

Q1

S + tax

tax

D2

Q2

D3

Q3

Need a reliable

estimate ofelasticity to

predict what

happens to tax

revenues andthe level of

smoking.

Q

P


15/23

III. The Firms Problem

1. production function

2. isoquants (same quantity)

3. isocost (same cost)

4. cost-minimization


16/23

1. Production Function

A production function

shows the maximum

sustainable output thatcan be obtained from

various combinations

of inputs, with existing

technology.

simple production

function only one input


17/23

A production function is typically expressed as

Q = f(X1, X2, X3, )

where X1, X2 and X3 represent inputs.

A particularly well-behaved production function is

the Cobb-Douglas production function:

Q = LK


18/23

Example:

Suppose the capital is fixed

and labor is the variable

input.

Putting values of K and L

into a production function

will produce Q.

How are Marginal Product

and Average Product

calculated?


19/23

2. Isoquants

- combinations of inputs that will produce a

certain level of output

L

K

Q=100

Negative slope means it is

possible to substitute

between inputs.- means MP is positive

Slope shows the

rate that K must

be given up touse one more unit

of L.

MRTSL,K


20/23

3. Isocost

- a line which shows all the possible combinations

of inputs that result in the same total cost

TC = wL + rK

TC wL = rK

TC/r (w/r)L = K

K intercept is TC/r.

slope is w/r.

L intercept is TC/w.

K

TC/r

TC/w L

TC


21/23

L

K

Q=100

4. CostMinimization Problem

- the firm would minimize costs by producing nothing

- the actual task is to minimize costssubject toproducing a certain level of output

TC

L*

K*

L* and K* are the cost

minimizing quantitiesof labor and capital to

use.


22/23

The flipside of the Cost-Minimization problem is the

Output-Maximization problem:

Cost-Minimization

- minimize costs while producing a

certain level of output

Output-Maximization

- maximize the level of output produced

while only incurring a certain level of cost


23/23

Suppose your firm has $5000 to spend on production.

- you would be able to achieve a certain level of

output

If your firm had $10,000 to spend on production, youwould be able to achieve a higher level of output.

L

K

Q1TC = 5000

Q2

TC = 10000

Expansion path

Documents

Health Economics- Lecture Ch02