Incentives & Elasticity PDF

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Class done by Professor Hill...

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Modules 3 & 4  Incentives o Economists believe strongly that people respond to incentives o Market economy  People meet and form markets  Buyers and sellers find each other o If individuals have a lot of information about the product, markets tend to keep up and produce the right amount  How do we incentivize? o Incentives exist at every level of the economy o Firms incentivize workers with bonuses  Consumers incentivize service with tips o The tax code is filled with incentives  Child tax credit  Mortgage interest deduction  Charitable giving deduction  Business investment tax deductions  How do people respond to incentives? o Why do people not respond to incentives?  Switching costs  Information limitations  Time constraints  Small changes  Elasticity o When an economic factor changes, how does the quantity demanded or supplied change?  %changeinX/%changeinY o Types of elasticity  Elasticity of demand  Elasticity of supply  Income elasticity o Inelastic - won’t change  Price won’t change because people need to have it  Elasticity of demand and supply o %changeinX/%changeinPx o Measures how your demand for a good changes as the price changes o Elastic demand: purchase of good changes a lot when the price changes  Elasticity > 1 o Inelastic demand: purchase of good changes very little when price changes  Elasticity < 1 o Supply is the inverse  Income elasticity o %changeinX/%changeinI o How much of a product do you buy if your income changes? o Normal good: positive income elasticity  Mercedes, beef, furniture

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Inferior good: negative income elasticity of demand  Ramen, used cars...