Elasticity of Demand and Decisions for Spring break

Elasticity of Demand and Decisions for Spring break

By Alice ,Congi ,Linda and Isha

Spring Break is just beyond the horizon! With a much-needed break in this cold, dreary semester, many of us yearn to go home for hot meals and hotter showers or to travel to someplace warm. With Mount Holyoke’s diverse campus full of people from all over the world, there are numerous factors in deciding how to spend this break--different income levels, different price tags, and thus endless possibilities of plans to be made.

Let us, look at two Students Joyce and Hannah. Joyce is an International student from Dubai where as Hannah is from California. They have the choice to either go home or go to Miami for spring break. During planning they would face problems like where to go? Which plane ticket to buy? How much money do they have?  So taking this as an example we will be discussing the elasticity of demand and how factors such as income and price affect it when Joyce and Hannah plan for spring break.

Factor 1: Income

First, let’s assume that Joyce and Hannah have the same preference which is traveling. For this example we will say that they choose to go to Miami. If we keep price constant and only look at the effects of income we will see shifts in demand as well. Lets look at how can their income affect their decision to buy plane tickets:

Both Hannah and Joyce have the same plane ticket price as $500 for Miami. Joyce had an income of $600 and now it increased to $1000. She could previously buy 1 ticket where as now she can afford to buy 2 tickets to Miami, perhaps one more for another vacation.

If we look at her Income Elasticity of demand we see:

IEoD= (%change in quantity)  = [      (2-1)/2     ]     =  1.5

            (%change in income)     [(1000-600)/600]

     Here we see that Joyce’s IEoD is more than zero. If the IEoD is more than zero it means the good they are buying is a normal good.

Factor 2 : Price change
         

        Now lets look at our case from another point of view. Airline companies are known to raise the airfare prices when vacations or holidays are near. Price is an important determinant to our students’ buying patterns. To only explore the effect of price we keep Joyce and Hannah’s purchasing power the same.   Both Hannah and Joyce think about going home. 

       

    If Joyce goes back home to Dubai, it will now cost her 1500 but the airfare for summer was $1000. At the previous price last year she bought 1 ticket to go home. Now she feels the price is too high and her consumption will be 0. With this information lets look at the PED in Joyce’s case:

Q1:1      Q2:0              P.E.D=  (ΔQ /Q)           = [   (0-1)/1      ]          = 2   [ P.E.D>1]

P1:1000  P2:1500                      (ΔP/P)                [(1500-1000) /1000]

Her Demand graph would looks like this:

From both the graph and example we see that the demand of plane tickets for international students like Joyce is very elastic. A change in price will affect the consumption highly. This is why the demand curve on Joyce’s graph looks almost flat. If the plane ticket prices had gone down, Joyce’s consumption would have risen greatly.  

        Looking at Hannah’s situation: a market for domestic college students buying plane tickets to go home. The airfare to go back to California is $300 during spring break, but at other times in the year it is $150. Last year when the price was $150 Hannah bought two tickets for two different weekends. Now for spring break she only buys 1 ticket. The PED here would be:

Q1:2      Q2:1              P.E.D=  (ΔQ /Q)       =      [   (2-1)/2      ]          = 1/2  [P.E.D<1 ]

P1:150   P2:300                           (ΔP/P)                [(300-150) /150]

The demand graph for Hannah would look like this:

 From both the graph and example we see that the demand of plane tickets for domestic students like Hannah is very inelastic. She can easily afford and will choose to go home. This is why the demand curve in Hannah’s graph looks almost vertical and a change in price will not greatly affect her consumption of plane tickets.

      Although the income and affordability affect the students in their decisions, price is also an important player. In the same market for plane tickets there can be various demands with different nature of price elasticity.

Therefore price and income changes greatly affect Joyce and Hannah's decision for spring break. Regardless of where they choose to go these two factors are key in their planning for Spring break. Using these factors Hannah, Joyce and other students in similar situations can analyze the elasticity of demand and how it is affected by the factors we discussed.

Work or Leisure – Comparative Statics of Labor Supply

Work or Leisure – Comparative Statics of Labor Supply 

Xianger, Shelley, Lady, and Delia

We’ve already talked about opportunity cost and consumer’s decision. The opportunity cost of leisure is the wage rate, which means people need to decide how they want to distribute their time between work and leisure. We’re going to talk about the tradeoff between labor and leisure that lies behind the graph.

The following assumption is based on the situation of a Mount Holyoke student named Anna. Anna receives a generous financial aid package from the college. She starts her first year in college with an endowment. However, as a requirement for work-study, she has to work in Dining Services her first year. The wage of this Level 1 job is $8 per hour. The money she earns comes from her work-study package, so she can spend the money as she wishes. She has the possibility of working 10 hours/week to earn $80 weekly. During her first year, Anna has to work but she can also afford some leisure time.

When Anna becomes a sophomore at Mount Holyoke College, she receives the same financial aid package as in her first year. She applies and gets a job as a Career Center Peer Advisor, which pays $8.70 an hour. Anna is faced with two choices. She could work the same amount of hours as she did in her first year as a Dining Services worker. Working the same amount of hours, she would still earn more because the wage at her new job is higher. On the other hand, she could choose to work more hours because the wage has gone up.  Anna decides to work more hours than she did last year precisely because her wage has increased. Her wage has increased but not to the point where she wants to work less. The substitution effect is stronger because labor goes up and the opportunity cost of leisure increases. At this point, leisure becomes more expensive than labor, so she wants to consume less leisure in order to make more money.

Anna starts her junior year at Mount Holyoke with the same financial aid package and an internship at a law firm in the town of Amherst. Her wage at the law firm is $20 an hour. She also stops working as a Career Center Peer Advisor. Anna has the choice to work more at the internship to earn a higher income or she could choose to work a decent amount since now she has additional income for all the hours she is working. By acquiring a job with an increased wage, the return from working additional hours and the opportunity cost of leisure both increase. If the substitution effect is stronger, Anna would want to increase her consumption since leisure will become more expensive (wages lost as the price of leisure). The higher wage at the internship gives her large incentive to work more hours. However, Anna does not need a large amount of money to live as a college student at Mount Holyoke. She is limited because she cannot choose to be a full time worker since this will come at the expense of her being a full time student. Additionally, choosing to work more hours will take time away from her schoolwork and social activities since she has to factor in transportation costs. It takes 50 minutes to get to her internship and back with the PVTA that takes her from Mount Holyoke College to the town of Amherst. She decides to work less hours a week at the internship than the amount she worked at her career center job on campus. Since the internship affords her more time while working less hours, the income effect starts to outweigh the substitution effect. Since Anna is now receiving a substantially higher wage, she is going to choose to use her income to purchase additional leisure time. The substantial increase in her wage reduces the supply of labor.

In conclusion, Anna begins her college education with an endowment due to her financial aid package. As the total wage she receives from either on-campus or off-campus job increases, her decision changes from work more in order to get more consumption to work less in order to enjoy more leisure. Her supply curve of labor bends backward as the wage goes up.

What do Wall Street Investment Bankers and MoHos Have in Common?

What do Wall Street Investment Bankers and MoHos Have in Common?

By: Jenni, Yuzhi, Marilyn, Edmee

We know you’re dying to know what the catchy, oh-so-clever answer to this blog post is… However! You’ll have to invest a little more time (i.e. spend more time reading this article) if you want to find out the answer. So, let’s begin:

The supply curve for labor as shown in Figure 1 below is backward bending. Let’s take a minute to make sense of the graph. For rational laborers, to a certain point, as wage goes up labor increases as well because as if you are being paid more to do your job (wage increase), then you will want to work more… To a certain point. After a certain point (it varies for each person), the worker won’t want to “supply” more labor (i.e. work more & earn more money), they will want to work less, thus causing the supply curve to have a negative slope at that certain point. When you work less, you also “consume” more leisure such as hanging out with friends (i.e. complaining about your life to your friends), watching Game of Thrones (Season 4 is starting in April!), going on a vacation (or a staycation if you don’t want to spend money), or going to Amherst for some boba tea (passion fruit green tea with lychee jelly is must-try, FYI) . Let’s return our thoughts to the labor supply curve. So, as a rational laborer, if your hourly wage was raised from $20 to $40, you might spend more time at the office working. Originally, at $20/hour, you worked 8 hours/day (you earn $160/work day); at $40/hour, you still work 8 hours/day (you earn $320/work day). If your wage was then raised to $80/hour, you might work be going home earlier because you wouldn’t need to work as much to earn $320. If you made $80/hour, you would only need to work for 4 hours each day to make $320. You could spend those extra 4 hours drinking boba tea or watching Game Thrones (or sleeping…). See the figure below. After you are earn a certain wage, you would stop “consuming” work and starting consuming more leisure.

Now, let’s answer our original question: What do Wall Street investment bankers and MoHos have in common? The answer is (drum roll, please): Wall Street bankers and Mohos both defy the law of the backward bending supply curve for labor. Why? Let’s look at Wall Street investment bankers first. Joe Amherst is an investment banker at JP Morgan. In his first year, he earns $800,000 plus a bonus of $200,000 working 6 days per week (8 hours each day). The next year, he earns $2 million plus a $500,000 bonus working 6.5 days per week (8 hours each day). Still, Joe is not happy because he is a true capitalist and wants as much money as possible. So, in his the third year, Joe earns $3 million plus a bonus of $1 million dollars working 7 days a week (8 hours each day). The fourth year, Joe is earning so much money we don’t even want to tell you the amount. However, in his fourth year, Joe brings work home with him and is working more than 12 hours each day. As we can see, though Joe Amherst’s income, or “wage”, has steadily increased each year, his “supply of labor” has not. There is no amount of money that will get Joe to produce less labor (i.e. work less) and consume more leisure (i.e. relax). Like many others, Joe is addicted to money and as a consequence, he is addicted to working. Therefore, his supply curve of labor is not backward bending, rather, it has a positive slope trending upwards. Joe’s supply curve never reaches a point where it bends backwards. Of course, not all Wall Street investment bankers are like Joe.

What about Mount Holyoke students? Well, like Joe Amherst, Jane Moholyoke is a hard working individual who wants to succeed in whatever she takes on. Currently, Jane is a student at Mount Holyoke.Jane chose Mount Holyoke for its well-known strong work ethic and incomparable dedication to academic excellence. At Mount Holyoke, or any other education system for that matter, Jane’s grades are equivalent to her wage. Jane is now a senior. Freshmen year, Jane had a 3.0 GPA. She was unsatisfied with this, so she dedicated more time to her studies and cut down on her “Game of Thrones” watching habits. Sophomore year, Jane earned a 3.4 GPA. Go Jane! Junior year, Jane decided if she cut out boba-drinking and “Game of Thrones”, she could do better. And she did! At the end of her junior year, Jane’s GPA was 3.7. Still, Jane wanted to do better. So senior year, Jane not only cut out boba-drinking and “Games of Thrones”, she also broke up with her boyfriend and stopped talking to all her friends explaining she needed to focus more on her studies. At the end of senior year, Jane’s GPA was a whopping 3.8. However, Jane was unhappy by the end because she realized how much fun she had missed out on. Like Joe Amherst, Jane Moholyoke’s supply of labor kept increasing no matter how high her “wage” (i.e. GPA) was. So, like Joe, Jane’s supply curve of labor is upward sloping for the most part. However, there is a slight difference in Jane’s curve. Jane’s supply curve does backward bend at a certain point. The only time it may start bending backwards is when she reaches the upper limit of a 4.0 GPA. A 4.0 is the highest GPA you can earn (in other words, the highest “income” a student can earn), therefore, after a 4.0 GPA, you would spend less time working since you would get nothing out of working harder.

Source(s) Consulted:

Polk, Sam. "For the Love of Money." The New York Times. The New York Times, 18 Jan. 2014. Web. 04 Mar. 2014.

"For the Love of Money" article link

Consumer Choice: Why are you Reading this Blog Post? No Seriously Why?

Consumer Choice: Why are you Reading this Blog Post? No Seriously Why?

By: Liz, Paula, and Weiding

You must be thinking, “couldn’t I be doing something else with my time instead of reading this article?”.  The answer is yes, you could be doing something else with your time, and that fact has inseparable connections with microeconomics. 

First, you are facing a trade-off: surfing the internet, watching television or playing flappy bird all seem to be more enjoyable ways of spending your time, and reading this post may not be your favorite activity.  However, you, like many of us, value a good grade for this class.  In choosing to read this article, a process which should take you less than 10 minutes, you gain more knowledge on the test material, which will allow you to achieve a higher grade. While sleeping for an extra ten minutes or surfing the Internet may give you short-term gratification, it has no significance in the long run. Thus, in choosing to read this blog you grant yourself greater utility, as you will spend a little less time playing games, but will receive a higher grade on your exam, hopefully.

Second, by choosing to read this article, you have made a choice subject to a time constraint.  Suppose you decide to read this blog post the morning of the midterm.  You wake up at 8:30am and only have one and a half hours before the exam.  Since you are still in your dorm at this point, you take those first 30 minutes to get ready and walk to class.  Now, although you really want to spend more time preparing for the exam, you are constrained by a one-hour time limit. You chose to spend ten minutes reading this article, and the other 50 minutes cramming the rest of the material that will be on the exam.  You allocate your time like this because you know that at least one blog post would be on the exam and you want to be somewhat familiar with it. 

Considering your exam goes well, and it is revealed that it’s more beneficial to read the blog and not study other material for those ten minutes. Being the rational being that you are, you decide to allocate your time the same way for next exam.  Unless you leave yourself more or less time to study for the test, you know that you will continue to allocate your time in this way if the result still turns out to be good. 

Now consider a different case. Before one exam, your friend suggests a group study. You two decide to study for the exam the night before and you have two hours. This is similar to a shift in the your budges constraint (time constraint in this case), where the line shifts out.  This will cause your optimum consumption bundle to shift to a higher indifferent curve.  Thus, you now have more time to fully prepare for the exam and you will read the blog more closely instead of briefly skimming the blogs hoping you get enough information to answer the question on the test. You will spend 20 minutes reading it rather than 10, and 100 minutes studying for the exam.  

We can graph this relationship similarly to an income offer curve that illustrates the bundles of time that you will spend reading blogs and studying other testable materials at different levels of free time you have. And from the graph we know that the more time you have, the more time you will be reading the blog. 

Rationality vs. Non-rationality Interpret Consumer Social Behavior at H&M

Rationality vs. Non-rationality

Interpret Consumer Social Behavior at H&M

By: Yixi, Jessica, Gabriela, & Tahlia

Economists make the assumption that people are rational, which means that people can rank bundles of goods depending on which goods will maximize their utility. A person makes choices based off of what will give him/her the highest happiness or satisfaction.  When a person is acting rationally he is also described as "wanting more rather than less of a good.” A person, who makes decisions, if rational, can defend the consumption choices made. Below we describe various three stories that involve choice and preferences in shopping at H&M.

When we enter a retail-clothing store like H&M, we often notice that customers tend to go around in different sections of items, and compare their prices, design and fitness. Rational consumers would weigh costs and benefits to maximize the utility, and they able to defend their choices. First, let us look at how a rational customer, Jane shopping at H&M: 

Jane decides to go shopping at H&M with a $50 budget. It is winter time and she needs a coat to fight the cold. Jane walks into H&M and sees a pair of shoes, coat, and a scarf. Although she would like all three items her limited budget only allows for her to choose two. So, she chooses the coat and shoes and leaves the scarf to maximize her utility. Jane’s decision is made based off of what she believes is best for her. The jacket and shoes meet her individual taste and she prefers this to any other combination of the three goods; she is happiest with the two goods she chose to purchase. In Jane’s case her opportunity cost foregone is the scarf. Opportunity cost is the best alternative foregone when having to make a choice between items, for example.

Sometimes, there are customers who are unable to make decisions and who walk out of the door with bare hands. Other times, they are unable to explain their decisions. We consider these people’s behavior as irrational. For example, Perry decides to go shopping with a $100 budget. He walks into H&M where he decides to buy the first two items he sees. If asked about his choices, Perry is not able to defend why he bought these first two items (a shirt and a pair of shoes). He does not act rationally because he does not think about what combination of items will result in the highest utility for him. Perry is extremely indecisive, has no preferences, and therefore no idea of what makes him better off. He cannot defend having bought the shirt and shoes because he purchased them randomly, without evaluation of each and without thinking of whether or not they made him better off or as better off as he can be. He did not use rationale in making his decision and thus is not rational.

If Perry were to act rationally he would know what he prefers. This would guide his decision making because his preferences would reveal what gives him a higher utility. With clear likes and dislikes Perry would know why he chose to consume a certain bundle.

(Below is a graph describing Jane’s behavior as a rational consumer)

At the OCB - X3, Y3 - Jane’s maximized utility is shown on the graph.

The rationality theory of consumer’s behavior also offers us a framework to understand the revealed preference. That being said, when a rational consumer is confronted with price and income, he/she will definitely choose the best bundle of goods he/she can afford. We can therefore find out consumer's revealed preference of goods from his/her choices.

Take Alice, an old customer of H&M for example. Alice is very fond of shirts and hats at H&M, and she would like to purchase new shirts and hats for the spring. She has a budget constraint of $90 for shopping. In early March 2014, the price for an average shirt is $30, and the price for a hat is $15. Under the assumption of strict convexity, Alice bought 2 shirts and 2 hats to maximize the utility. Since she made a rational choice to consume the best bundle she is able to afford, we can reach the following conclusion: where the bundle of 2 shirts and 2 hats was the chosen bundle with prices (30, 15), then for any combination of goods where the total price is less or equal to $90, she strictly prefer consuming 2 shirts and 2 hats to other possible bundles, such as buying 1 shirt and 2 hats. 

Works Cited

"The Rational Model." Boundless. N.p., n.d. Web. 27 Feb. 2014.

http://www.investopedia.com/terms/r/rational-behavior.asp

Lawrence E. Blume and David Easley (2008). "rationality," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract." by Abstract] & pre-publication copy.

   • Amartya Sen (2008). "rational behaviour," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.

"Rational Choice Theory." Wikipedia. Wikimedia Foundation, n.d. Web. 28 Feb. 2014.