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0:10
today we're going to continue our discussion of consumer choice and we're going to talk now about what happens when we take that unconstrained choice we talked about on Monday and impose budget constraints we'll talk about what budget constraints are will then come to talking about how consumers may constrain choices and then we'll end with an example of food stamps so let's talk start by talking about budget constraints and we'll start by talking about their construction the
0:47
construction of budget constraints so basically um last time we talked about the fundamental axiom of consumer choice that more is better so what stopped people from just binging on everything it's their budget constraint it's their limited resources now for most of this course we're gonna make a simplifying assumption that your budget that is what you spend equals your income that is what you earn okay that is there won't be any savings or borrowing okay now that is a simplifying
1:21
assumption and indeed we'll spend a couple lectures to the end of semester talking about what happens when people can save or borrow that said this is not a terrible description of most Americans the median American household has four hundred dollars in the bank so this is not kind of a terrible description of the way most people live their lives in America which is what they earn each week is what they spend each week so that's what we'll do it also might not
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be sort of a terrible description of your life I presume in college you're not doing a lot of savings you maybe do a little borrowing but not a lot of savings are borrowing so we're gonna do is we're gonna assume that's true for you as well we're gonna assume your parents have given you some amount of money to spend we'll call it why your income why is the amount of money your parents are giving you to spend for save the semester or the month and once again
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let's say all you spend your money on is pizza and cookies okay that's all you want to spend your money on we write the budget constraint as saying that your resources your income why can spent on either pizza or cookies and the constraint is that you could spend it that that a budget has to be divided between Pizza where there's the price per slice of pizza times the number of slices of pizza or cookies we have the price per cookie times the number of cookies so P sub P is the price per
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slice of pizza P sub C is the price per cookie P's then it repeats us and sees the number of cookies that's your budget constraint you can essentially devote your income to some combination of pizza and cookies and but you have to consider how much they actually cost in doing that I find this easy to see graphically so let's turn to figure 3 1 figure 3 1 shows a budget constraint so how's the budget constraint look well the x-axis is your income divided by the price of
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cookies that is if you decide to devote all your income to cookies that how many cookies you can you have Y over PC if your income is 100 and cookies are 10 bucks yeah that means you're going to miss on your cookies then then you can only have 10 cookies etc likewise the y-intercept is the income divided by the price of pizza that's how many pieces you can have the budget constraint represents the budget constraint the slope of the budget constraint is the price ratio the negative of the price
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ratio because it's a downward sloping line PC over P P that is on every extra cookie that you by holding your income constant lowers the amount of pizza you can have by P sub P ok so let's consider an example suppose that Y is 96 dollars that the price of pizza is expensive pizza place is $12 and the price of a cookie is $6 ok $12 for pizza this is like downtown San Francisco or New York $96 come $12 for a slice of pizza $6 for a cookie okay I'm sorry why it's going to
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make y72 my bed it's why 72 your income is $72 okay and you could spend it on pizza and cookies and those two prices now what that means is if you wanted just pizza you get six pizzas if you want to just cookies you can get twelve cookies and generally the rate of the rate at which you can trade off pizza for cookies is minus a half okay that is every additional cookie would require giving up half a slice of pizza okay every additional cookie Christ give me have a slice of pizza that's why the
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slope would be negative 1/2 okay so basically we're gonna call the slope of the budget constraint the slope we're gonna call the marginal rate of transformation the MRT last time with EMRs the margin rate of substitution now we're gonna have MRT the margin rate of transformation which is equal to minus PC over P P or the slope of the budget constraint okay that is the marginal rate of transformation now this class is not alchemy we are not literally transforming pizza into cookies that
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would be kind of cool but we're not doing that that's somewhere else at MIT okay but if effectively doing the same thing what we're doing is given Italy a fixed amount of money and given that we're going to spend it all the more you spend on pizza the less you spend on cookies so you're effectively transforming pizza into cookies and vice versa because you're gonna spend all your money you guys been on something so the more you spend on one the less you get of another go through the budget
6:30
string we are effectively transforming one good to the other worth by having more of one we're getting less of the other so that's this said to which we call it the marginal rate of transportation and you have transformation so basically this comes back to the key concept we talked about in the very first lecture opportunity cost the opportunity cost of a slice of pizza is two cookies remember opportunity costs is that is the value of the next best alternative
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okay the opportunity cost is value the next best alternative well here you only have two alternatives pizza and cookies so the opportunity cost of a slice of pizzas to cookies and that's the sense of what you're transforming pizza into cookies or cookies into pizza okay now this seems kind of abstract but let's actually think of an organization which is taking this principle the heart to develop the best method of weight loss in America which is Weight Watchers
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okay Weight Watchers now it turns out that dieting is super hard and basically doesn't work okay there's a large literature which says that people go on diets all the time then they stop them and they gain the weight back okay dieting is incredibly hard to base that doesn't work okay but a much more successful approach has been established by Weight Watchers it's not the only approach but it's been proven and much more successful okay and essentially what does Weight
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Watchers do they set up a budget constraint and ask you to follow it so for example they essentially assign point values to every good you might consume you go on the website and everything in the world you might want to eat has a point value they then asked well what weight do you are you today what's your age and gender that stuff matters for weight loss and what weight do you want to achieve and they say if you want to achieve a weight loss of X over Y days then you've got to limit
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yourself to Z points okay so essentially your goal is to lose weight so we're going to view the budget constraint we're not gonna tell you what to eat that's why it's better than dieting because once again Adam Smith was right people like to have choices they like to let choice drive things but we are going to tell you total budget so for example weight vegetables are like zero points Snickers bars are like six points etc they have various point systems okay so for example suppose your
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budgets 30 points which would be pretty typical okay suppose you go to McDonald's for lunch and you get a number one the number one in McDonald's is a Big Mac which has 14 points fries which have ten points and a coke which has six points that's thirty points and it's only lunch okay you've blown your whole budget for the day on lunch now you could just get depressed and say screw it I'll just be fat but clearly looking around the room you guys have not made that choice or you could
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look at the budget constraint say well what else can I get what turns out you can get a ten-piece nugget which is twelve points apple slices which is one point in a diet coke which is zero points for only 13 points now if 13 points have plenty of room for dinner now to be honest anyone who tells you that second lunch is goes that first lunch is a liar okay I'd much rather a Big Mac and fries and a coke then nuggets an apple slices and Diet Coke give me a break
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but I'd also much rather have dinner okay so basically this lets you make the trade-off by imposing a budget constraint by setting relative prices across goods the points are like noodles they're not meaningful they're only meaningful relatively let's you said relative price across goods and then it lets you essentially optimize across those various across those various goods so budget constraints essentially by setting up this marginal rate of transformation help can help with a lot
10:29
of kind of decisions in life okay questions about that okay now what happens if we shock the budget constraint so we talked about constructing them what about shocking the budget constraint we're gonna do a lot in this class what we call comparative statics which is essentially making changes in one thing or another and seeing what it does to the system so let's talk about shocking the budget constraint let's start first with a change in prices suppose the price of
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pizza goes from 12 dollars up to 18 dollars this is a really good slice of pizza okay well what happens to the budget constraint let's look at figure three to figure three two shows what happens your regional budgets for NBC one the equation of that line is 12 people 6 equals 72 ok the price of pizza dough number slice of pizza plus the price of cookies times the number of cookies equals 72 now the price of pizzas gone up what that's done is that has pivoted
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inward your budget strength to be C 2 it is flattened the budget constraint because the slope remembers the ratio of the price of cookies to the price of pizza right that's a ratio well that ratio is just fallen it used to be a half now it's 1/3 negative 1/2 do all used to be 1/2 now it's 1/3 so slope has fallen from negative 1/2 to negative 1/3 so what's happened is you can still have as many cookies as you had before the y-intercept has not changed but you can have fewer slices of
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pizza that's why it's a pivot because one price has not changed only the other price so it's a pivot inward the other thing here you'll notice we have all these funny dots and stuff ok that represents what has happened to what we call your opportunity set your opportunity set which is an important concept ok your opportunity set is the set of choices available to you given your income and market prices the set of choices available to you given your income and market prices so your
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opportunity set initially was the black dots plus the red dots now your opportunity set has shrunk your opportunity set is now just the black dots given your income you can now get less stuff same amount of cookies but less pizza and you are worse off your opportunity set has shrunk okay your opportunity even though your parents still send me the same check you are worse off because you can now buy for less pizza with it ok so that's that's what happens the opportunity set when a
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price changed and likewise should show to yourself the same thing will happen when the price of cookies change and that you'll get an increase in the steepness of the budget constraint okay but your opportunity set will still your opportunity set will still shrink okay now what about yeah well that's a good point we're gonna come back to that we haven't we assume they're spending all their money but it's just a way of representing you can think of the line being lower it's the same thing
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so the Rappard we care about we just care about the area because it represents the set but you're right you could just focus on the line and say the line is everywhere lower so they're they're worse off that's another way to look at it but we like to think about it as a set it comes in handy for later for various reasons okay it's a good question now let's ask about a second thing what if your income goes up what if prices are back to twelve and six but your parents decide to send you more money
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suppose your parents or set thank you less money turns out you haven't been paying enough attention to 14:01 your parents are mad they're monitoring you that's why we have the camera here this goes directly to all your parents okay I'm sort of joking and and so let's say your parents cut your allowance to $60 okay well what does that do that's in figure 3 3 okay in figure 3 3 the old budget constraint was that you get pizzas and cookies at prices 6 and 12 and you get them to spend $72 now you
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can only get them to you spend $60 now what we see is not a pivot in the budget constraint but an inward shift in the budget constraint because the relative price of pizza cookies has not changed therefore the slope hasn't changed okay the slope is dictated solely you don't do anything to control the slope the market controls the slope okay but you and your family control the level okay and the level has shrunk so you're pivoting inwards okay and once again now
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instead of being able to buy say 12 cookies and six pizzas now you can only buy say 10 cookies and five pizzas that's the most you can get okay so once again your opportunity stat has been restricted but in a different kind of way do this pivot inward so that's how we sort of manipulate these budget constraints so we're going to come back to that next lecture that'll be important yeah is it more showing that like the change of slopes doesn't really invite you to the state by more cookies and
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pizza boiling in terms of accurate budget as a whole decreases and it affects you overall that's a great question and we're gonna actually answer that question next election very explicitly so hold on to that question and we'll talk about we're gonna compare explicitly why income changes differ from price changes and what are the underlying mechanisms yeah
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great great question so as I said we always are going to start with simplifying it some just to make life easy there's no reason that this couldn't be written in three dimensions and you'd have relative marginal rates of transformation and rates of which you're willing to trade off various things so you could just extend the math from all dimensions it wouldn't add any richness and just make your head spin so but the base so the basic all the basic ideas can come across with two goods but
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it would be the same mechanics with more goods okay you essentially when we get to the constrained optimization you essentially have more first-order conditions in your constrained optimization it's the way to think about it okay so let's access a great segue let's turn to the second part which is how we use budget constraints and the utility function we learned out last time to actually decide describe how consumers make choices so we take utility remember
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I said last time consumers are going to maximize the utility subject your buckets budget constraint well now we've taught you about utility we've taught you about budget constraints let's put them together okay how to consume how do consumers put them together well graphically the representation of preferences was our indifference curves that represented people's indifference with further indifference curves made people happy right that was last time so a sense who organized graphically is
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what is the highest indifference curve you can achieve given your budget right we know you want be the highest indifference curve possible buy mores better so we're simply going to ask what is the highest indifference curve you can reach given your budget okay so let's consider the same utility from last time utility is square root of P times C okay and let's consider the same budget we wrote down up here $72 income $12 price of Pizza $6 price of cookies and now
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let's ask where can you go with that so let's sort of figure three four and do it graphically we'll do it mathematically in a minute okay so in figure three four you have our budget constraint which runs from six pizzas to twelve cookies that the original budget constraint and you have a series of indifference curves and these indifference curves i1 i2 i3 i-4 they all come directly from this utility function so simply I've solved this utility function I'll start to talk about the
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math in a little bit you'll do more math and section on Friday okay but essentially you can solve we will show you you'll derive on Friday how you take this utility function literally can draw the indifference curves from it okay but for now take my word that these indifference curves represent this utility function and what we see is that point D is the farthest out indifference curve you can achieve while still meeting your budget while saving your budget constraint and therefore we say
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that the optimum graphically is the tangency between your indifference curve and your budget constraint is the optimal constrained bundle you see we brought last time we talked about further indifference curves make you happier this today we talked about the fact you are limited by your budget so we have the furthest indifference curve you can get to is going to be definitionally at the tangent of the indifference curve in the budget constraint and once again that gives you
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we realize we don't want to measure utils but just for mathematical for Rep methanol voters that gives utility at that tangency of square root of 18 okay at that point you are choosing six cookies and three pizzas that is the choice you are making that is the best off you can get given your budget and to see this let's talk about some other points and why they're not better okay let's talk about point a why is it point a about it why isn't it better to have
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two maybe just maybe you like cookies a lot and don't let it would like pizza on all the cookies that much how can we say that point D is better than point a yeah it's not a higher indifference curve so Point D dominates point a because a higher indifference curve well find the same person by that logic why not choose point E yeah you can't afford it so the bottom line is you can see graphically why the tangency is the best your going is the best you're going to to do okay
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likewise points II wouldn't choose Point C is has this has the same slope it has the same slope as Point D in other words the slopes minus 1/2 at Point C you've drew a line tangent to Point C the slope will be minus 1/2 just like it is a point D but you wouldn't be spending all your money so you wouldn't choose that point either yeah we're we're gonna we're gonna come to it we got well I just first of all we're not gonna have discrete and if it well we can have
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lines and the lines could end up you could end up lying along and then you could and then applying along a budget constraint for example or you could have you could even have utility functions which judge your budget rating at one extreme or another and we'll talk about those cases yeah yeah well let's come to the math then ok let's come to the mathematical derivation so that's the graphics let's come to the math okay now always a bit of a tightrope act when I'm
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doing math up here on the board so bear with me okay but the key thing is the math of constraint optimization is all about the marginal decision remember it's hard to say how many cookies you want it's easier to say should I have the next cookie okay it's about constraint optimization and what we want to ask is we essentially want to compare how do you feel about trading off pizzas versus cookies versus what will the market let you do instead of trading off pieces versus cookies that
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is we the Optoma is going to occur when we set your marginal rate of substitution which remember we defined is minus mu c over mu P equal I'm going to get rid of this equal to ah your marginal rate of transformation which we defined as - PC over PEP and this is the fundamental equation of consumer choice if you understand this equation you can solve virtually every consumer choice problem we'll give you okay that basically at the optimum the ratio of margin utilities equals the ratio of
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prices prices that is the rate at which you want to trade off Pizza for cookies is the rate at which the market will allow you to trade off Pizza for cookies okay basically it's saying the ratio of the benefits think of this as the benefits and this is the cost think of the mrs as the benefits it's what you want MRT is the cost it's where your constraint you want set the ratio of the benefits equal to the ratio of the costs okay now I find it actually easier to think of it
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this way if you just rearrange terms you can write it as mu C over PC equals mu P over P sub P I like this way of writing it because I I call this the bang for the buck equation what this is saying your marginal happiness per dollar should be equal this is sort of the happiness per dollar spent on cookies this is the happiness per dollar spent on pizza and you want those to be equal if you want the bang for the put your next dollar where it's gonna make you happiest okay
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and so basically think of that as your bang for your buck so for example suppose you were in a position where the mrs was greater than the mrt you're in a position where the marginal utility of cookies and I'm getting rid the negatives there's negative on both sides I'm just gonna get rid of the negatives okay the Marrs utility of cookies over the Marg utility of pizza was greater than the price of cookies over the price of pizza okay that is the slope of the
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indifference curve was greater than the slope of the budget constraint this is a slope of the indifference curve okay so I'll be your scribe this is the slope of the budget constraint in absolute value the slope of the indifference curve is greater an absolute value than the slope of the budget constraint okay that'd be true at points like point a point a where you intersect where you basically except from above the the budget rent by the indifference curve so a point like a
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point a has a steeper slope of the indifference curves than does the budget constraint what that says is intuitively and once again I want you to see any intuition the rate at which you are willing to give up the rate at which you are willing to give up cookies for pizzas I'm sorry let me say that let me say in a better way the marginal benefit to you of another cookie relative to another pizza is higher than what the market will charge you to turn pizza into cookies let me say it again the
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marginal benefit to you of another cookie which is this this how much more you want the next cookie relative how much more you want the next pizza it's greater than what the markets gonna charge you to trade in your pizza for cookies therefore you should trade in your pizza for cookies okay so let's see this mathematically at a point like a point a okay you have your margin utility for pizza is the derivative of the utility function with respect to the number of
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slices of pizza it's marginal utilities the river the utility function so it's D u DP okay which is equal to 0.5 times C over square root of P times C okay so and at Point a at Point a we had we had two cookies and five pizzas at Point a P was five C was - okay that's true point a so we can evaluate this Marg utility UDP which equals zero point five times C over square root of P times C so that's 1 over the square root of 10 okay that's a margin utility of the next
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slice of pizza the next slice the Pichichi makes you one over square root of ten happy once again that numbers meaningless we only care about in ratios so we need the ratio so let's do the Mars utility of cookies that's D you DC which is 0.5 times P over square root of P times C which is 2.5 over the square root of 10 okay so the Mars utility of Pizza is 1 over square root of 10 large utility of cookies is 2.5 or the square root of 10 therefore your marginal rate
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of substitution is minus 2.5 remember marginal rate of substitution is mu C over mu P so your modulated substitutions minus 2.5 what does that mean can anyone tell me what that means your margin rate of substitution is 2.5 what is that that is a meaningful concept noodles are not but that is yeah say you'll at least within here you will exactly or willing to give up 2.5 slices of pizza for one cookie that's what that number means and that is a meaningful number that's not an order that's
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cardinal we can use that you are willing to give up 2.5 slices of pizza to get one cookie what is the market asking you to give up how much pizza do you have to give up to get one cookie half a slice you are happy to give up two and a half slices of pizza to get a cookie but the markets saying we'll let you have a cookie for half a slice of pizza so what should you do eat less Petey more cookies that will unambiguously make you happier and that's why you should move from point A
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towards point D okay that's the intuition okay you basically want to trade pizza for cookies until these things are equal indeed I would like you to go home and do the same math starting at point B if you the main same math start at point B you'll find the MRF is much below 1/2 that is at that point you're happy to give up tons of cookies to get pizza because geez you got 10 cookies at one slice of pizza you give up tons of cookies to get pizza but the market says you only have to get 2
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cookies to get pizza so you'll happily do it and you move back towards point D and that's the sort of in a bundle sort of the intuition in math and graphics of how we do constrained optimization okay that is hard and very important questions about that don't hesitate to ask okay that is hard and very important if you understand this you're sort of done with consumer theory okay this is sort of the core of what consumer theory is all about it's all about this balancing act
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the whole course is fundamentally all about one equation which is marginal benefits equals marginal costs okay everything we do is going about weighing the marginal benefit of an activity against its marginal costs the if we take the next step what's the benefit what's the cost well here the marginal benefit CMRS the marginal cost the MRT we want to set them equal and this sort of example I hope explained why ok so that is how we think about good strange choice now want to apply it I don't
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apply it by looking at the example of food stamps ok now food stamps are not actually called food stamps anymore when I was a kid they're called food stamps it's basically a program the government has that provides money for individuals to buy food if they're low-income essentially we have in the u.s. what's called the poverty line and I'll talk a lot more about this at the end of the class but the poverty line says she's a measure of what's a minimum level of
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resources you need to live in America the poverty line for an individual is about $14,000 ok for a family of four it's about $28,000 I feel that number obvious can depend on where you're from if you're in Boston will say that's insane if for some real part of the country you think yeah that's poor but manageable ok we'll talk later about the poverty line what's good and bad about it but in any case if you're below the poverty line in America roughly speaking you get help with buying food
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and that comes the program we now call snap used to be called food stamps I got update my notes supplemental nutrition and I don't know I know the answer for nutrition okay so basically what the snap program does is it gives you a debit card if you qualifying income grounds you get a debit card and that debit card can be used to buy food and food only okay so essentially a debit card from the government that you can use to buy food if you're poor enough and they give you sort of a fixed amount
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every month and that month could be used to purchase food so here's the question why Co through this rigmarole why not just give people cash well this fancy thing one if we want to give poor people money much give money and we're gonna I don't want the answer yet okay what I want to do is show you graphically how we think about the trade-off and then we'll come to the answer so hold your thoughts so let's actually graph how we think about food stamps let's go to figure
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three five a and let's start with a cash transfer so here's the setup imagine people start with an income of $5,000 that's super poor okay five thousand dollars a whole family income for the year okay and let's say all they can spend it on is food or shelter remember us this gentleman pointed out in life there's more than two goods but it makes a lot easier to have two goods so imagine in this case you're two goods are food and shelter and actually quite frankly you're that poor that probably
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is only two goods you have to well you can worry about at that level of income okay it's food and shelter see if five thousand dollars to vote to food and shelter so you have some original budget line okay which is labeled their original budget line that runs from five thousand and food to five thousand shelter and then you can have some of in-between some some of some along the way okay now let's say we give someone five or drawls in cash obviously this graph is not to scale okay it looks like
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you're doubling as income is only five hundred dollars just this just sort of makes it easier not to scale graph let's say we give someone we say to them look you're poor we're gonna give you five hundred bucks in cash well now all we've done is shift out your budget constraint from five thousand fifty five hundred okay we've shifted out your budget training for five thousand and fifty five hundred what is that due to your choices well consider two different types of people
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person why okay they used to be on different skirt eyes ear oh they used to spend almost all their income on food and not allowed on shelter they're probably homeless okay so they spend all their money on food and we're basically homeless now what do they do well they spend a little more on food and a lot more on shelter maybe now they get you know foreign Joss doesn't buy you much shelter they spend a little more okay maybe if maybe a night a week they can get shelter okay so basically
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that's what they do that's their constrained optimization we're not saying it's right or wrong this is not normative economics it's positive the positive thing is given their utility function they move from point y1 to y2 now imagine someone like individual X they're different their tastes are such that they don't need to eat they just want to have shelter so they're up at point x1 initially and you even that $500 and they spend just a little bit more of it than food and even more of it
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on shelter they just love their shelter okay and they're just super they're super weight watchers they don't eat okay so basically they move from x1 x2 once again not normative right or wrong it's just these are feasible choices people could make given the opportunity set with which they're faced and that's absolutely the $500 in cash question about what I did here on this graph alone yeah okay that's a good point we'll come back to that that's time out if you're not a sports fan okay
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so we will we will we will come back to that and in fact um okay but but do people understand what the cash transfer is how it works okay now let's go to snap and let's say with snap instead of giving them 500 hours to get in the debit card instead of hanging them 500 AutoCheck we give them a debit card with 500 hours on it that can only be used on food how does this affect their budget constraint now we see where budget renditions start to get interesting and
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fun and the kind of challenges you're going to face in this course in drawing budget constraints the original budget constraint continues to be the original budget line running for five thousand five thousand the new budget constraint is this kinked line that runs from 5,000 the y-axis to the point x2 okay at 5,000 y-axis so it starts at 5,000 y-axis 0 on the x-axis there's a flat line that goes to 5000 on Y axis 500 on the x-axis and then it slopes down parallel to the original
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budget constraint to 5500 can someone explain to me why that's the new budget constraint yeah exactly we are forcing you to spend at least $500 compared to cash we can do whatever the hell you want we are forcing you to spend $500 of your money on food come into the question back there it doesn't have to be a specific label 500 could be any 500 but we're forcing you to spend at least 500 dollars on food well what does that do to your choices well for person Y it makes no
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difference whether they get cash or whether they get food stamps now the person like blue shirt turquoise shirt or ask that question why does it make no difference yeah why does it with whatever greenish I'm no waste yeah you what why does it make no difference for person Y it's like in food stamps or cash
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exactly he could just reallocate his money okay that's exactly right so foreperson why there's no difference look they're already spending what forty nine hundred bucks on food you give him a thing labeled five dollars for food it's not going to affect their life they'll just take five hundred they'll just Spence they'll just treat his 500 more in cash they're indifferent so nothing affects them but what about person X well person X remember the dashed portion of this
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budget constraint is from the old cash example and the dotted indifference curve is what they would have chosen with cash remember person X with cash what ifs chosen to still spend less than five hundred dollars on food even when you gave them five hundred dollars they still only spent $300 on food so we are forcing them to not be on their preferred budget constraint rather we're forcing them down to point X 2 which is they'll spend you know the minimum they
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can on food to the minimum is $500 okay they are forcing them down to point X 2 now why do I say forcing them why do I know for sure they are being forced that they're less happy at X 2 than they would have been when they get in the cash I don't know that for sure yeah exactly think of it this way the fundamental thing is people always get to the point that makes them happiest okay we call the robustness of economic equilibria people get to what makes and happiest they want they always before
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had the choice of any 500 food and they chose not to therefore if you forced a 9,500 food they must be less happy ok think of it that way they always could have spent $5.00 on food they didn't there's where I forced them you're making them less happy ok so they are worse off okay they are forced to spend they'd rather spend some of that money finding nicer place to live but we're not letting them we're making them buy food ok do people I don't want I just want to be understand that the
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graphics here and the collusions I drew ok now why why are we doing this why would you they're better off with cash why would we force them to have food yeah
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okay but basically what you're saying is you know better than the guy if let me let me say I'm not accusing you I'm just saying look if if people knew best maybe they'd like to just like have a nice house and die okay if people knew best then there'd be no reason to do this the reason to do this is because we think they don't know best so for example let's change the label on the y-axis just a small change let's cross our shelter and write cocaine okay well in that case maybe we don't feel so
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bad by forcing the guy to buy food instead of cocaine okay in other words this is a program which might make sense if we are paternalistic now we're getting into norm of economics paternalistic if we think that people will initially make the right decisions for themselves then it may be worth actually making them worse off because they're not worse off they're their perceived benefits are worse but they don't know what they're doing okay now you can see why I hope you can sort
41:26
of immediately see why this concept makes economists a little nervous because why don't we know what they want better than they do okay so it makes people a little bit nerdy kinds a little bit nervous a lot of people a little bit nervous to say gee maybe they're just happy you're doing cocaine and how do we know that that's the wrong way for them to spend the resources yeah
41:55
that's a very good point now but there's sort of two points there first of all if the taxpayers goal is to help poor people then why shouldn't you make them as happy as possible right if they tax why am i giving money this poor guy because I'm sad he's poor but what you're saying I'm not actually that sad he's poor I'm sad he's not eating if you're really just sad he's poor they should give him money if what you're sad about is gee I don't like how he's living I don't like this I'm sad he can
42:25
have better food eat excited Felice didn't live then you're starting to impose your preferences but let's be important that's imposing your preferences yeah well that's that's a related point of the taxpayer if the taxpayer cares about look we want healthy populace that's going to live a long time and be productive and pay taxes then that would be a reason to do this but once again I want to emphasize okay this is paternalism if you really just care what makes people happy it's
43:02
you should give them cash okay so that raises two questions okay um first of all uh first question yeah
43:32
yeah yeah so basically it's a great question in general we're gonna I'm gonna answer a lot of those questions with the same cheat this semester which is we're going to assume the markets are perfectly functioning so there's no you're imposing sort of a market failure if there's no market once there's market failures all bets are off but with no market failure and no paternalism you'd want to give them cash this raises an important question do food stamps actually increase food purchases first
43:59
of all there's two reasons why that might not reason one is everybody could be like why ok X is sort of silly case right you're gonna die if you eat that little and food stamps aren't that much they're you know maybe like three grand a year that reason is ten three grand on food so the first issue is you know the first reason why food stamps may not matter is that in fact everybody's spending at least a dime a degrees like why nobody's like X what's another
44:23
reason why it might not matter what's a REIT what's a way people could get around food stamps yeah yeah they could set up a black market where they essentially say look I only want two thousand dollars of food the guards making worth three thousand I'll buy my extra thousand dollars of food I'll sell the people who do want it and I'll end up still leaving two thousand dollars worth of food so we actually want to know do food stamps actually increase food consumption in practice are they
44:49
making a difference well actually we've run an experiment on this okay we're gonna talk in this class a lot about empirical results in economics we'll talk where this class is mostly going to be a theoretical class that is we talk about models and ideas but we're also since basically I'm an empirical economists we're going to talk about about empirical economics which is results and testing the theories we develop empirically now here's a great example in our mixes we set up a
45:19
theoretical model you always want to start with the theory but the theory sometimes has predictions which are uncertain here we have an uncertain prediction from theory about whether food stamps will affect food purchase or not so let's test it and the way we test it is we actually have run that food stamps cash out experiments where we literally take food stamps that give them cash instead and watch what happens to their consumption before and after it's a real
45:42
randomized trial we literally flip a coin head you keep your food stamped tails we replace those food stamps with an equal amount of cash then watch what happens what happens is that people spend about 15% less on food when you give them cash instead of food stamps that is food stamps is forcing people to spend about 15% more on food than they would like to unconstraint by the cash yeah
46:23
yeah you know it's a great question and that's there's you're asking about richer theory richer theory and I'm telling you that I'm gonna give you the empirical evidence or whatever the theory is the empirical evidence tells you what happens and you just those different explanations for why empirical evidence is that basically the price of our paternalism is 15% okay we are making people effectively 15% worse off making them spend 15% more on food and they want to so is it worth it well
46:50
actually the evidence is starting to pour in that it might not be worth it because there's starting to be a lot of experiments we're giving people just cash especially developing countries and developing countries the answer seems to be just giving people cash makes them better off that actually especially in developing countries people use the cash in productive ways so for example they have a series of evaluation programs where they've given people cash most in
47:16
developing countries in Africa in particular some in the US and they find that people spend relatively little of that on you know drugs and alcohol but they actually tend to spend it productively and in fact they found developing countries this all provides valuable resources for individuals to start businesses sarandon experiment in Uganda where a non-profit company randomly offered a group of winner 150 dollars okay which is huge Rolf's our income that's 50 to 100 percent of
47:44
annual income in Uganda fifty one hundred and fifty dollars and what they found was after two months after eighteen months these women had used that money to start businesses and that actually raised their earnings that actually effectively doubled their earnings from that one in injection of cash it led them to actually double their annual earnings okay so that leads one to think that maybe we should stop being paternalistic and just give cash unfortunately if you're a
48:14
reader of policy websites like I am the best one of which is voxcom it's a great website they had an article just the other day pointing out how it so he followed these women up nine years later in nine years later the effect had totally gone away so until you know the story isn't quite necessarily positive but it's not negative they're not worse off but it looks like at least was in the short run made them better off all that effect fades over time but the bottom line is at this point the
48:38
evidence is sort of probably in favor of being less paternalistic in just giving people cash but that that runs into a lot of difficulties in terms of our concerns about how people spend it so let me stop there we will come back on Monday and we'll talk about how we actually go from this stuff to the demand curves we started the class with
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