Microeconomics3070 Prof. Barham
Lecture 1: Introduction
Syllabus and Website
All assignments and solution keys will beposted on the web site.
I will send you a notice when they are posted.
Outline
Cover chapter 1
What is microeconomics
Economic models
Tools for microeconomics
Constrained optimization
Marginal analysis
Equilibrium analysis
Comparative statics
Next class are going over calculus, may startChapter 2
What is mircoeconomics
Can you buy all the clothing, vacations,sport equipment, health care, food, beautyproducts, yoga classes, seasons ticketsto sport event, donations to charity youwant?
No
Mircoeconomics models our decision makingprocess on how much you decide to spent onwhat.
What is mircoeconomics
Official Definitions:
Microeconomics is the study of how individuals andfirms make themselves as well off as possible in aworld of scarcity and the consequences of thoseindividual decisions on the markets and the entireeconomy.
Microeconomics is the study of the allocation ofscarce resources.
Mircoeconomics is also often called price theory.
This is to emphasize the important role that price plays.
Price not only thing studied – think of health care market
What is mircoeconomics
Because we can’t have everything, we need tomake trade-offs and microeconomics helpsus make those tradeoffs.
A society faces 3 key tradeoffs:
1.Which goods and services to produce
2.How to produce them
•How much labor and inputs should a firm use toproduce a car
3.Who gets the good and services (allocation)
What is microeconomics
Workers need to choose how to allocate theirtime between labor and leisure.
Firms need to choose how to allocate theirinvestment between human capital andmachines.
Households need to choose how to allocatetheir incomes between savings andexpenditure.
Micro versus Macroeconomics
What is the difference between micro andmacro economics?
Microeconomics: behavior of individual economicunits like consumers, producers, landowners,families, etc. How and why do they make thedecisions they make?
Macroeconomics: analyzes how the entirenational economy performs. It analyzesunemployment, inflation, price levels, interestrates (many things we take as given inmicroeconomics).
Economic Models
How do economists allocate resources?
They develop theoretical model.
“Everything should be made a simple as possiblebut not simpler” Albert Einstein
Economic Models
The models are abstractions of the real world
Too complicated to take into consideration all factors
Without simplifications we would not be able to makepredictions.
Like a roadmap, does not give each house, but the bareessentials i.e. major streets, highways and sometime mainattractions.
It may appear that the model makes heroicabstractions (assumptions) from the complexities ofthe real world.
Economic Models Example
Determinants of Poster Demand on Campus
You are advertising a big event for the freshman class howmany posters will you need?
Factors in your model:
Price to make poster, size of freshman class
Factors not in your model:
Content of poster, placement of poster, relative size of poster
Are there any constraints to this model?
the amount of budget you have to spend on poster advertising.
Types of Variables in a Model
Exogenous Variable: one whose value istaken as given in a model.
Endogenous Variable: one whose value isdetermined within the model being studied
Which factor(s) would have you taken as givenin the poster example?
Price, size of freshman class (exogenous)
Which factor(s) are determined by your model?
The quantity of posters needed (or demanded)
Tools of Microeconomic Analysis
1.Constrained Maximization
2.Equilibrium Analysis
3.Comparative Statics
Constrained Optimization
Constrained optimization: an analytical toolused when a decision maker seeks to makethe best (optimal) choice, taking intoconsideration possible restrictions on thechoice.
Constrained Optimization
This tool has two parts:
1.Objective function: is the relationship thedecision maker seeks to optimize(maximize or minimize).
2.Constraint: limits or restrictions that areimposed on the decision maker
Constrained OptimizationExamples
You want to maximize your happiness duringyour second year at CU.
Objective function:
Happiness=f(days skied per month, beers per week).
Constraints: s.t. (subject to)
Income, time for leisure
Marginal Analysis
Solution to a constrained optimization problemdepends on the marginal impact of the decisionvariables on the value of the objective function.
But what is marginal?
The term marginal tells us how the value of theobjective function changes as a result of adding oneunit of a decision variable.
Marginal Analysis
Happiness
$spent
Frombeer
Fromskiing
0
0
0
25
80
4
50
90
10
75
92
15
100
94
20
Marginal Happiness
Frombeer
Fromskiing
80
4
10
6
2
5
2
5
How much do you spend on beer and skiing toMaximize your happiness if you have 100 budget?
Marginal Analysis
$100 on beer = 94 units of happiness
$75 beer plus $25 skiing = 96 units ofhappiness.
$50 on beer and $50 on skiing = 100 units ofhappiness.
Yes a day of skiing with a nice apres ski makesyou very happy.
Marginal Analysis
You just did a constrained optimizationproblem
Optimize happiness (beer and skiing) subject toyou $100 weekly entertainment budget.
Max H(B, S) s.t. Ps*S + Pb*B=100
where B= quantity of beer; Pb=price beer
S=days of skiing; Ps=price skiing.
Equilibrium Analysis
Price (P)
Doctors visit
Quantity (Q)
Number of appointmentsper day
.
10
P*
Qd: demand
Qs Supply
Equilibrium: Qd=Qs
50
Q1
Q2
Equilibrium Analysis
In a competitive market, equilibrium isachieved at a price at which the marketclears – that is, at a price at which thequantity offered for sale just equals thequantity demanded by consumers.
Since Qd = Qs at P*, there is no upward ordownward pressure on price. Hence, pricecould stay at P* indefinitely.
Equilibrium AnalysisWhat if price is higher than P*?
50
8
Qd: demand
Qs Supply
13
70
Excess Supply
Quantity (Q)
Number appointmentsper day
P
Price ($)
Doctors visit
Equilibrium AnalysisWhat is price is lower than P*
50
5
Qd: demand
Qs Supply
13
70
Excess Demand
30
P
Price ($)
Doctors visit
Q Quantity
Number of appointmentsper day per doctor
Comparative Statics
Examine how a change in an exogenousvariable will affect the level of an endogenousvariable.
First, look at the value of the endogenous variableat the initial level of the exogenous variable
Second, look at the value of the endogenousvariable at the new level of the exogenousvariable.
Comparative Statics Example
P
Price ($)
Doctors visit
Q
Number of appointmentsper day per doctor
.
10
P*
D
S
50
Q*
Comparative Statics Example
Suppose we are in China and there is anoutburst of the Avian Flu. A few weeks laterthere are some new regulations put ondoctors and they are unhappy about it. Sothey do a rotating strike.
How will these factors affect our Supply andDemand curve and the price?
Comparative Statics Example
P
Price ($)
Doctors visit
Q
Number of appointmentsper day per doctor
.
10
P1
D1
S1
50
D2
Outbreak of avian flu,
P2
60
13
Q1
Q2
Moves demand to the right,
but supply curve does notchange
Comparative Statics Example
P
Price ($)
Doctors visit
Q
Number of appointmentsper day per doctor
D1
S1
D2
The rotating strike will lead to
P3
65
11
S2
A reduction in supply
This is a shift to the left
Q3