micro-chapters_1-2-3.pdf

INTERMEDIATE MICROECONOMICSLi-An ZhouGuanghua School of ManagementPeking UniversityIntroduction The course will cover the basic principles of microeconomics,but in a more formal and structured way than the introductory economics does Classical price theory(consumer choice,producer theory,market equilibrium analysis)Monopoly and Oligopoly Game theory and information economics Market failure(externality and public goods)Welfare economicsIntroduction Demonstrate the beauty and rigor of microeconomic theoriesAlso apply these analytical tools to the real world and use many real world examples to show the relevance and power of economic thinkingThe principles we will cover in this course provide the foundation of almost all theories in modern economics,and also distinguish economists from scholars in other disciplinesTextbooksThe main textbook I will use for this class is Intermediate Microeconomics by Hal Varian I may also turn to the following two texts for reference Microeconomics by Robert Pindyck and Daniel Rubinfeld Microeconomic Theory by Walter Nicholson.Grading PolicyThere will be five homework assignments graded on a check,check-plus basis.They will count for 20 percent of the final gradeYou can drop one of them.Late problem sets will not be accepted.No exceptions.You will have a final exam(accounting for 80 percent)which is in-class and closed-bookOffice hoursMy office hours:2-4 pm,Sunday,Rm.405,Guanghua New BuildingMy contact info:,Tel:6275-0431TA will also hold office hours every week,and TA sections(details to be announced later in class)Chapter 1What is Economics?What does Economics study?Lionel Robbins(1935):allocation of scarce resourcesGary Becker(1976):any human behavior related to the allocation of scarce resources Family and marriage Crime,religion,LawMethodological Features of EconomicsRationalityStable PreferencesEquilibriumEfficiencyMethodological FeaturesRationality:maximizing the object function of the decision-maker Its not necessarily selfishness and can be consistent with altruism A kind of simplification:we care about averagebehavior of people We test hypothesis,not assumptions Using rationality assumption to rule out obvious cheating trapsMethodological FeaturesStable preferences:constant throughout the model Preferences are unobservable but constraints are:falsifiability requirement Emphasis on man-made constraints and institutional design The“moral blood”of real estate developers in China Why are some animals dying out?The Rise and fall of Somali piratesMethodological FeaturesEquilibrium analysis:a tool to aggregate behaviors of individuals and predict the outcome of human interactions A Puzzle of Happiness:Californian vs.Oregon Peltzman effect and offsetting behavior Reinterpretation of Marriage Law in China:Are Mothers-in-laws hurt by this legal change?Methodological FeaturesEfficiency criterion:a normative notion of optimality Is the economic outcome efficient?Is there any room for improvement in efficiency?Economists are chiefly concerned with efficiency implications of policies or behaviors Why should we economists care?Themes of MicroeconomicsMicroeconomics deals with limits or constraints Limited budgets Limited time Limited ability to produceHow do we make the most of limits?How do we allocate scarce resources?Themes of MicroeconomicsWorkers,firms and consumers must make trade-offs Do I work or go on vacation?Do I purchase a new car or save my money?Do we hire more workers or buy new machinery?How are these trade-offs best made?Themes of MicroeconomicsConsumers Limited incomes Consumer theory describes how consumers maximize their well-being,using their preferences,to make decisions about trade-offs How do consumers make decisions about consumption and savings?Themes of MicroeconomicsWorkers Individuals decide when and if to enter the workforce Trade-offs of working now or obtaining more education/training What choices do individuals make in terms of jobs or workplaces?How many hours do individuals choose to work?Trade-off of labor and leisureThemes of MicroeconomicsFirms What types of products do firms produce?Constraints on production capacity and financial resources create needs for trade-offs Theory of the Firm describes how these trade-offs are best madeThemes of MicroeconomicsPrices Trade-offs are often based on prices faced by consumers and producers Workers make decisions based on prices for labor wages Firms make decisions based on wages and prices for inputs and on prices for the goods they produceThemes of MicroeconomicsPrices How are prices determined?Centrally planned economies governments control prices Market economies prices determined by interaction of market participants Markets collection of buyers and sellers whose interaction determines the prices of goodsTheories and ModelsEconomics is concerned with explanation of observed phenomena Theories are used to explain observed phenomena in terms of a set of basic rules and assumptions:The Theory of the Firm The Theory of Consumer Behavior The Theory of Government behavior Theories and ModelsTheories are used to make predictions Economic models are created from theories Models are mathematical representations used to make quantitative predictions Parsimony and richness:the role of a map There is no bad math,but bad modelTheories and ModelsValidating a Theory The validity of a theory is determined by the quality of its prediction,given the assumptions Theories must be tested and refined Theories are invariably imperfect but give much insight into observed phenomena and leave a lot of room for extensions and refinementsPositive&Normative AnalysisPositive Analysis statements that describe the relationship of cause and effect Questions that deal with explanation and prediction What will be the impact of an import quota on foreign cars?What will be the impact of an increase in the gasoline excise tax?Positive&Normative AnalysisNormative Analysis analysis examining questions of what ought to be Often supplemented by value judgments Should the government impose a larger gasoline tax?Should the government decrease the tariffs on imported cars?Think Like EconomistsUsing baseline models as benchmarks Competitive markets Theories of producers and consumers What makes economists different?Ask interesting and deep questions Significant deviations from baseline models serve as a starting place for asking questions Coases famous question Soft budget constraint for SOEs All classical theories will receive attacks and revisions but lay foundations for further progressThe Wisdom of EconomicsHayeks warnings to the world“The road to hell paved with good intentions”The debate about the vitality of market vs.planning economy in 1930s Malthusian view on population(1798)How to achieve the consistency between goals and means when making policies Debate on the effect of the minimum wageDismal Science:The Current VersionEconomists in China are not popular in the eyes of the general publicThey make arguments which evoke heated debates and often invite negative commentsAre they really the bad people standing only for the rich and against the poor?The tension between economists and general public is chiefly caused by the unique logic underlying economicsChapter 2The Market How Do Economists Think?Supply-demand analysis is a fundamental and powerful tool that can be applied to a wide range of interesting and important issuesWe will examine a model of a particular market(apartment market in a college town)Give you a flavor of how economists establish a theory to analyze practical issuesEconomic ModelingWhat causes what in economic systems?Which variables are determined outside the model(exogenous)Which variables are to be determined by the model(endogenous)At what level of detail shall we model an economic phenomenon?(simplifying assumptions)Modeling the Apartment MarketCentral question:How are apartment rents determined?Suppose(simplifying assumptions)apartments are close or distant,but otherwise identical distant apartments rents are exogenous and known many potential renters and landlords,i.e.,competitive marketA Normative QuestionWill the allocation of apartments be desirable?Need to know:Who will rent close apartments?At what price?Two Principles in EconomicsOptimization:Each person tries to choose the best alternative available to him or herEquilibrium:Market price adjusts until quantity demanded equals quantity supplied.Modeling Individual DemandDiscrete commodity:0 or 1 unit Choose either distant or close apartmentClose apartments are more desirable but more expensiveTend to choose close apartment if Distant apartments are also expensive.Higher incomeDecide:The maximum rent you are willing to pay for a close apartment.Modeling Market DemandSuppose the most any one person is willing to pay to rent a close apartment is$500/month.Then p=$500 QD=1Reservation price:a persons maximum willingness to pay for somethingSuppose the price has to drop to$490 before a 2nd person would rent.Thenp=$490 QD=2Modeling Apartment DemandThe lower is the rental rate p,the larger is the quantity of close apartments demandedp QDThe quantity demanded vs.price graph is the market demand curve for close apartments.Market Demand Curve for ApartmentspQDModeling Apartment SupplySupply:It takes time to build more close apartments so in this short-run the quantity available is fixed(at say 100)Market Supply Curve for ApartmentspQS100Competitive Market EquilibriumAssume that there are so many landlords and students in the markets that no one can influence the prevailing price in the market Price-takers“low”rental price quantity demanded of close apartments exceeds quantity available price will rise“high”rental price quantity demanded less than quantity available price will fall.Competitive Market EquilibriumQuantity demanded=quantity available price will neither rise nor fallso the market is at a competitive equilibriumIn the equilibrium no one is willing to change the decision he or she has madeCompetitive Market EquilibriumpQD,QS100Competitive Market EquilibriumpQD,QSpe100Competitive Market EquilibriumpQD,QSpe100People willing to pay pefor close apartments get closeapartments.Competitive Market EquilibriumpQD,QSpe100People willing to pay pefor close apartments get closeapartments.People not willing to pay pefor close apartmentsget distant apartments.Competitive Market EquilibriumQ:Who rents the close apartments?A:Those most willing to pay.Q:Who rents the distant apartments?A:Those least willing to pay.So the competitive market allocation is by“willingness-to-pay”（价高者得）Comparative StaticsWhat is exogenous in the model?price of distant apartments quantity of close apartments incomes of potential rentersWhat happens if these exogenous variables change?Comparative StaticsSuppose the price of distant apartment risesDemand for close apartments increases(rightward shift),causing a higher price for close apartments.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QSpe100Higher demandMarket EquilibriumpQD,QSpe100Higher demand causes highermarket price;same quantitytraded.Comparative StaticsSuppose there were more close apartmentsSupply is greaterSo the price for close apartments falls.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QS100Higher supplypeMarket EquilibriumpQD,QSpe100Higher supply causes alower market price and alarger quantity traded.Comparative StaticsSuppose potential renters incomes rise,increasing their willingness-to-pay for close apartmentsDemand rises(upward shift),causing higher price for close apartments.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QSpe100Higher incomes causehigher willingness-to-payMarket EquilibriumpQD,QSpe100Higher incomes causehigher willingness-to-pay,higher market price,andthe same quantity traded.The Effect of an Apartment TaxSuppose the city council decides that there should be a tax on the apartmentEach landlord has to pay a certain amount of tax to the cityWhat will this tax policy change the apartment price?Imperfectly Competitive MarketsAmongst many possibilities are:a monopolistic landlord a perfectly discriminatory monopolistic landlord a competitive market subject to rent control.A Monopolistic LandlordWhen the landlord sets a rental price p he rents D(p)apartments.Revenue=pD(p).Revenue is low if p 0Revenue is low if p is so high that D(p)0.An intermediate value for p maximizes revenue.Monopolistic Market EquilibriumpQDLowpriceLow price,high quantitydemanded,low revenue.Monopolistic Market EquilibriumpQDHighpriceHigh price,low quantitydemanded,low revenue.Monopolistic Market EquilibriumpQDMiddlepriceMiddle price,medium quantitydemanded,larger revenue.Monopolistic Market EquilibriumpQD,QSMiddlepriceMiddle price,medium quantitydemanded,larger revenue.Monopolist does not rent all theclose apartments.100Monopolistic Market EquilibriumpQD,QSMiddlepriceMiddle price,medium quantitydemanded,larger revenue.Monopolist does not rent all theclose apartments.100Vacant close apartments.Perfectly Discriminatory Monopolistic LandlordImagine the monopolist knew everyones willingness-to-pay and he was able to charge different renters different pricesCharge$500 to the most willing-to-paycharge$490 to the 2nd most willing-to-pay,etc.Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$5001Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012p3=$4753Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012p3=$4753Discriminatory Monopolistic Market EquilibriumpQD,QS100p1=$500p2=$49012p3=$4753peDiscriminatory monopolistcharges the competitive marketprice to the last renter,andrents the competitive quantityof close apartments.Rent ControlLocal government imposes a maximum legal price,pmax pe,the competitive price.Market EquilibriumpQD,QSpe100Market EquilibriumpQD,QSpe100pmaxMarket EquilibriumpQD,QSpe100pmaxExcess demandMarket EquilibriumpQD,QSpe100pmaxExcess demandThe 100 close apartments areno longer allocated bywillingness-to-pay(lottery,lines,large families first?).Which Market Outcomes Are Desirable?Which is better?Rent control Perfect competition Monopoly Discriminatory monopolyPareto EfficiencyVilfredo Pareto;1848-1923.A Pareto outcome allows no“wasted welfare”;i.e.the only way one persons welfare can be improved is to lower another persons welfare.Pareto ImprovementGiven an allocation,if we can find a way to make some people better off without making anybody else worse off,we have a Pareto improvementIf an allocation allows for a Pareto improvement,it is called Pareto inefficientIf an allocation doesnt allow for any Pareto improvement,it is called Pareto efficientPareto EfficiencyAn allocation is Pareto efficient if we cant find another allocation such that no one is worse off and at least someone is better offPareto efficiency exhausts any Pareto improvement opportunitiesThis efficiency criterion requires minimum value