Course Outline Microeconomics 0

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Course Outline Microeconomics 0

• 1st week Introduction and Overview (chapter 1
  textbook)
• Consumers and Preferences (ch. 2)
• Demand and Behavior in Markets (ch. 3)
• 2nd week Emergence of Markets and Exchange (ch.
  4)
• Production, Technology, and Cost Functions
  (chs. 5, 6)
• Game Theory (ch. 7)
• 3rd week no lectures
• 4th week Internal Organization of the Firm (ch.
  8)
• Monopoly, Natural Monopoly, and Regulation
  (chs. 9, 10)
• 5th week Midterm Exam
• Oligopoly (ch. 11)
• 6th week Market Entry (ch. 12)
• Perfectly Competitive Markets (ch. 13)
• 7th week Uncertainty and Insurance (ch. 14)
• General Equilibrium, Welfare and Equity, Input
  Markets (chs. 15, 19)
• 8th week Moral Hazard and Adverse Selection (ch.
  16)
• Externalities, Public Goods and the Role of
  Government (chs. 17, 18)
• 9th week Final Exam

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Requirements and Grading

• Problem Sets 20
• Midterm Exam 30
• Final Exam 50
• Problem sets will be assigned regularly. They
  will be discussed by the teaching assistants in
  the exercise sessions.
• Readings
• Textbook Schotter, Andrew Microeconomics A
  Modern Approach. Second/Third Edition, New York,
  Addison Wesley, 1997/2001.
•  
• Further Suggested Reading
• Nyarko, Yaw, 2001 Study Guide to Accompany
  Schotter, A. Microeconomics A Modern Approach.
•  
• Varian, Hal R. Intermediate Microeconomics A
  Modern Approach. Fourth Edition, New York,
  Norton, 1996 or Third Edition 1993.

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Announcements

• Extra Micro lecture Thursday, June 24th
• Micro instead of macro lecture on Tuesday, June
  29th
• Macro instead of micro lecture on Wednesday, July
  7th
• Teaching Assistants
• Vitezslav Babicky, Ekaterina Goldfain,
• Sylvester van Koten

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1. Overview Economics and Institutions

• Institutions shape daily life, e.g. conventions
  to drive on the right side, wages including
  particular bonus systems, rules for decision
  making in committees, etc.
• Definition Institutions can be conventions like
  tipping in a restaurant or sets of rules like the
  political system, more loosely institutions refer
  to large, established organizations
• Economic Institutions refer to conventions
  developed to solve recurrent economic problems or
  sets of rules that govern economic behavior (and
  organizations that serve an economic purpose)
• Often these institutions are taken for granted,
  but arrangements could be different, and in
  different societies they often are.

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• Microeconomics provides a technical apparatus for
  understanding why specific institutions are the
  way they are, i.e. it asks the question How do
  individuals, in an attempt to maximize their
  self-interest create a set of economic
  institutions that structure their daily lives?
• Conventional Microeconomics How are scare
  resources allocated by one type of institutions
  markets?
• allocation problem microeconomics helps to
  understand the question of allocation of scarce
  resources in two ways
• How should the resources be spent, given certain
  objectives (Normative or welfare economics)
  economics does not prescribe or give advise on
  the objectives, though
• How will the resources be spent, given a
  description of the decision making process, i.e.
  the institutions (Positive economics)
• Positive question of institutional economics why
  do we have the set of institutions we have?
• Normative question of institutional economics
  how can we design (or redesign) economic
  institutions to increase economic welfare?

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• Economic models are abstract representations of
  reality, can be in the form of mathematical
  models or analogies (in particular to games, to
  be analyzed by game theory)
• The model used in Schotters book
• Starts with primitive state of nature (no
  production)
• then gradually introduces markets, production,
  firms, market entry, uncertainty (insurance
  companies), asymmetric information, external
  effects, public good problems
• Three fundamental institutions are assumed to be
  present
• The state (guarantees protection of property
  rights)
• property rights (enhance the efficient use of
  resources, avoid tragedy of the commons)
• economic consulting firms (as a tool to examine
  economic theory)

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2. Consumers and their Preferences

• People differ, but there are certain regularities
  of behavior. This part aims at identifying these
  regularities and understanding what they tell us
  about consumer preferences and decision making
• primitive society without social institutions
• people decide only how to allocate time between
  leisure and picking apples and raspberries and
  which mixture to consume (everything also works
  for more than 2 goods, but the graphs get ugly)
• homo economicus (economic man) fictional
  perfectly rational decision maker

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• 2.1 The Consumption Possibility Set
• set of bundles feasible for the agents to consume
• not bounded from above, no economic restrictions
  incorporated yet
• assumptions
• divisibility goods are infinitely divisible
• additivity if a and b can be consumed, so can
  a b
• convexity if a and b can be consumed, then for
  any 0? ? ?1, the combination c?a(1- ?)b can be
  consumed as well

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• 2.2 Rationality
• people are assumed to be rational, i.e. that
  they have preferences over available consumption
  bundles (notation aRb a is at least as good as
  b) and that these satisfy specific properties
• complete binary ordering for all pairs a,b aRb
  or bRa holds. If both aRb and bRa hold, i.e. a is
  exactly as good as b the agent is indifferent
  between a and b, denoted aIb
• Reflexivity for any bundle a, aRa
• Transitivity if aRb and bRc, then aRc.
• Why transitivity is important an intransitive
  agent can be exploited.

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• 2.3 The Economically Feasible Set
• The economically feasible consumption set is
  bounded from above due to
• time constraints assume that goods are only
  consumed in daylight, 12 hours of daylight are
  available and that it takes 4 hours to consume 1
  unit good 1 and 2 hours to consume 1 unit good 2.
  Due to divisibility and convexity the set of
  economically feasible consumption bundles is
  given by all bundles on or below the line of
  bundles that take exactly 12 hours to consume
  (Fig. 2.3)
• budget constraints assume the agent has an
  income of 6, the cost for 1 unit of good 1 is 2
  and for 1 unit of good 2 it is 1. This leads to
  the same constraint as above

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• 2.4 Rationality and Choice
• A complete, reflexive, transitive preference
  relation allows an agent to choose an optimal
  bundle from the economically feasible set.
  Without completeness, an optimal bundle might not
  exist since some bundles could not be ranked.
  Without transitivity, cycles can occur.
• It is useful to express preferences by utility
  functions each bundle is assigned a utility
  number and the higher the number, the better the
  bundle. Choosing the best bundle then amounts to
  choosing the bundle that maximizes utility
• utility need not be observable, but an agent with
  preferences as above will behave as if he is
  maximizing a utility function
• required to be continuous, implies that for any
  bundle there is another bundle that is exactly as
  good.
• counterexample lexicographic preferences (rank
  countries on liberty first and on availability of
  chocolate second)

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• examples
• additive separable utility function U x y,
  enjoyment from good x is independent of level of
  consumption of good y
• multiplicative utility function U x y, either
  good produces utility only if the other is
  consumed as well.
• different types of utility function obviously
  imply different behavior
• cardinal utility not only comparison between
  different utility levels is meaningful (higher
  is better) but also difference (20 is twice as
  good as 10)
• ordinal utility only ranking meaningful, e.g. if
  there are two objects and a is preferred over b
  then both U1 with U1(a) 1000, U1(b) 0 and U2
  with U2(a) 2, U2(b) 1 represent the same
  preferences.

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• 2.5 Psychological Assumptions
• We make the following assumptions about the
  psychological makeup of the agents
• Selfishness people judge allocations only in
  terms of what they receive
• Nonsatiation more of any good is always better,
  i.e. an allocation that contains more of one good
  and not less of the others is preferred. To
  include economic bads (that reduce utility) in
  the analysis, define as a good anything that
  removes or prevents the bad
• Convexity of Preferences diversifying is always
  good, i.e. if aIb then any mixture such as ?a
  ?b is at least as good as a and at least as good
  as b

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• 2.6 Indifference Curves
• Indifference curve line through all bundles that
  yield equal utility, i.e. through all bundles
  between which agent is indifferent
• Indifference map diagram that depicts an agents
  indifference curves (Fig 2.7)
• Each IC corresponds to one utility number, all
  bundles on that curve yield that level of utility
• Properties
• ICs dont slope upward (due to nonsatiation)
  (Fig 2.8)
• ICs cannot cross (due to transitivity and
  nonsatiation) (Fig 2.9)
• ICs farther from origin represent higher level
  of utility (due to nonsatiation) (Fig 2.10)
• ICs are bowed to the origin (due to convexity
  and nonsatiation) (Fig 2.11)

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• The marginal rate of substitution
• Assume we take -?x1 of good 1 away from the
  consumer. How much of good 2 do we have to give
  him to keep his utility level the same?
• Let this be ?x2 . (Fig 2.12)
• The marginal rate of substitution is - ?x2/ ?x1
  (actually the limit as these go to 0), the rate
  at which the consumer would be willing to trade
  good 1 for good 2.
• the MRS equals the slope of the indiff. curve
• convexity of preferences implies diminishing
  marginal rate of substitution, i.e. the MRS falls
  when we move along IC
• we have MRS (?U / ?x1) / (?U / ?x2)

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• Different indifference curves represent different
  tastes (Fig 2.13)
• flat lines good 1 yields no utility (strict
  nonsatiation violated)
• straight lines perfect substitutes (constant
  MRS)
• Right-angled indiff. curves perfect complements
• Bowed-out indiff. curves non-convex preferences
  (increasing MRS).

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• 2.7 Optimal consumption bundles
• which bundle will an agent choose to maximize her
  utility if she can choose from the economically
  feasible set?
• the optimal consumption bundle is characterized
  by the indiff. curve being tangent to the budget
  line (Fig 2.15)
• slope of indiff. curve and budget line are
  identical
• MRS equals price ratio, i.e. rate at which agent
  is willing to trade good 2 for good 1 is equal to
  the rate at which she can trade good 2 for good 1
• MRS p 1 / p2 .
• Example Optimal tipping (violates selfishness
  assumption, this demonstrates that the apparatus
  can be applied to settings outside the basic
  framework) (Fig 2.18)