Applied Microeconomics

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Applied Microeconomics

• Introduction

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Course Info.

• Teacher Jens Josephson
• E-mail jens.josephson_at_upf.edu
• Office 20.1E44
• Office hours Thursdays 10.40-11.40
• Course web http//www.econ.upf.es/jens/applied/h
  ome.htm
• Teaching Assistant Piya Sereevinyayut
• E-mail piya.sereevinyayut_at_upf.edu
• Office 20.159

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Literature

• Perloff, J. F., Microeconomics, 3rd or 4rd
  edition
• Van Zandt, Tim Firms, Prices, and
  Marketshttp//faculty.insead.edu/vanzandt/main.h
  tml
• Course package available at the OCE
• Perloffs website http//occawlonline.pearsoned.
  com/bookbind/pubbooks/perloff2_awl/
• References
• Gibbons, R., A Primer in Game Theory. Harvester
  Wheatsheaf, 1992.
• Jehle, G. A., and Reny, P. H., Advanced
  microeconomic Theory, second (or third) edition,
  Addison Wesley, 2001.
• Mas-Colell A., Winston, M. D., and Green J. R.,
  Microeconomic Theory, Oxford University Press,
  1995.
• Watson, J., Strategy. An Introduction to Game
  Theory. Norton 2002.
• Tirole, J. The Theory of Industrial
  Organization, The MIT Press, 1988.

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Grading

• Final Exam 90
• Problem sets 10 (to be handed in the box
  outside 20.159 before Mon. 12.00)
• Participation in class

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Will you learn something useful?
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Examples of Questions We Want to Be Able to Answer

• What is the rationale behind franchising?
• How can profit be increased by segmenting a
  market?
• What is the rational for two-part pricing?
• Why are certain goods bundled together?
• How can a firm prevent other firms from entering
  its market in a credible way?
• How much bonus and fixed wages should a firm pay
  its managers?

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Course Outline

• Introduction
• Consumer Theory
• Producer Theory
• Pricing with Market Power
• Price Discrimination and Bundling
• Competitive Markets
• Welfare
• Expected Utility and Risk Aversion
• Game Theory
• Oligopoly
• Asymmetric Information
• Network externalities

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Readings for This Lecture

• Kreps Chapter 1-2
• Perloff 1-2
• Zandt Chapter 1
• Article An economist takes tea with a
  management guru, The Economist, 12/21/91, Vol.
  321, Issue 7738.

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Learning Microeconomics

• Two legs
• Studying theory and concepts
• Solving problems

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What is Microeconomics About?

• Models and analysis
• Purposeful Behavior
• Equilibrium
• Description (positive)
• Evaluation and Improvement of Outcomes (normative)

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Models and Analysis

• Models are simplified and analytical depictions
  of reality
• Simplified to help us understand complex
  realities by focusing on what is important
• Analytical in the sense of breaking down a a
  whole into small pieces, examining them and then
  putting the pieces together
• The point of the model is to
• Sharpen intuition - learn what is important and
  why
• Give us testable predictions

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Economics vs. Management

• Finance, accounting, strategic management,
  marketing, operations management, and human
  resource management all rely upon microeconomics
  to some degree
• Modern microeconomics incorporates realistic
  behavioral assumptions

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The Most Famous Picture in Economics

• Where does it come from?

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A Simple Market

• Consider a market for an indivisible good with
  one buyer and one seller
• Assume the buyer purchases at most one unit and
  the seller supplies at most one unit of the good
• Assume that the maximum price at which the buyer
  is willing to buy the good is V
• The difference between the V and the price he
  pays P is the buyers surplus

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A Simple Market

• Assume the cost of producing the good to a seller
  is C
• If the buyer and the seller are bargaining, and
  VC, then we would expect trade at a price P
  somewhere between C and V
• At such a price, P-C is the sellers surplus, and
  V-P is the buyers surplus

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A Simple Market

• Suppose now that there are a number of buyers and
  sellers with different valuations and production
  costs respectively
• There are various mechanism for organizing trade
  in this case auctions, pit markets, etc.
• But if trade is recurrent, there are no frictions
  or transaction costs, and all transactions are
  observable, there should be a unique price
• How is this market price determined?

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Demand

• Draw a diagram with price on the vertical axis
  and units of the good on the horizontal axis
• Plot the number of buyers willing to buy for each
  price and connect the dots
• Seen horizontally, this is the demand curve for
  the good
• Seen vertically, this curve gives us the marginal
  valuation of an additional unit of the good

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Supply

• Draw a diagram with price on the vertical axis
  and units of the good on the horizontal axis
• Plot the number of sellers with a cost below or
  equal to the price for each price and connect the
  dots
• Seen horizontally, this is the supply curve for
  the good
• Seen vertically, this is the marginal cost of an
  additional unit of the good

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Equilibrium

• By combining the two diagrams we can find the
  intersection between supply and demand
• This point gives us the equilibrium price P and
  quantity Q
• The expenditure is given by the rectangle below
  the price and to the left of the quantity sold

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Surplus

• The sum of buyers surplus at this price is the
  consumer surplus
• The sum of the sellers surplus is the producer
  surplus
• The sum of the two is the total surplus of the
  gains from trade

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Why Are You Supposed to Believe This Picture?

• Empirical evidence spot market for oil
• Experimental evidence experimental markets
  (Smith, 1982)

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Is the Allocation Efficient?

• An allocation (of goods and money) to the agents
  of the market is feasible if what is consumed is
  not greater than what is produced
• A feasible allocation is Pareto Efficient if
  there is no other feasible allocation that makes
  at least one agent strictly better off and nobody
  worse off
• In this case, this is equivalent with total
  surplus being maximized

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The Equilibrium Allocation is Efficient

• In our simple market the equilibrium allocation
  of money and goods is efficient since
• Only the buyers with the highest valuation and
  the sellers with the lowest cost trade
• There is not too much trade
• There is not too little trade

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Conclusions

• Microeconomics is the foundation for many of the
  of management sciences
• Microeconomics uses models assuming purposeful
  behavior studying equilibrium to describe and
  evaluate
• Demand and supply, consumer and producer surplus,
  Pareto efficiency are important concepts
• Both empirical and experimental support for the
  demand and supply model