MICROECONOMICS Classroom Lecture Notes by Zeke Wang

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(No Transcript)
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MICROECONOMICSClassroom Lecture Notes (3
credits, as of 2005)
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• based on Hal R. Varians
• Intermediate Microeconomics,
• Sixth Edition,
• referring to Pindyck and Rubinfelds
• Microeconomics,
• Fourth Edition.

4
Chapter 0
Economics
5
The source of all economic problems is scarcity.
6

• Problem of trade-off, and choice.
• Economics, as a way of thinking,
• as a dismal science.
• Problems
• - solutions
• - hidden consequences.

7
Main decision-making agents

• 1 individuals (household),
• 2 firms, and
• 3 governments.

8

• Objects of economic choice are
• commodities,
• including
• goods and services.

9
Main economic activities

• Consumption,
• Production, and
• Exchange.

10
Microeconomics and macroeconomics

• to show the market mechanism (the invisible
  hand),
• to supplement it.

11
The circular flow of economic activities.
product market
factor market
12
The product market and the factor market.

• The market relation is mutual and
  voluntary.
• Positive issues and normative issues.

13
Marginal analysis

• Relations between
• Total magnitudes,
• Average magnitudes, and
• Marginal magnitudes.

14

• 1, MM is the slope of the TM curve
• 2, AM is the slope of the ray from the origin to
  the point at the TM curve

TM
MM(x)
AM(x)
x
x
15

• 3, TM increasing (decreasing)
• if and only if
• MM gt 0 ( MM lt 0 )
• 4, If TM is at maximum or minimum,
• then MM 0

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• 5, AM increasing (decreasing)
• if and only if
• MM gt AM ( MM lt AM )
• 6, If AM is at maximum or minimum,
• then MM AM,
• or
• MM cuts AM at the latters
• maximum or minimum.

17
Chapter 1
The Market
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• Economics proceeds by developing Models of
  social phenomena.
• By a model we mean a simplified
  representation of reality.

19

• Exogenous variables
• taken as determined by factors not
  discussed in a model.

Endogenous variables determined by forces
described in the model.
20
The optimization principle

• People try to choose whats best for them.

The equilibrium principle
Prices adjust until demand and supply are equal.

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The demand curve

• A curve that relates the quantity demanded
  to price.

The reservation price
Ones maximum willingness to pay for something.
22

• From people's reservation prices to the
  demand curve.

Fig.
Similarly, the supply curve.
23
Pareto efficiency

• A concept to evaluate different ways of
  allocating resources.

A Pareto improvement is a change to make some
people better off without hurting anybody else.
24

• An economic situation is
• Pareto efficient
• or
• Pareto optimal
• if there is already no way to make any more
  Pareto improvement.

25
Short run and long run

• Equilibria in the short run (some factors are
  unchanged) and in the long run.

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Chapter 2
Budget Constraint
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• Vector variables and vector functions.
• The inner product of two vectors.
• With the price vector p ( p1, , pn ),
• the value of
• the commodity bundle x ( x1, , xn )
• is pTx Si pixi.

However, two goods are often enough to discuss.
28

• The budget constraint
• p1 x1 p2 x2 m.

• The budget line and the budget set (the market
  opportunity set).

29

• The slope of the budget line d x2 /d x1 p1 /
  p2 .

• How the budget line moves
• when the income changes, or
• when a price changes.

30
Budget line and budget set
x2
m/p2
Budget line Slope -p1/p2
Budget set
x1
m/p1
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Increasing income
x2
m/p2
Budget line
m/p2
Slope - p1/p2
x1
m/p1
m/p1
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Increasing price
m/p2
Budget line
Slope - p1/p2
Slope - p1/p2
m/p1
m/p1
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Taxes, quantity taxes, value taxes (ad valorem
taxes), and lump-sum taxes.

• A subsidy
• is the opposite of a quantity tax.  

Rationing.
Their effects on the budget set.
34
Chapter 3
Preferences
35

• Prerequisite
• A binary relation R on X is said to be
• Complete if xRy or yRx for any pair of x
  and y in X
• Reflexive if xRx for any x in X
• Transitive if xRy and yRz imply xRz.

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Rational agents and stable preferences

• Bundle x is strictly preferred (s.p.), or weakly
  preferred (w.p.), or indifferent (ind.), to
  Bundle y.
• (If x is w.p. to y and y is w.p. to x, we say
  x is indifferent to y.)

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Assumptions about Preferences

• Completeness x is w.p. to y or y is w.p. to
  x for any pair of x and y.

Reflexivity x is w.p. to x for any bundle x.
Transitivity If x is w.p. to y and y is w.p.
to z, then x is w.p. to z.
38

• The indifference sets, the indifference curves.

Fig.
They cannot cross each other.
39
indifference curves
x2
x1
40

• Perfect substitutes and
• perfect complements.
• Goods, bads, and neutrals.
• Satiation.
• Figs

41
Perfect substitutes
Blue pencils
Indifference curves
Red pencils
42
Perfect complements
Left shoes
Indifference curves
Right shoes
43

• Well-behaved preferences are monotonic (meaning
  more is better) and
• convex (meaning average are preferred to
  extremes).
• Figs

44
Monotonicity
x2
Better bundles
Better bundles
(x1, x2)
x1
45

• The marginal rate of substitution (MRS) measures
  the slope of the indifference curve.
• MRS d x2 / d x1, the marginal willingness to
  pay ( how much to give up of x2 to acquire one
  more of x1 ).
• Usually negative.
• Fig

46

• Convex indifference curves exhibit a diminishing
  marginal rate of substitution.
• Fig.

47
Convexity
x2
(y1,y2)

•  

Averaged bundle
(x1,x2)
x1
48
Chapter 4

Utility
(as a way to describe preferences)
49
Utilities

• Essential ordinal utilities, versus
• convenient cardinal utility functions.

50

• Cardinal utility functions
• u ( x ) u ( y ) if and only if
• bundle x is w.p. to bundle y.
• The indifference curves are
• the projections of contours of
• u u ( x1, x2 ).
• Fig.

51

• Utility functions are indifferent
• up to any
• strictly increasing transformation.
• Constructing a utility function in the
  two-commodity case of well-behaved preferences
• Draw a diagonal line and label each
  indifference curve with how far it is from the
  origin.

52
Examples of utility functions

• u (x1, x2) x1 x2
• u (x1, x2) x12 x22
• u (x1, x2) ax1 bx2
• (perfect substitutes)
• u (x1, x2) minax1, bx2
• (perfect complements).

53

• Quasilinear preferences
• All indifference curves are vertically (or
  horizontally) shifted copies of a single one,
  for example u (x1, x2) v (x1) x2 .

54

• Cobb-Douglas preferences
• u (x1, x2) x1c x2d , or
• u (x1, x2) x1ax21-a
• and their log equivalents
• u (x1, x2) c ln x d ln x2 , or
• u (x1, x2) a ln x (1 a) ln x2

55
Cobb-Douglas
56

• Marginal utilities
• MU1 and MU2.

• MRS along an indifference curve.
• Derive MRS MU1 / MU2
• by taking total differential along any
  indifference curve.

57
Marginal analysis

• MM is the slope of the TM curve

AM is the slope of the ray from the origin to the
point at the TM curve.
58
Reservation price
500
490
The demand curve
480
Number of apartment
From peoples reservation prices to the market
demand curve.
59
Equilibrium
supply
P
E (P,Q)
P
Demand
Q
Q
60
Equilibrium
p
supply
E
Demand
q
61
Rationing
x2
Budget line
Market opportunity
Budget set
x1
R
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MRS
x2
Indifference curve
Slope dx2/dx1
dx2
dx1
x1
63
Chapter 5

• Choice of consumption

64

• Optimal choice is at the point in the budget line
  with highest utility.
• The tangency solution of an indifferent curve and
  the budget line
• MRS p1 / p2.
• Fig.

65

• Basic equations
• MU1 / p1 MU2 / p2 and
• p1 x1 p2 x2 m.
• Figs.
• ( How if negative solutions.)

66

• Interior solutions, and
• Boundary (Corner) solutions.
• Kinky tastes.
• Figs.

67

• Three approaches to
• the basic equations
• Graphically
• As-one-variable
• Lagrangian.

68

• The optimal choice is the consumers demanded
  bundle.
• The demand function.

69

• Examples
• perfect substitutes,
• perfect complements,
• neutrals and bads,
• concave preferences.
• Figs.

70

• Cobb-Douglas demand functions.
• Choosing taxes.
• (By Slutsky decomposition.)
• Figs.

71
Chapter 6

• Demand

72

• Demand functions
• x1 x1 (p1, p2, m),
• x2 x2 (p1, p2, m).

73

• Normal and inferior goods (by income)
  Fig.
• Luxury and necessary goods (by income). Fig.
• Ordinary and Giffen goods (by price).
  Fig.

74

• The income expansion path
• or the income offer curves,
• and the Engel curve.
• Figs.

75

• The price offer curve
• and the Demand curve.
• Figs.

76

• Substitutes and complements.
• Cobb-Douglas preferences.
• Quasilinear preferences.

77

• Homothetic preferences
• if (x1, x2) is preferred to (y1, y2),
• then (tx1, tx2) is preferred to
• (ty1, ty2) for any t gt 0.
• Thus both the income offer curves and the Engel
  curves are all rays through the origin.

78

• Example
• Quasilinear preferences
• lead to
• vertical (horizontal) income offer curves and
• vertical (horizontal) Engel curves.

79
Chapter 8

• Slutsky Equation

80

• How the optimum moves when the price of a good
  changes?

81

• Decomposition
• the total effect
• the substitution effect
• the income effect.
• p139

82

• The pivot gives
• the substitution effect,
• the shift gives
• the income effect.
• P103andp137

83

• Slutsky identity, pivoting the budget line around
  the original choice.
• Fig.
• Hicks decomposition, pivoting the budget line
  around the indifference curve.
• Fig.

84
Chapter 9

• Buying and Selling
• for a consumer with an endowment ?

85

• Net and gross demands, net supply.
• Offer curve and demand curve.p164

p1
x2
?
x1
x1
?1
?1
86

• Labor supply p174

W
E
Labor
Leisure R
Leisure
87
Chapter 10

• Intertemporal Choice

88

• Suppose for example in a 3-period model,
• the consumption is ck and
• the interest rate is rk in period k,
• then the present value of the consumptions is
• c1 c2 / (1r1) c3 / (1r1) (1r2).
• p190

89
Chapter 12

• Uncertainty

90
Utilities and probabilities.

• Expected utility functions, or
• von Neumann-Morgenstern
• utility functions.
• They are indifferent up to
• any positive affine transformation.
• (affine transformation y a bx).

91

• Risk aversion and risk loving.

U
U


Concave vs convex utility.
The second derivatives.
92
Chapter 14

• Consumers surplus

93
?????
r1
r2
???
r3
p
r4
r5
r6
1 2 3 4 5
6
Consumers Surplus p246
94
Producers surplus p255
P
Producers surplus
P
Supply curve
Q
Q
95
P
Change in producers surplus
P
Supply curve
R
T
P
Q
Q
Q
96
The water-diamond paradox

• Pd
• Pw

Q
97
Calculating gains and losses
B
T
Change in consumers surplus
98
Chapter 15 Market Demand
99
One can think of the market demand as the demand
of some representative consumer.
100
Adding up demand curves The horizontal
summation principle.
101


Horizontal summation
102
The market demand curve
PRICE
DEMAND CURVE
D(p)
QUANTITY
It is the sum of the individual demand curve
103
The price elasticity of demande (?q / q ) /
(?p / p) ( p / q ) / (?p /?q), ore ( d
q / q ) / ( d p / p) ( p / q ) / ( d p / d
q) slope of ray / slope of curve .
104
A good has an elastic ( inelastic, unitary)
demand if e gt 1 ( e lt 1 , e 1 ).
105
Elasticity and revenue. R pq, ?R q?p
p?q , and then ?R/ ?p q 1 e(p) where
e( p ) ( p?q ) / (q?p).
106
The elasticity of a linear demand curve
p a b q
PRICE
?e?8
?e ?gt1
?e ?1
a /2
?e ?lt1
?e ?0
p267
a / 2b
QUANTITY
107
Strikes and profits. The Laffer
curve.
Similarly, MR ?R / ?q
p (q) 1 1 /e(q) where e(
q ) ( p?q ) / (q?p).
108
The income elasticity of demand. The arc
elasticityandthe point elasticity.
109
Marginal revenue p275
PRICE
Slope-b
a
Slope-2b
a/2
Demand, AR
a/2b
a/b
QUANTITY
MR
Marginal revenue for a linear demand curve.
110
Marginal revenue
PRICE
D, AR
MR p(q)1-1/e
QUANTITY
MR for a constant elasticity demand curve
111
Chapter 16 Equilibrium
112

• The market supply curve.
• The competitive equilibrium.
• Pareto efficiency.

113
Pareto efficiency p301
Willing to buy at this price
PRICE
Supply
Pd
PdPsP
Demand
Ps
Willing to sell at this price
Q
Q
QUANTITY
114
Market supply and market shortage
price
supply
demand
P
equilibrium
P
Qd
Qs
quantity
Q
Market shortage
115
Shortage is not scarcity.
116
Special cases of equilibrium p286
PRICE
PRICE
Demand curve
Supply curve
Supply curve
Demand curve
p
p
q
q
QUANTITY
QUANTITY
A
B
117

• Algebra of the equilibrium.
• Comparative statics.
• Shifting both curves. p289

118
Taxes. DistinguishPp , the price paid by
consumers, Pr , the price received by
producers, andPo , the original price.
119
The deadweight loss of a tax p296
Demand
PRICE
Supply
Pp
Amount of tax revenue AC
A
B
D
C
Pr
QUANTITY
Q
The deadweight loss of the tax BD
120
Chapter 18 Technology
121
Inputs and outputs. Factors of production
land, labor, capital, raw materials, and
so on.
122
A production set p321
Y Output
Y f (X ) production function
Production set
X Input
123
Examples of technology (isoquants analysis)

• Fixed proportions,
• Perfect substitutes,
• Cobb-Douglas.
• Figs. p322

124
Fixed proportion
x2
Isoquants
x1
125
Perfect subsitutes
x2
Isoquants
x1
126
Assumptions of technology monotonic (free
disposal),
127
and convex. p324
x2
a2
(a1/2 b1/2 , a2/2 b2/2)
b2
isoquant
x1
a1
b1
128
The marginal product, MPi d y / d x i . Y is
output
129
The technical rate of substitution (TRS)

• With d y 0 along any isoquant,
• TRS (x1, x2 ) d x2 / d x1
• MP1 (x1, x2) / MP2 (x1, x2 ).

130
The long run (LR) and the short run (SR)
131
Returns to scale Increasing, decreasing, and
constant gtf ( t x ) lt t f ( x )
132
Chapter 19 Profit Maximization
133
The organization of firms

• Proprietorships,
• partnerships,
• corporations.

134
SR profit maximization

• p py - w1x1 - w2x2
• y p/ p w2x2 / p w1x1 / p
• describes isoprofit lines,
• max x1p gives pMP1 w1.
• Fig. p337

135
Profit maximization
Isoprofit lines slope w1/p
Output
y
y f (x1, x2) Production function
p/pw2x2/p
x1
x1
136
Optimum lies on the tangency of an isoprofit line
and the production function.
137
P324 Comparative statics

• Increasing p increases x1 and then y.
• Increasing w1 reduces x1,
• and thus the factor demand curve follows.
• LR both x1 and x2 are variable.
• Figs.

138
Comparative statics
????
????
f(x1)
f(x1)
High w1
Low p
Low w1
High p
x1
x1
A
B
139
Chapter 20

• Cost Minimization

140
Basic model

• min x1, x2 w1 x1 w2 x2
  subject to f (x1 , x2 ) y

gives c ( w1 , w2 , y )
141
Isocost lines p351
x2 C/w2 w1x1/w2.
142
Tangency of an isocost line and an isoquant.
MP1 (x1, x2) / MP2 (x1, x2 ) TRS(x1, x2 )
w 1 / w 2
143
x2
Optimal choice
.
Isocost lines slope w 1 / w 2
x2
Isoquant f (x1 , x2 ) y
x1
x1
144

• Minimizing costs for
• y minax1 , bx2????
• y ax1 bx2 ????
• and y x1a x2b. Cobb-Douglas

145

• Fixed and variable costs.
• (FC and VC)

Total, average, marginal, and average variable
costs. (TC, AC, MC and AVC)
146

• MC gt (lt) AC if and only if AC is increasing
  (decreasing)

MC cuts AC (AVC) at ACs (AVCs) extreme.
147
AC
MC
AC AVC MC
.
AVC
.
y
148
Chapter 21

• Cost
• Curves

149

• The area under MC
• gives VC

?MC VC
150
MC
MC
Variable costs
y
151
Division of output among plants of a firm.
MC1
MC2
152
Typical cost curves.
153
Example
c (y) y 2 1.
154
MC
AC MC AVC
AC
AVC
.
2
y
1
The cost curves for c (y) y 2 1
155

• LR and SR cost curves.

156
AC
SACC(y1, k )/y
.
LACC(y)/y
y
y
Short-run and long-run average costs
157
Short-run average cost curves
AC
Long-run average cost curves
y
y
Short-run and long-run average costs
158
Sunk costs
are costs that are not recoverable. A special
kind of fixed costs.
159
Chapter 22

• Firm Supply

160
Pure competition.

• Price Taker..

161
The demand curve facing a competitive firm. p380
Market demand
P
Demand curve facing firm
Market price
P
Q
162
The supply decision

• FOC MC ( y ) p.

SOC MC ( y ) 0.
163
The firms supply curve is the upward-sloping
part of MC that lies above the AVC curve.
The part of MC is also seen as the inverse supply
function.
164
AC
MC
AC AVC MC
AVC
firms supply curve
P
y
y2
y1
165
Three equivalent ways to measure the producers
surplus ( R VC p FC ). p389
166
P389 Example
c ( y ) y 2 1.
167
LR p MC ( y, k ( y ) )
vs
SR p MC ( y, k )
168
Chapter 23

• Industry Supply

169
Horizontal summation
gives
the industry supply.
170
P
S1
S2
S1 S2
Y
171
Entry and exit.
172
The zero profit
theorem.
173
Free entry vs barriers to entry.
174
Economists versus lobbyists
Rent seeking.
175
Chapter 24
Monopoly
176

• The coincidence of the inverse demand curve D
  and the average revenue curve AR. Fig.

177

• With
• MR d R / d y p (y ) 1 1 /e(y) ,
• p ( y ) MC ( y ) / 1 1 / e( y ) .

178

• Two equivalent ways to
• determine the equilibrium
• MC MR, or
• AR MC / ( 1 e ). Figs.
• FOC MC MR.
• SOC MC MR .

179

• The impact of taxes on
• a monopoly. p425
• Inefficiency of monopoly.
• Fig. p426
• Deadweight loss of monopoly.
• Fig,

180
Inefficiency of monopoly
Price
Deadweight lost
Mc
pm
pc
Demand, AR
MR
ym
yc
output
181
Deadweight loss of monopoly
PRICE
????
MC
Monopoly Price P
A
B
C
Demand, AR
Competitive price
MR
output
Y
182

• Natural monopoly.
• Figs. p417
• What causes monopolies by nature or by
  permission.
• The minimum efficient scale factor.
• Regulation of monopoly AC AR.

183
Chapter 25
Monopoly Behavior  
184

• Price discriminations
• of first-degree (perfect),
• of second-degree (bulk discounts),
• and
• Price discrimination of third-degree
• (market segmentation) Figs.

185

• MC(y1y2) MR1(y1) MR2 (y2)
• gives
• p1 1 1 / e1 ( y1 )
• p2 1 1 / e2 ( y2 ) .

186
Fig!
187
Chapter 28

• Oligopoly,
• mainly Duopoly

188

• Quantity or price competitions.

• Identical products

p p (Y ), Y y1 y2 .

• Sequential games.

• Backward solution.

189

• Quantity leadership
• Stackelberg model.

190
dp / dy2 MC2

• MR2 p (y1y2) y2

• gives the followers
• reaction function
• y2 f 2 (y1)
• then
• max y1 p (y1 f2 (y1 )) y1 c1 ( y1 )
• determines y1.

191

• Example

p ( y1 y2) a b ( y1 y2) , c 0.
192

• Price leadership

• The leader is supposed to set p first,
• then max

y2 py2 c2 (y2)
S2(p).
gives
Now, the leader goes as a monopolist facing the
residual demand
R(p) D(p) - S2(p).
193

• Example

D(p) a bp, c2 ( y2 ) y22 / 2, c1 ( y1 )
c y1.

194

• Simultaneous games.
• Bertrand price competition leads to p MC even
  only two firms.
• Thus only quantity setting consideration.

195

• Cournot model of quantity competition
• max yi p( yi yje) yi ci ( yi ),
• where yje is the output of Firm j expected by
  Firm i,
• gives yi fi (yje),
• then the consistence determines the equilibrium.

196

• Adjustment to an equilibrium.

• Several firms in Cournot equilibrium

Y y1 yn ,
p (Y) 1 si / e(Y) MCi(yi)
where si yi / Y.
197
Chapter 28

• Game Theory

198

• Three fundamental elements
• to describe a game
• Players,
• (pure) strategies or actions,
• payoffs.

199
Color Matching
B
b r
1, -1
-1, 1
b A r
-1, 1
1, -1
200

• Payoff matrices
• for Two-person games.
• Simultaneous(-move) games.
• Finite games Both the numbers of players and of
  alternative pure strategies are finite

201
The Prisoners Dilemma
B
Confess Deny
Confess A Deny
-3, -3
0, -5
-5, 0
-1, -1
202

• Dominant strategies, and dominated
  strategies.
• Method of iterated elimination of strictly
  dominated strategies.

203

• The Prisoners Dilemma
• shows also that a Nash equilibrium does not
  necessarily lead to a Pareto efficient outcome.
• Two-win games.

204

• A pair of strategies is a
• Nash equilibrium if As choice
• is optimal given Bs choice,
• and vice versa.
• Nash is a situation,
• or a strategy combination of
• no incentive to deviate unilaterally.

205
Battle of Sexes
Girl
Soccer Ballet
2, 1
0, 0
Soccer Boy Ballet
-1, -1
1, 2
206

• Method of underlining relatively advantageous
  strategies.
• Double underlining gives Nash.
• There can be no, one, and multiple (pure) Nash
  equilibria.

207
Price Struggle
Pepsi
L H
L Coke H
3, 3
6, 1
1, 6
5, 5
208

• How if there is no Nash
• of pure strategies?
• Mixed strategies
• (by probability).
• Method of response functions.

209
Color Matching again
B
b r
q 1-q
1, -1
-1, 1
b p A r 1-p
-1, 1
1, -1
210

• With
• EUA 1 pq (-1)p (1-q)
• (-1) (1-p) q 1 (1-p) (1-q)
• pq - p pq - q pq 1 - p - q pq
• 4 pq - 2 p - 2 q 1
• 2 p (2 q - 1) (1 - 2 q ) ,
• we have
• 1 if q gt 1/2 ,
• p 0, 1 if q 1/2 ,
• 0 if q lt 1/2 .

211

• Similarly,
• 0 if p gt 1/2 ,
• q 0, 1 if p 1/2 ,
• 1 if p lt 1/2 .

q 1
N
1 p
0
212

• Method of response functions The intersections
  of response functions give Nash equilibria
• ((p, q) (1/2, 1/2) in example)
• Nash Theorem
• There is always a ( maybe mixed) Nash
  equilibrium for any finite game

213

• Sequential games.
• Games in extensive form
• versus
• in normal form.

214

• Battle of Sexes again

Ballet
( 1, 2)
Girl
( -1, -1)
Ballet
Soccer
Boy
Ballet
( 0, 0)
Soccer
( 2, 1)
Soccer
215

• Strategies as Plans of Actions.
• Boys strategies Ballet, and Soccer.
• Girls Strategies
• Ballet strategy
• Soccer strategy
• Strategy to follow and
• Strategy to oppose.

216
Chapter 29Exchange
217
Partial equilibrium and general equilibrium
218
Edgeworth box p497

• A pure exchange model of two goods, two consumers
  with fixed endowments w.

219

• Region of mutual advantages.
• Pareto set and the contract curve.
• Bargaining for relative prices.
• Gross demand x (p) ,
• Net or excess demand
• z (p) x (p) - w (p).

220
wB1
Person B
xB1
GOOD 2
xA2
xB2
M
wA2
wB2
Endowment
xA1
wA1
GOOD 1
Person A
221
Contract curve
GOOD 2
Person B
A Pareto efficient allocation
Person As indifference curve
Person Bs indifference curve
Endowment
Person A
GOOD 1
222

• From disequilibrium to the competitive
  equilibrium.
• Which good is too cheap?
• Offer curve approach.
• The existence problem of equilibrium.

223
Equilibrium price
As offer curve
Bs ind. curves
Good 1 is Too cheap
E
Bs offer curve
W
As ind, curves
224
Chapter 29 Production
225
The Robinson Crusoe economy
Coconuts
Indifference curves
C
Production function
Labor
L
226
Production possibilities set
(Two outputs case)
COCNUTS
SLOPEMARGINAL RATE OF TRANSFORMATION
C
PRODUCTION POSSIBILITIES SET
FISH
F
227
Trade leads toSeparation of prod. and coms.
(P/C),Production specialization(A P),
andWealth improvement( A C).
C
P
A
228
Heckscher-Ohlin theory on international
trade,under many idealization assumptions.
229

• Costs of exchange.
• Price difference between
• selling and buying.
• Fig.
• GATT and WTO.

230
Chapter 30 Welfare
231
The social preference. Two kinds of voting
majority, and rank-order.
232
The social welfare function.

• Benthamite
• W (u1, ,u n ) a 1u 1 a n u n .
• Rawlsian
• W (u1, ,u n ) min u1 , , u n .

233
Three requirements on a social decision
mechanism

• 1, It should be complete, reflexive, and
  transitive
• 2, If everyone prefers X to Y, then the society
  should prefer X to Y
• 3, The preferences between X and Y should depend
  only on how people rank X versus Y, and not on
  how they rank other alternatives.

234
Arrow's Impossibility Theorem

• If a social decision mechanism satisfies
  properties 1, 2, and 3,
• then it must be a dictatorship
• all social rankings are the rankings of one
  individual.

235
Chapter 31

• Externalities

236
The lack of markets for externalities causes
problems.
237
With externalities, the market will not
necessarily result in a Pareto efficient
provision of resources.
238
However, some other social institutions can
"mimic" the market mechanism.
239
The model of smokers and nonsmokers
(showing excellent analysis techniques).
240
Possible endowment E
Person B
SMOKE
Bad
Possible equilibrium X
Possible equilibrium X
As indifference curves
Good
Possible endowment E
Person A
MONEY
241

The practical problems with externalities
generally arise because of poorly defined
property rights.
Caose Theorem
242
Chapter 35

• Asymmetric Information

243
Common knowledge and private information. The
latter leads to Asymmetric information,
or Asymmetry of information.
244
Akerlof model the market for lemons.
Density
Quality
245
Adverse selection as a hidden information
problem.
Moral hazard as a hidden action problem.
246
Signaling Two roles of education To raise and
to distinguish Productivities Spence model
247

• 
  C(Y) for L
• wage system
• 
  C(Y) for H
• Y
  Y
• Best Choice of L, and of H

248
Graph to show separating equilibria and
pooling equilibria.
249
END
and
Thanks