Slide Number 1Slide Number 2Slide Number 3Slide Number 4Slide Number 5Slide Number 6 Slide Number 9Slide Number 10Slide Number 11Slide Number 12Slide Number 13Slide Number 14Slide Number 15Slide Number 16Slide Number 17Slide Number 18Slide Number 19Slide Number 20Slide Number 21Slide Number 22Slide Number 23Slide Number 24Slide Number 25• The Allocation of Scarce Resources • What is microeconomics? • Why should we study microeconomics? • Microeconomic modeling - Modeling elements - Key analytical tools • Normative and positive analysis • Calculus prerequisite 1. Introduction 1• Scarcity implies trade-offs • Resources (workers, raw materials, capital, and energy) are available in limited supply. • Which goods and services should be produced? • How should we produce those goods and services? • Who gets to consume those goods and services? • Decision-makers • Individuals (consumers) • Firms • Government Allocation of Scarce Resources 2• Prices determine resource allocation • Which goods? How to produce? Who gets them? • Prices answer these important questions by influencing decision-makers. • Markets • A market is where interactions between consumers, firms, and the government occur. • Prices of goods and services are determined in a market. • Applications • Flu vaccine • Twinkie tax 3Economics is a science on how to allocate limited resources to satisfy unlimited human wants. Microeconomics is the study of the economic behavior of individual economic decision-makers such as a consumer, a worker, a household, a firm, or a manager. This study involves both the behavior of these economic agents on their own and the way their behavior interacts to form larger units, such as industries, labor unions, or markets. What is Microeconomics 4• To learn a systematic analytical framework, which can serve as foundation for studies of other fields in economics - Perspective (e.g., preferences, technologies, welfare criteria) - Benchmark or references (e.g., perfect competition) - Approaches (e.g., partial or general analysis) • To use this framework to make sense of the world around us - Economic phenomena (e.g., B2B, internet markets) - Policy analysis (e.g., polution, minimal wage, taxes and subsidies, health care programs, regulations) Why Study Microeconomics? 5• Models are abstract from complexities of the real world trying to capture the “essentials.” • An economic model is an abstract description of how an economic environment, such as a market, works. • Models usually based on assumptions, a priori (presumptive) statements that capture the essentials of the economic environment or human motivations. Microeconomic Modeling 6Example: World-wide market for unprocessed coffee beans, December, 1997 Price per pound Quantity, pounds Supply (P,W) Demand (P,I) 7• Constrained optimization • Equilibrium analysis • Comparative statics Key Analytical Tools 8Agent’s behavior can be modeled as optimizing the objective function, subject to his various constraints. • Objective functions Examples: profit maximization, cost minimization, welfare maximization, etc. • Constraints: whatever limits is placed on the resources available to the agent. Constrained Optimization 9Example: Consumer purchases Food (F), Clothing (C), Income (I) Price of food (pf), price of clothing (pc) Satisfaction from purchases: S = (FC)1/2 Max S (F,C) subject to: pfF + pcC < I 10Variables that have values that are taken as given in the model are exogenous variables. Variables that have values that are determined as a result of the workings of the model are endogenous variables. - Independent variables vs. dependent variables Exogenous and Endogenous Variables 11Solution concept: Equilibrium An Equilibrium in a system is a state or condition that will continue indefinitely as long as the exogenous factors remain unchanged – that is, as long as no outside factor upsets the system. Solving the Models 12Equilibrium with a Ball and Cup 13Example: The Market for Coffee Beans Price per pound Quantity, pounds Supply (P,W) Demand (P,I) • Q* P* 14A market equilibrium is defined as the state (point) where demand just equals supply in the market (i.e., the point where the demand and supply curves cross). This state will stay as long as exogenous factors (e.g. weather, income) remain unchanged. **(, )PQ15A comparative statics analysis compares the equilibrium state of a system before change in the exogenous variables to the equilibrium state after the change. Comparative Statics 16Comparative Statics: Increase in Income 17Comparative Statics: Increase in Rainfall 18The marginal impact of a change in the exogenous variable is the incremental impact of the last unit of the exogenous variable on the endogenous variable. Marginal Reasoning 19Budget = $1m to allocate between TV ( T ) and radio ( R ) Problem: Max B(T,R) (T,R) subject to: T + R < $1m where: B is “barrels’’ of beers sold Example: Advertising Spots 20Total Spent New Beer Sales GeneratedTV Radio$ 000$100,000 4,750 950$200,000 9,000 1,800$300,000 12,750 2,550$400,000 16,000 3,200$500,00018,750 3,750$600,000 21,000 4,200$700,000 22,750 4,550$800,000 24,000 4,800$900,000 24,750 4,950$1,000,000 25,000 5,00021Positive analysis can explain what has happened due to an economic policy or it can predict what might happen due to an economic policy. Normative analysis is an analysis of what should be done. The truth of a positive statement can be tested. A normative statement contains a value judgment that can’t be tested. Positive vs. Normative Analysis 22Example: “Should we increase income equality rather than focus on economic efficiency?” Example: “Should we impose a progressive income tax or a sales tax to increase income equality?” Example: “Will a progressive income tax reduce aggregate hours worked?” 23• Derivatives • Partial derivatives • Maximization of functions of several variables • Constrained maximization: Lagrangian multiplier method Calculus Requirement 24• We have reviewed the basic elements of microeconomic modeling. • The rest of the course will provide examples of such models. • The rest of the course will also deepen many of the concepts we have discussed today (such as “marginal utility,” “marginal benefit” etc.).