Introduction- Course Syllabus
What is economics?
Study of how we allocate scarce resources among competing groups with unlimited
What is the difference between Microeconomics and Macroeconomics?
Why should you study Microeconomics?
-Offers insights into real world situations that affect us every day.
Ex: Climate change = common resource problem.
Ex: Cap and Trade = lowest cost solution.
Why prices fluctuate in different markets. Should we raise P or lower P to
Three types of models
1. Constrained Optimization
2. Equilibrium Analysis
3. Comparative Statics
Df – Try to max or min an objective function subject to a constraint.
Ex: Suppose you wish to fence your yard.
Want to maximize area
s.t. the constraint that you have a limited amount of fencing (100m)
Objective function that you are trying to maximize = area = L x W
s.t. perimeter = 2L+ 2W ≤ 100m
Write: CHOOSE L and W
s.t. 2L +2W ≤ 100.
Exogenous v. Endogenous variables
Exogenous are taken as given. EX: total fencing=100m.
Endogenous are determined by the model. EX: Choose L and W to max area.
Ex: Consumer Theory
Lives in two-good world. Can expand to many more goods.
Chooses F and C to max utility (satisfaction) s.t. income constraint. Max F,C(C,F)
s.t. PcC +PfF ≤ I
Exogenous? Pc, Pf, I
Endogenous? C, F
Ex: Firm Theory
Production function – turn K,L into output Qo.
Given that we want to produce a certain amount of output, how do we maximize
-We choose an input level that minimizes out costs of production.
Minimizes costs = wL +rK s.t. an output constraint.
Min L,K wL + rK
s.t. Qo = f(K,L)
Exogenous? w, r, Qo
Endogenous? L, K
Marginal Decision Making
Constrained Optimization is a form Marginal Analysis.
Asks how a marginal unit change in the exogenous (independent) variable changes
the endogenous (dependent variable).
Ex: 1.16 Real world: To maximize SUV sales, where should we spend our advertizing budget, on NFL,
on PGA golf, or on both?
d) How should we allocate?
Common ans: Spend all on Football since 2 million sells 20
SUV’s instead of 9.
NOTE: Can do better if use marginal reasoning look at
The manager should spend $750,000 on football (44 SUV) and $250,000
on golf (4 SUV). 2.Concept of Equilibrium
a. Natural state in which a system rests.
Q: What is the equilibrium price and quantity?
Q: Why is this price the equilibrium price?
Why will the price not stay at P=$2.50? Surplus Qs > Qd. Prod
Why will the price not stay at $1.50?
b. How to think about the Demand Curve.
willingness to pay for the last unit consumed
- marginal benefit to society of the last unit consumed
-Law of Demand
c. How to think about the Supply Curve
- Q producers willing to supply at a particular price, ceteris
-Marginal costs of producers summed
-Qs=Qd -Market eqbm is Efficient because those who value most and
those who produce at lowest costs transact.
3. Comparative Statics
How a change in an exogenous variable affects the endogenous
-Applied to both Constrained Optimization and Partial Eqbm.
Partial Eqm saw before:
1. Initial Eqbm P, Q
2. Change which affects the D or S or both curves
3. Look at final eqbm P,Q.
Ch. 2 – Comparative Statics of Demand and Supply
Qd = f(Po, P, I, ….) ordinary demand curve
Po = h(Qd,P, I, …) Inverse Demand curve
Downward sloping because of Law of Diminishing MU.
Giffen good exception. (Rice in Hunan – Rob Jensen)
1. Change in Qd v. Change in Demand
Change in Quantity Demanded
-Due to change in Good’s own price.
Change in demand
-Shift entire curve
2. What are some other factors that shift market demand?
1. Income ↑
-Normal good - demand ↓ (most items)
-Inferior good – demand ↑ (bus ticket, used item)
2. Prices of Related Goods ↑
-Substitutes – demand ↑ Examples? (Coke v. Pepsi)
-Complements – demand ↓ Examples? (hotdog v.hotdog buns)
3. Tastes - advertizing
4. Expectations of future P and Income – electronics, deflation
5. Number of buyers – Baby boom(1947-1966) Echo(1980-
3. Inverse Demand Function to graph
Po = f(Qd, …)
SLOPE: Increase P by 1 unit, decrease Qd by 2 units.
Student Example: Write the inverse demand function for the ordinary
demand curve Qd = 4-2P and graph.
Tells us that the quantity of a good supplied by all producers in the
market depends on various factors.
1. Quantity supplied v. Change in Supply
2. What are some factors that shift market supply?
1. Prices of Inputs – oil prices and supply of plastics
2. Prices of other goods produced – natural gas is byproduct of
3. Technology – fracking increased supply of natural gas. 4. Expectations of future prices – hoarding by oil companies
5. Number of sellers – LR entry drive Supply up, P down.
a) Note the positive and negative coefficients. The sign tells you how and
increase in one variable affects Qd or Qs. Note and increase in P is a
movement along the demand or supply curve since P is on the y-axis. A
change in anything else (G or E) represents a shift in demand and/or
Qd = 1000 + 50G -4E -400P
Qs = 200-30G +100P
G↑ → Qd ↑ (price of substitute) and Qs↓(input in production)
E↑ → time cost of driving ↓ (price of sub ↓) → Qd taxi ride ↓ b) G=$4.00/gallon and E = 30 min.
Qs = 80+100P
Find Eqbm taxi fare P.
Qs = Qd
1080-400P = 80+100P
P = $2.
QS=Qd = 1080-400(2) = 280.
Graphing a line. Graph.
B+) Comparative Statics: What happens to eqbm P,Q if Pgas (G)
increases to $5.00?
Qs = 50 + 100P
Qd = 1130 -400P
New Eqm: QS = Qd
1130 – 400P = 50 + 100P
Qs=Qd = 50+ 100(2.16) = 266
Does this match your intuition?
Elasticity = responsiveness
A. Own Price Elasticity of Demand
1) Definition - The price elasticity of demand measures how much the quantity
demanded responds to changes in the good’s own price.
Q: Why do governments and firms care about elasticity? 2) Calculation
a. The price elasticity of demand is calculated as the percentage change in
quantity demanded divided by the percentage change in price.
a) d = %Qd / %P
Ex. If the price of ice cream increases by 10% and the quantity demanded
decreases by 30% then the d= -30%/10%= -3.
NOTE: d is negative because an increase in P causes a decrease in Qd. This
negative sign will be important for determining income elasticity and cross-price
elasticity. However, by convention, we make the own-price elasticity positive
because it is the magnitude of the changes that matter not the direction. So we
make it positive by taking the absolute value of the own-price elasticity, and it
should be written:
d = %Qd / %P
Q: If the elasticity of demand is 3, what how much do we expect Qd to decrease
if Pincreases by 20%?
Q: Does this make intuitive sense?
Surely, I would respond differently to a price increase of 20% than a price increase of
just 1%. This may be true. Note that elasticity is calculated at a particular point on
the demand curve. In other words, it is point dependent. A20% price increase will
place you further away from the original price point, and the elasticity may differ in
this region. For our purposes, we will ignore this complication and assume that the
effect of a 20% price increase has the same elasticity as a 1% price increase for a
particular price point on the demand curve. b) Midpoint method –observe 2 prices associated with 2 different quantities
i. Use when calculating the elasticity between 2 points (P1,Q1) and
(P2, Q2) on a demand curve because the percentage change will
vary depending on whether you use (P1, Q1) or (P2, Q2) in the
denominator. The midpoint method eliminates this problem by
using the average of the two points.
εd = (Q2−Q1)/ [(Q2+Q1)/2 ]
(P2− P1)/ [(P2+ P1)/2 ]
ii. Example: Suppose we increase the price of a pack of cigarettes
from $8 to $13.33 and the quantity demanded drops from 100
million sold to 80 million sold. What is the price elasticity of
Q: Is the demand elastic or inelastic?
c) Finding elasticity for a LINEAR demand curve
So if we return to our previous formulation of the equation of a demand curve in
Problem 2.18 and assume that P = 2 and Q=280, we can calculate the own-price
elasticity of demand as follows: 1. Slope =ΔQ/ΔP = -400
2. P/Q = 2/280
3. εd = (-400)(2/280) = -2.86
4. Taking the absolute value, εd = 2.86
NOTE: For any linear demand of the form Qd = a - bP , the own-price
elasticity of demand is given by the formula
NOTE: The inverse demand curve allows us to find the choke price where the price
is so high that Qd is zero.
The choke price = a/b is the P at which Qd falls to 0.
3) Calculus method.