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Week 1

Introduction, Demand and Supply

Hyojung Lee
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What is Economics?
Economics is the study of how scare resources are
allocated among alternative uses.
Economists seek to develop simple models to help
understand that process.
Many of these models have a mathematical basis
because the use of mathematics offers a precise
shorthand for stating the models and exploring their
consequences.

Why Should We Study It?


The study of economics is a good preparation
for a variety of careers
Economics majors generally earn more than
similar individuals with other majors
The Economic Reward to Studying Economics Economic

Inquiry 41(3), 2003. Dan A. Black, Seth Sanders, Lowell Taylor

Influences your way of thinking. Makes your life more


efficient (Hopefully).

Contents of Microeconomics

Week 1
Week 2
Week 3
Week 4
Week 5
Week 6
Week 7
Week 8
Week 9
Week 10
Week 11
Week 12
Week 13
Week 14

Introduction, Demand and Supply


Consumer Preferences
Consumer Choice
The Theory of Demand
Inputs and Cost Minimization
Cost Curves
Perfect Competition
Recess Week
Monopoly and Price Discrimination
Game Theory
Duopoly, Oligopoly
General Equilibrium
Market Failures
Revision Week
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Goal of this course


Intermediate Microeconomics is not so much
about acquiring a bunch of knowledge. Rather
it is about mastering a set of skills (mostly
quantitative), and be able to apply the skills to
solve economic problems.

Textbook
Our textbook is available at the University Bookstore
Besanko and Braeutigam (2014) Microeconomics 5th ed. Wiley

Course Grading
Mid-term (Covering week 1-6): 40%
Close-book exam only the calculator is allowed.
Final (Comprehensive): 50%
Close-book exam only the calculator is allowed.
In-class quizzes (10times): 8%
Close-book quizzes.
I will drop the lowest TWO quiz scores.
Homework (6times): 2%
Due right before the class starts.
I encourage you to form a group of 3 4 students and discuss about
the problem sets. However, you should write the solution by
yourself. Copied solutions will get no points.

Microeconomic Modeling
Societies must answer these questions that relate to
microeconomics:
1. What goods and services will be produced and in what quantities
2. Who will produces these services and how will they produce them
3. Who will receive these goods and services and how will they get them

Models are like maps using visual methods, they simply


process and facilitate understanding of complex concepts.
Microeconomic models need to:
Resemble reality; Be understandable
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Microeconomic Modeling
1. Exogenous & Endogenous Variables
Exogenous variables: Variables that have values taken as given in the
analysis.
Endogenous variables: Variables that have values determined as a result
of the models workings.
Example:
How would a manager hire the most possible workers on a budget of $100?
vs.
How would a manager minimize the cost of hiring three workers?
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Microeconomic Modeling
2. The Objective Function
The Objective Function specifies what the agent cares about.
Examples)
- Consumers try to maximize their utility.
- Firms try to maximize profits (or, minimize costs).

3. The Constraints
Limits that are placed on the resources available to the agent.
Examples)
- Time, Budget, Technical Capabilities

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Constrained Optimization
The consumer wants to maximize her satisfaction with the two goods: food (F)
and clothing (C). Suppose the consumers level of satisfaction when she
purchases F units of food and C units of clothing is measured by , = .
The consumer has fixed income , and she must not spend more than during
the month. Each unit of food costs , and each unit of clothing costs .
-

What is the objective function for this problem?

What is the constraint?

Which variables ( , , , , and ) are exogenous? Which are endogenous?

Write a statement of the constrained optimization problem.

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Microeconomic Modeling
What is Equilibrium?
Example Sale of Coffee Beans

P*

Equilibrium is defined as the


point where demand just equals
supply in this market (i.e., the
point where the demand and
supply curves cross).

Demand

Q*

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Microeconomic Modeling
What is Equilibrium?
More broadly, Equilibrium is a state that will continue indefinitely as
long as the exogenous factors remain unchanged.

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Microeconomic Modeling
What is Comparative Statics Analysis?
A Comparative Statics Analysis compares the equilibrium state of a system
before a change in the exogenous variables to the equilibrium state after the
change.
Example Sale of Wheat
Supply of Wheat has decreased
due to a drought. As a result,
equilibrium quantity and price
have changed.

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Chapter 2
Demand and Supply Analysis

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Demand
Quantity demanded, , is a function of the price of the good, , and
other variables (e.g., income, or other goods prices)
To draw a demand curve, hold all other variables constant to write as a
function of , i.e., = .
We always graph on vertical axis and on horizontal axis, but we write
demand as as a function of If is written as function of , it is
called the inverse demand.

Movements along the demand curve Vs. Shifts of the demand curve
Movements along the demand curve: changes, while all other
factors remain unchanged.
Shifts of the demand curve: other factors change, while own price
stays constant.
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Demand
Law of Demand: The quantity of a good demanded decreases when the price
of this good increases.

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Demand
Example:
Suppose the demand for new automobiles in Europe is described by the equation,
= 12 0.1, where is the number of new automobiles demanded per
year (in millions) when is the average price of an automobile (in thousands of
euros).

(a) What are the quantities of automobiles demanded per year when the average
price of an automobile is 15, 25, and 35 (in thousands euros)?
(b) Obtain the inverse demand curve.

(c) Sketch the demand curve for automobiles.

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Supply
Quantity supplied, , is a function of the price of the good, , and other
variables (e.g., income, or other goods prices)
To draw a supply curve, hold all other variables constant to write as a
function of , i.e., = .
We always graph on vertical axis and on horizontal axis, but we write
supply as as a function of If is written as function of , it is called
the inverse supply.

Movements along the supply curve Vs. Shifts of the supply curve
Movements along the supply curve: changes, while all other factors
remain unchanged.
Shifts of the supply curve: other factors change, while own price
stays constant.

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Supply
Law of Supply: The quantity of a good offered increases when the price of
this good increases.

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Market Equilibrium
Equilibrium price satisfies = .

The equilibrium quantity is = = ( ).


Example)
= 500 4
= 100 + 2

= price of cranberries (dollars per barrel)


= demand or supply in millions of barrels per year
What are and ?

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Market Equilibrium

Q* = 100
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Market Equilibrium
Excess Demand: A situation in which the quantity demanded
at a given price exceeds the quantity supplied.
Excess Supply: A situation in which the quantity supplied at a
given price exceeds the quantity demanded.

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Microeconomic Modeling
What is Comparative Statics Analysis?
A Comparative Statics Analysis compares the equilibrium state of a system
before a change in the exogenous variables to the equilibrium state after the
change.
Example Sale of Wheat
Supply of Wheat has decreased
due to a drought. As a result,
equilibrium quantity and price
have changed.

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Example: Comparative Statics

Suppose the supply curve for wool is given by = , and the demand curve for
wool is = 10 + , where is the level of income (exogenous variable).

(a) Suppose the level of income is = 20. Graph the supply and demand
relationships, and indicate the equilibrium levels of price and quantity on
your graph.
(b) Explain why the market for wool would not be in equilibrium if the price of
wool were 18 and 14.
Now, suppose income rises from 1 = 20 to 2 = 24.

(c) Using comparative statics analysis, find the impact of the change in income
on the equilibrium price and quantity of wool.

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Shifts in Demand
Demand Increases:
P Q
Demand Decreases:
P Q

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Shifts in Supply
Supply Increases:
P Q
Supply Decreases:
PQ

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Price Elasticity
Price Elasticity of Demand measures the sensitivity of the
quantity demanded to price. The percentage change in quantity
demanded resulted from a one-percent change in the price of the
good.

Or,

100

=
=
=
= ()

( ) 100

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Price Elasticity
Perfectly inelastic demand ( = 0): Quantity demanded is completely
insensitive to price.
Inelastic demand (-1< < 0): Quantity demanded is relatively insensitive to
price.
Unitary elastic demand ( = -1): Percentage increase in quantity demanded
is equal to percentage decrease in price.
Elastic demand (-< <-1): Quantity demanded is relatively sensitive to
price.
Perfectly elastic demand ( =-): Any increase in price results in quantity
demanded decreasing to zero, and any decrease in price results in quantity
demanded increasing to infinity.

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Price Elasticity
Example:
Price is initially $5, and the corresponding quantity demanded is
1000 units. If the price rises to $5.75, the quantity demanded will
fall to 800 units.
=> What is the price elasticity of demand over this region of the
demand curve? Is demand elastic or inelastic?

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Elasticity Linear Demand Curve


Qd = a bP

Where:
a and b are positive constants
p is price
b is the slope
a/b is the choke price

Re-writing, we have:
P = a/b (1/b)P

Elasticity is: , =

( )

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Elasticity Linear Demand Curve


P
a/b

Q,P = -
Elastic region

a/2b

Q,P

= -1
Inelastic region
Q,P = 0

a/2

Q
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Other Elasticities
Income elasticity of demand =

100

( )100

=> measures sensitivity of the demand to income


changes

Cross price elasticity of demand =

100

)100

=> measures sensitivity of the demand for good i to the price


of the different good j.
=> Demand substitutes: > 0
=> Demand complements: < 0
Price elasticity of supply =

100

( )100

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35

36

37

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What are the values of b and m?

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What are the values of b and m?

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Exercise)
The price and quantity information below is from the 1989 US market for
sugar. The price elasticity of demand in the US has been estimated to be - 0.3
while the price elasticity of US supply has been estimated to be 1.54.
US sugar production: 13.7 billion pounds in 1989
US sugar consumption: 17.5 billion pounds in 1989
US price in 1989: $0.23 per pound
Using the 1989 price and quantities along with the elasticity estimates, find
linear approximations to the US supply and US demand curves. [Find the
formulas to use in the region where price and quantity are positive.]

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Must read
Determinants of the price elasticity of demand; Market level
versus Brand-level price elasticity (pg. 39-41)
Elasticity in the long run versus short run (pg.45-47)

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