ECONOMICS 305: INTERMEDIATE MICROECONOMICS

(Winter 2013)

Instructor: Professor Ahmed M. Hussen

Office: Dewing 306A, Phone #: x7025
Office Hours: MWF 2 to 3pm or by appointment

COURSE DESCRIPTION:

Intermediate Microeconomics is an advance treatment of the concepts that you have already been
exposed to in your first course in economics. It is predominantly a theory-oriented course and as such tends
to be somewhat abstract and technical. It is a course designed primarily to economic majors with the sole
intent of teaching them the ‘neoclassical economics ways of thinking’ on resource allocations (i.e., the
apportionment of scarce resources among competing uses) in a rigorous and comprehensive manner. More
specifically, this is a course where students actually, through repeated mathematical derivations and
graphical exhibits, learn the broad and wider applications of those analytical approaches that are so
profoundly unique to modern economic science, such as equi-marginal equilibrium conditions, partial
equilibrium analysis, constrained optimization, and game theoretic (i.e., a strategic decision-making
techniques). In addition, where it is appropriate, concerted efforts are made to highlight the relevance of the
insights gained from microeconomics theories to public policies and the decision making processes of
households and business concerns.

The course is organized in four parts. Part I starts by a formal analysis of the general implications of
resource scarcity. This is then followed by providing a detailed outline of the basic ‘axiomatic’ assumptions
of modern microeconomic theory. In this regard, attention is directed to enumerate the specific social
(people’s behavior), institutional, and resource conditions that are necessary for the existence of a ‘perfect’
market condition – a situation where no one single economic entity (a buyer or a seller) can be able to
influence market price. This part ends with brief remarks that are intended to show the implication(s) of
deviating from each core assumption for perfect market.

Part II examines the theory of consumer choice. The objective here is to develop a general
framework of analysis that would allow us to develop rules for the careful measuring and balancing of costs
and benefits of particular activities undertaken by individual consumer’s (such as buying goods and services,
selling labor services, lending money) with a clearly stated objective to maximize utility (gain happiness).
This general framework of analysis will also allow us to delve into the basic factors behind the determinants
of the: (i) demand for final goods and services, (ii) supply for labor, and (iii) supply for loanable funds—
financial capital.

Part III deals with the theory of the firm. In this section, several general theoretical frameworks are
developed to understand the technological (i.e., production functions) and economics (i.e., cost and revenue
functions) that influences the decision of a firm in both the short and long run settings. Once this is done, the
next step is to develop rules for careful measuring and balancing of costs and benefits of particular activities

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(such as buying input, producing output, borrowing money) undertaken by individual producer with a clearly
stated objective to maximize returns. The ultimate goal in the theory of the firm is to understand the
determinants of: (i) the supply for final goods and services, and (ii) the demand for factors of production,
such as labor and capital.

Part IV, starts with the formal evaluation of the long-run performance of an economy under a
perfectly competitive market structure—the so-called ‘invisible hand theorem’. This is then followed by
careful examinations of the implications of market imperfection on prices for final goods and services. The
intent here is to provide a systematic and comprehensive examination: (i) how, in general, monopoly ‘power’
causes price distortion and in so doing may lead to losses in social welfare, (ii) alternative public policy
measures that can be used to correct price distortion that are caused by monopoly power, and (ii) show the
applications of game theoretic models to understand the strategic decision making behaviors of oligopolistic
firms. Finally, time permitting an attempt will be made to shed light on the implications of markets with
asymmetric information.

This course assumes that students have taken a course in calculus. Prerequisites: Eco 105 or 101
and Eco 205 or Math 112.

REQUIRED READINGS:

Textbook: Pindyck, Robert and Rubinfeld, Daniel, Microeconomics, 8th ed., Prentice Hall Publishing, 2013

Outside readings: Occasionally you will be asked to read articles reserved in the main library of the college
and/or online sources.

LECTURE OUTLINE:

PART I

AN INITIAL LOOK AT SCARCITY AND ITS SOCIO-ECONOMIC IMPLICATIONS

1. Introduction: Scarcity and Its Implications

a) What is economics all about!

b) The three implications of scarcity: Choice, opportunity cost, and efficiency
c) The production possibility frontier: A model to illustrate the implications of scarcity
d) The three basic questions in resource allocation: what, how, for whom
e) The division of labor, efficiency in production, and ‘the store house metaphor’
f) Allocation 1: ‘From each according to his ability to each according to his need’
g) Allocation 2: A decentralized market is a ‘good’ way to organize economic activities
h) The fourth implication of scarcity –the need for institutional mechanisms (such as the
market) to ration scarce resources among competing uses

2. Resource allocation under an ‘ideal’ market setting

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 a) The circular flow diagram – elemental constituents of the microeconomics universe
b) Rudiments of demand and supply and market price formation
c) Basic assumptions of competitive markets: people, resources, and institutions
d) Definition and implications of price-takers
e) An initial look at how competitive markets that is guided on promoting the self-interest of
economic actors can be an effective principle of social organization—the invisible hand
theorem
f) A cursory look at what happens to the market outcome(s) when any given assumption of the
perfect market model is violated: monopoly power, externality, asymmetric information,
rationality of economic agents, and high transaction costs.
g) An overview of some widely used and important features of modern microeconomic
theoretical concepts and general method of analysis: marginal analysis, the ceteris paribus
assumptions, and equilibrium analyses (static, partial, and general)

 Exam #1: Week 2 

PART II

THE THEORY OF CONSUMER CHOICE:

Output Demand and Input Supply

The Theory of Consumer Choice: A Schematic View

Consumer
Preference
 Demand for Final
Goods and Services
 Supply for Factors of
Utility Production
Maximization  Labor
 capital

Budget
Constraint

Part II, the theory of consumer choice, deals with every day decisions a rational and well-
informed consumer makes, such as on how much of her/his monthly income to spend for buying food or
other consumption goods and services; how much time to spend working or relaxing; and how much to
save. These decisions, as implied by the above diagram, are done after careful consideration of the
preference function, budget constraint and utility maximizing behavior of the individual consumer. As
implied by the entries in the last box of the above diagram, it is also out of this intellectual exercises that
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generalized theories of consumer demand for final goods and services and supply for a factor of
production, such as labor are derived.

1. The choice of the optimal consumption bundle

a) Basic assumptions about consumer behaviors

b) Consumer preference and budget functions
c) The equi-marginal condition for utility maximizing consumption choice
d) Applications

2. From the theory of consumer choice to the theory of consumer demand

a) Changes in price & its effect on individual consumer’s choice: Derivation of the individual
demand curve
b) The substitution and income effects
c) From the individual to market demand
d) Consumers’ surplus and its applications

3. From the theory of choice to the theory of supply for labor

a) The income-leisure preference function

b) Wage as the opportunity cost for leisure
c) The equi-marginal condition for utility maximizing choice of time spent for work versus
leisure
d) Derivation of the supply for labor
e) Factors affecting the supply for labor

4. From the theory of choice to the theory on consumers decision to save or borrow money (the
demand and supply for loanable funds)

a) The notion of intertemporal time preference

b) Positive time preference and discount rate
c) The equi-marginal condition for utility maximizing choice between borrowing and saving
d) A cursory look at the demand and supply for loanable funds and the determination of market
interest rate

 EXAM #2: Week 5 

PART III:
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 THE THEORY OF THE FIRM:
Output Supply and Input Demand

The Theory of the Firm

Budget
Constraints
 Supply for Final
Goods and Services
 Demand for factors of
Production
Profit  Labor
Maximization  Capital

Production
Technologies

Part III, the theory of the firm, deals with how a business entity with a singular objective to
maximize profit makes decisions, such as on how many units of output to produce and workers or some
other factor of productions to use in its daily business dealings. This is done, as indicated in the diagram
above after careful considerations of the firm’s technological options (which determines the structure of the
cost of production), budget constraint and profit maximizing behavior. This basic theory of the firm is the
cornerstone for the neoclassical theories of supply for final goods and services and the demand for factors of
production (see the last box in the above diagram).

1. The nature and scope of the technological option of the firm

a) The firm and its objectives

b) The technology of production: The production function
c) The notion of short-run and long-run
d) The law of diminishing marginal product and its significance
e) The concept of an isoquant and factor substitution
f) Diminishing marginal rate of technical substitution
g) Returns to scale
h) Technical progress versus input substitution
i) The Cobb-Douglas type production functions and their properties
j) Applications

2. The optimal input mix and long-run cost of a competitive firm

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 a) The firm’s budget constraint—the isocost line
b) The equi-marginal condition for cost minimization-the optimal input mix
c) The expansion path
d) Derivation of the long-run cost function of the firm
e) General future of long-run cost functions
f) Economies and diseconomies of scale

3. Theory of the short-run costs

a) The link between short-run and long-run cost functions

b) The various concepts of cost
c) The conventional short-run cost functions and their properties

4. From production & cost functions to the output supply function of a competitive firm & industry:

a) A competitive firm and its revenue functions

b) The equi-marginal condition for profit maximization
c) Derivation of the short-run supply curve of a competitive firm
d) The market supply function
e) Key determinants of the short-run supply function
f) The notion of producer surplus

5. From production function & information on output & input prices to the derivation of the
demand for labor

a) The notions of derived demand and marginal revenue product of labor

b) The equi-marginal condition for optimal employment (use) of labor
c) The demand for labor: a single variable input case
d) Two variable inputs case
e) The key determinants of the demand for labor
f) The notion of rent

6. The long-run adjustment process of competitive industry

a) The long-run equilibrium condition of a competitive firm an industry

b) The notion of a normal profit

 EXAM 3: Week 8 

PART IV

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 PRICING AND OUTPUT DECISION UNDER IMPERFECTLY COMPETITIVE
MARKET STRUCTURES

Parts II and III together thoroughly and systematically examined the neoclassical theories of demand
and supply (for both the product and factor markets). This investigation was done assuming a perfectly
competitive market structure. Part IV, which in some respect is an extension of Parts II and III, deals with
two pertinent issues. It starts with a comprehensive evaluation of the performance (i.e., economic
efficiency) of a competitive market system in the long-run—the so-called Adam Smith’s Invisible Hand
Theorem. In this case, economic efficiency entails the maximization of aggregate consumer and producer
surplus. The second issue deals with the effects of market imperfections on the pricing, production and
employment decisions of a firm and what these outcomes might suggest to the efficiency by which resources
allocated for society at large. Furthermore, time permitting, the discussion in Part IV, will include an
overview of a very important microeconomics topic; namely, asymmetric information – market situations
where some parties know more than others.

1. Evaluating the performance competitive markets: The best of all worlds!

a) A revisit of the long-run equilibrium condition of a competitive industry

b) The equivalence of achieving maximum net social surplus and the long-run equilibrium
condition of a competitive markets: the invisible hand theorem
c) Possible scenarios where markets may fail to achieve maximum net social surplus

2. Pricing and output decision under pure monopoly

a) Equi-marginal condition for profit maximizing output and price

b) Measure of monopoly power: The Lerner formula
c) Monopoly power and elasticity of demand
d) The welfare loss of monopoly
e) The practice of price discrimination
f) Regulating monopoly practices through tax on profit, tax on output, or price control
g) Natural monopoly and its regulations

3. Pricing and output decision under monopolistic competition

a) Equi-marginal condition for profit maximizing output and price

b) The excess capacity hypothesis
c) The prevalence of non-price competition
d) The Economics of advertisement

4. Pricing and output decision under oligopolistic market structure

a) Mutual interdependencies and strategic decision making

b) The Nash equilibrium
c) The von Stackelberg duopoly model
d) The Cournot duopoly model
e) Concluding remarks

5. Markets with Asymmetric Information

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 a) Quality Uncertainty – when a seller of a product knows more about its quality than the buyer
does and the vice versa
b) Market signaling
c) Moral hazard
d) The principal-Agent problem

READING ASSIGNMENTS

Textbook: Pindyck, Robert and Rubinfeld, Daniel, Microeconomics, 8th ed., Prentice Hall Publishing, 2013

PART I: BASIC MICROECONOMICS THEORIES & APPLICATIONS

1. Preliminaries and basic demand and supply analysis, Chapters 1& 2: pp. 3 – 32.
2. Several lecture handouts from the instructor

PART II: THE THEORY OF CONSUMER CHOICE: Output Demand and Input Supply

1. Utility and choice, Chapter 3: pp. 67 – 96

2. Derivation of individual and market demand curves, Chapter 4: pp. 111-143.
3. The leisure-income preference function and the derivation of the supply for labor, Chapter 14: pp.
539- 541 and several lecture handouts provided by the instructor
4. Intertemporal time preference function and consumers’ decision to save or borrow and the role of
market interest in loanable fund markets (based on lecture handouts provided by the instructor)

PART III: THE THEORY OF THE FIRM: Output Supply and Input Demand

1. Production function, Chapter 6: pp. 201-226

2. The cost of production, Chapter 7: pp. 229 – 258 and pp. 265-269
3. Profit maximization and competitive short-run market supply curve, Chapter 8: pp. 279-306
4. The demand for a factor input (labor), Chapter 14: pp. 529-535
5. Equilibrium in a competitive factor market, Chapter 14: pp. 542-544

PART IV: PRICING AND OUTPUT DECISION UNDER IMPERFECTLY COMPETITIVE

MARKET STRUCTURES

1. The analysis of competitive markets, Chapter 9: pp. 317-328

2. Monopoly, Chapter 10: pp. 357-382; 389-392
3. Pricing with market power—price discrimination , Chapter 11: pp. 399-411; advertising & its
implications, pp. 429-432
4. Monopolistic competition, Chapter 12: pp. 452 – 456
5. Oligopolistic market structure and competition: game theory, Chapters 12 & 13: pp.457- 473;
487-496
6. * Markets with asymmetric information, Chapter 17: pp. 631-657

GRADING:

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 Exam 1 10%
Exam 2 30%
Exam 3 30%
Final Exam 20%
Homework Assignments 10%

IMPORTANT NOTES:

 Any student with a disability who needs an accommodation or other assistance in this course should
make an appointment to speak with me as soon as possible.

 Exams must be taken at the times designed except in the case of illness with a physician's excuse.
No late assignment will be accepted. Violation of an academic regulation could have a very
serious consequence ranging from a reduction of grade on a specific project to failure in a course.
In this class, in no time and under no circumstance is academic dishonesty tolerated.