You are on page 1of 24

1

Copyright (c)2014 John Wiley & Sons, Inc.

CHAPTER 1

Analyzing Economic
Problems

Chapter One Overview


1.
1.Defining
Defining Microeconomics
Microeconomics

3.
3.Microeconomic
Microeconomic Modeling
Modeling
Elements
Elements of
of Models
Models
Solving
Solving the
the Models
Models
4.
4.The
The Types
Types of
of Microeconomic
Microeconomic Analysis
Analysis

Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

2.
2.Who
Who Should
Should Study
Study Microeconomics?
Microeconomics?

Microeconomics Defined

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 markets.
Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Microeconomics is the study of how


individual economic decision-makers
such as consumers, workers, firms
or
managers
allocate
scarce
resources among alternate uses.

Who Should Study Microeconomics?

Policy Makers
Managers

Lenders
Business Owners

Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Union Leaders

Key Societal Questions


Societies must answer these
questions that relate to
microeconomics:

2. Who will produces these services and how will they produce them

Copyright (c)2014 John Wiley & Sons, Inc.

1. What goods and services will be produced and in what quantities

3. Who will receive these goods and services and how will they get them

Chapter One

Microeconomic Modeling
Choice vs. Alternatives

Resemble Reality
Be Understandable
Be an Appropriate
Scale
Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Models are like maps using visual


methods, they simply the process and
facilitate
understanding
of
complex
concepts. Microeconomic models need to:

Exogenous & Endogenous Variables


Variables that have values taken as given in the
analysis are exogenous variables. Variables that
have values determined as a result of the models
workings are endogenous variables.

How
How would
would aa manager
manager hire
hire the
the most
most possible
possible workers
workers on
on aa budget
budget of
of
$100?
$100?
vs.
vs.
How
How would
would aa manager
manager minimize
minimize the
the cost
cost of
of hiring
hiring three
three workers?
workers?
OR
OR
How
How much
much food
food and
and clothing
clothing should
should the
the consumer
consumer purchase
purchase in
in order
order
to
to maximize
maximize satisfaction
satisfaction on
on aa budget
budget of
of I?
I?
vs.
vs.
What
What is
is the
the minimum
minimum level
level of
of expenditure
expenditure that
that the
the consumer
consumer must
must
receive
receive in
in order
order to
to reach
reach aa subsistence
subsistence level
level of
of satisfaction?
satisfaction?
Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Examples:

Defined:

The Objective Function


Dependent on How the Objective Function is Specified

Defined:

The Objective Function specifies


what the agent cares about.

Does
Does manager
manager
care
care more
more about
about
raising
raising profits
profits or
or
increasing
increasing
power?
power?
Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Example:

The Constraints

Constraints are whatever limits is


placed on the resources available to
the agent.

Examples:
Time
Budget
Other Resources
Technical Capabilities
The Marketplace
Rules, Regulations, and Laws
Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Defined:

The Constraint Optimization


Behavior can be modeled as optimizing
the objective function, subject to various
constraints.

Example:

Facilities
Facilities((FF):): NN=
=budget
budget//
$30
$30
R&D
R&D((RR):): NN=
=budget
budget//$100
$100

Max
MaxNN
(F,R)
(F,R)
Subject
Subjectto:
to:expenditure
expenditure<
<$100
$100
Where:
Where: NNisisthe
thenumber
numberof
of
workers
workers
Chapter One

Cost
CostPer
PerUnit
Unitof
ofTime
Time

Copyright (c)2014 John Wiley & Sons, Inc.

Managers Investment Choice

Facilities
Facilitiesworkers
workerscost
cost$30
$30
R&D
R&Dworkers
workerscost
cost$100
$100

10

The Constraint Optimization


Example:
Consumer
Consumer purchases
purchases

Satisfaction
Satisfactionfrom
frompurchases:
purchases:SS
=
=(FC)1/2
(FC)1/2
Max
MaxS(F,C)
S(F,C)--subject
subjectto:
to:pfF
pfF+
+
pcC
pcC<
< II
Chapter One

11

Copyright (c)2014 John Wiley & Sons, Inc.

Food
Food(F),
(F),Clothing
Clothing((CC),),
Income
Income(I)
(I)
Price
Priceof
offood
food(pf),
(pf),price
priceof
of
clothing
clothing(pc)
(pc)

The Constraint Optimization


Example Consumer Purchases

Example:

C
Chapter One

12

Copyright (c)2014 John Wiley & Sons, Inc.

P FF + P C C = I

The Constraint Optimization


Example Consumer Purchases

Example:

(FC)1/2 = S0
0

Chapter One

C
13

Copyright (c)2014 John Wiley & Sons, Inc.

P FF + P C C = I

The Constraint Optimization


Example Consumer Purchases

Example:

(FC)1/2 = S1
(FC)1/2 = S0
0

C
Chapter One

14

Copyright (c)2014 John Wiley & Sons, Inc.

P FF + P C C = I

The Constraint Optimization


Example Consumer Purchases

Example:
P FF + P C C = I

(FC)1/2 = S2
(FC)1/2 = S1
(FC)1/2 = S0
0

C
Chapter One

15

Copyright (c)2014 John Wiley & Sons, Inc.

S2 > S1 > S0

Marginal Impact

The 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.
Chapter One

16

Copyright (c)2014 John Wiley & Sons, Inc.

Defined:

Equilibrium

Chapter One

17

Copyright (c)2014 John Wiley & Sons, Inc.

Example Sale of Coffee Beans

Equilibrium
Example Sale of Coffee Beans

Demand (P,I)

Chapter One

18

Copyright (c)2014 John Wiley & Sons, Inc.

Equilibrium
Example Sale of Coffee Beans

Demand (P,I)

Q*
Chapter One

19

Copyright (c)2014 John Wiley & Sons, Inc.

P*

Equilibrium
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).

Equilibrium
Equilibrium analysis
analysis is
is an
an
analysis
analysis of
of aa system
system in
in aa state
state
that
that will
will continue
continue indefinitely
indefinitely
as
as long
long as
as the
the exogenous
exogenous
factors
factors remain
remain unchanged.
unchanged.

Chapter One

20

Copyright (c)2014 John Wiley & Sons, Inc.

Defined:

Defined:

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.
Chapter One

21

Copyright (c)2014 John Wiley & Sons, Inc.

Comparative Statics Analysis

Comparative Statics Analysis

Chapter One

22

Copyright (c)2014 John Wiley & Sons, Inc.

Sale of
Pistachio Nuts

Microeconomic Analysis

Positive
Positive Analysis:
Analysis:
Is
Is an
an analysis
analysis that
that attempts
attempts to
to
explain
explain how
how an
an economic
economic system
system
works
works or
or to
to predict
predict how
how itit will
will
change
change over
over time
time
Normative
Normative Analysis:
Analysis:
Is
Is an
an analysis
analysis of
of what
what should
should be
be
done
done
Chapter One

23

Copyright (c)2014 John Wiley & Sons, Inc.

Some Types

Microeconomic Analysis
Some Examples

Example:
Example: Should
Should we
we impose
impose aa
progressive
progressive income
income tax
tax or
or aa
sales
sales tax
tax to
to increase
increase income
income
equality?
equality?
Example:
Example: Will
Will aa progressive
progressive
income
income tax
tax reduce
reduce aggregate
aggregate
hours
hours worked?
worked?
24
Chapter One

Copyright (c)2014 John Wiley & Sons, Inc.

Example:
Example: Should
Should we
we increase
increase
income
income equality
equality rather
rather than
than
focus
focus on
on economic
economic efficiency?
efficiency?