Chapter One Overview

1.
1. Defining
DefiningMicroeconomics
Microeconomics

2.
2. Who
WhoShould
ShouldStudy
StudyMicroeconomics?
Microeconomics?

3.
3. Microeconomic
MicroeconomicModeling
Modeling
•• Elements
ElementsofofModels
Models
•• Solving
Solvingthe
theModels
Models

4.
4. The
TheTypes
Typesof
ofMicroeconomic
MicroeconomicAnalysis
Analysis

Chapter One
Economics

Economics is the science that deals with the

allocation of scarce resources to satisfy
unlimited human wants.

Resources are said to be scarce because their

supply is limited.

Chapter One
Microeconomics Defined

Microeconomics is the study of how

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

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. 3

Chapter One
Who Should Study Microeconomics?

 Policy Makers

 Managers

 Union Leaders

 Lenders

 Business Owners
4

Chapter One
Key Societal Questions

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?

Microeconomic analysis attempts to answer these questions by 5

studying the behaviour of individual economic units.

Chapter One
Microeconomic Modeling
Choice vs. Alternatives

Models are like maps – using visual methods, they

simplify the process and facilitate understanding of
complex concepts. Microeconomic models need to:

 Resemble Reality
 Be Understandable
 Have an Appropriate Scale
6

Chapter One
Exogenous & Endogenous Variables

Defined: Variables that have values taken as given in the analysis are
exogenous variables. Variables that have values determined as
a result of the model’s 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 isis the
the minimum
minimum level
level of
of expenditure
expenditure that
that the
the consumer
consumer must
must receive
receive in
in
7
order
order to
to reach
reach aa subsistence
subsistence level
level of
of satisfaction?”
satisfaction?”

Chapter One
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
The Constraints

Defined: Constraints are limits placed on the resources

available to the agent.

 Time
 Budget
 Other Resources
 Technical Capabilities
 The Marketplace
 Rules, Regulations, and Laws 9

Chapter One
Constrained Optimization

Behavior can be modeled as optimizing an objective

function, subject to various constraints.

10

Chapter One
Constrained Optimization

Consumer
Consumerpurchases
purchases
Food
Food(F),
(F),Clothing
Clothing((CC),), Income
Income(I)(I)
Price
Priceof
offood
food(p
(pf),f),price
priceof
ofclothing
clothing(p(pc)c)

Satisfaction
Satisfactionfrom
frompurchases:
purchases:SS(F,C)
(F,C)==(F
(F∙∙C)
1/2
C)1/2

Max
MaxS(F,C)
S(F,C)--subject
subjectto:
to:ppf f∙∙FF++ppcc∙∙CC<<II

11

Chapter One
Constrained Optimization
Example – Consumer Purchases
F

PFF + PCC = I

S2 > S 1 > S 0

(FC)1/2 = S2
(FC)1/2 = S1
(FC)1/2 = S0
0 C 12

Chapter One
Marginal Impact

Defined:
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.
13

Chapter One
Marginal Impact
Table 1.1   New Beer Sales from TV and Radio Advertising
New Beer Sales Generated (in
barrels per year)
Total Spent TV Radio
$        0 0 0
$  100,000 4,750 950
$  200,000 9,000 1,800
$  300,000 12,750 2,550
$  400,000 16,000 3,200
$  500,000 18,750 3,750
$  600,000 21,000 4,200
$  700,000 22,750 4,550
$  800,000 24,000 4,800
14
$  900,000 24,750 4,950
$1,000,000 25,000 5,000
Chapter One
Equilibrium
Example – Sale of Coffee Beans

P* •

Demand (P,I)

15

Q*
Chapter One
Equilibrium
Equilibrium is the point where demand just
Defined: equals supply in this market (i.e., the point
where the demand and supply curves cross).

Equilibrium
Equilibrium analysis
analysis isis 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
remainunchanged.
unchanged.
16

Chapter One
Comparative Statics Analysis

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.

17

Chapter One
Comparative Statics Analysis

18

Chapter One
Microeconomic Analysis
Some Types

Positive
Positive Analysis:
Analysis:
•• isis an
an analysis
analysis that
that attempts
attempts toto explain
explain how
how
an
an economic
economic system
system works
works oror to
to predict
predict
how
how itit will
will change
change over
over time
time

Normative
Normative Analysis:
Analysis:
•• isis an
an analysis
analysis of
of what
what should
should be
be done
done
19

Chapter One
Microeconomic Analysis
Some Examples

Example:
Example: “Should
“Should we
we increase
increase income
income equality
equality
rather
ratherthan
thanfocus
focuson
oneconomic
economicefficiency?”
efficiency?”

Example:
Example: “Should
“Should wewe 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
reduceaggregate
aggregatehours
hoursworked?”
worked?”
20

Chapter One