Problems

Economic
Analyzing

1
CHAPTER 1

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

Chapter One Overview

1.
1. Defining
DefiningMicroeconomics
Microeconomics

2.
2. Who
WhoShould
ShouldStudy
StudyMicroeconomics?
Microeconomics?

3.
3. Microeconomic
MicroeconomicModeling
Modeling
•• Elements
ElementsofofModels
Models

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

•• Solving
Solvingthe
theModels
Models

4.
4. The
TheTypes
Typesof
ofMicroeconomic
MicroeconomicAnalysis
Analysis

Chapter One 2
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.

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

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 3
Who Should Study Microeconomics?

 Policy Makers

 Managers

 Union Leaders

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

 Lenders

 Business Owners

Chapter One 4
Key Societal Questions

Societies must answer these questions

that relate to microeconomics:

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

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

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

Chapter One 5
Microeconomic Modeling
Choice vs. Alternatives

Models are like maps – using visual methods, they

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

 Resemble Reality

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

 Be Understandable
 Be an Appropriate Scale

Chapter One 6
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

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

“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 ofof I?”
I?”
vs.
vs.
“What
“What isis the
the minimum
minimum level
level ofof 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 7
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 carecare

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more
more about
about raising
raising
profits
profits or
or increasing
increasing
“power”?
“power”?

Chapter One 8
The Constraints

Defined: Constraints are whatever limits is placed on

the resources available to the agent.

 Time
 Budget

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

Chapter One 9
 The Constraint Optimization
Behavior can be modeled as optimizing the objective
function, subject to various constraints.

Manager’s Investment Choice

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

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

Cost
CostPer
PerUnit
Unitof
ofTime
Time
•• Max
MaxNN •• Facilities
Facilitiesworkers
workerscost
cost$30
$30
•• (F,R)
(F,R) •• R&D
R&Dworkers
workerscost
cost$100
$100
•• Subject
Subjectto:
to:expenditure
expenditure<<$100
$100
•• Where:
Where: NNisisthe
thenumber
numberofofworkers
workers

Chapter One 10
The Constraint Optimization

Consumer
Consumerpurchases
purchases
Food
Food(F),
(F),Clothing
Clothing((CC),), Income
Income(I)
(I)
Price
Priceofoffood
food(pf),
(pf),price
priceofofclothing
clothing(pc)
(pc)

purchases:SS==(FC)
1/2
Satisfaction
Satisfactionfrom
frompurchases: (FC)1/2

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

Max
MaxS(F,C)
S(F,C)--subject to:ppf F
subjectto: + pc C < I
f F + pc C < I

Chapter One 11
The Constraint Optimization
Example – Consumer Purchases
F

PFF + PCC = I

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

C
0 Chapter One 12
The Constraint Optimization
Example – Consumer Purchases
F

PFF + PCC = I

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(FC)1/2 = S0
C
0 Chapter One 13
The Constraint Optimization
Example – Consumer Purchases
F

PFF + PCC = I

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

(FC)1/2 = S1
(FC)1/2 = S0
C
0 Chapter One 14
The Constraint Optimization
Example – Consumer Purchases
F

PFF + PCC = I

S2 > S 1 > S 0

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

(FC)1/2 = S2
(FC)1/2 = S1
(FC)1/2 = S0
C
0 Chapter One 15
Marginal Impact

Defined:
The Marginal Impact of a change
in the exogenous variable is the
incremental impact of the last unit

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of the exogenous variable on the
endogenous variable.

Chapter One 16
Equilibrium
Example – Sale of Coffee Beans

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

Chapter One 17
Equilibrium
Example – Sale of Coffee Beans

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Demand (P,I)

Chapter One 18
Equilibrium
Example – Sale of Coffee Beans

P* •

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

Demand (P,I)

Q*
Chapter One 19
Equilibrium

Defined: 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 isis an
an analysis
analysis of
of aa
system
system inin aa state
state that
that willwill continue
continue

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

indefinitely
indefinitely as
as long
long as
as thethe exogenous
exogenous
factors
factorsremain
remainunchanged.
unchanged.

Chapter One 20
Comparative Statics Analysis

Defined:
A Comparative Statics Analysis
compares the equilibrium state of a
system before a change in the

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

exogenous variables to the
equilibrium state after the change.

Chapter One 21
Comparative Statics Analysis

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

Chapter One 22
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

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

Normative
Normative Analysis:
Analysis:
•• IsIs an
an analysis
analysis of
of what
what should
should be
be done
done

Chapter One 23
Microeconomic Analysis
Some Examples

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

Example:
Example: “Should
“Should we we impose
impose aa
progressive
progressive income
income tax
tax or
or aa sales
sales tax
tax to
to

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

increase
increaseincome
incomeequality?”
equality?”

Example:
Example: “Will
“Will aa progressive
progressive income
income tax
tax
reduce
reduceaggregate
aggregatehourshoursworked?”
worked?”

Chapter One 24