EC107 ECONOMICS 1
1999-2000
DEPARTMENT OF ECONOMICS
UNIVERSITY OF WARWICK
Topic 1
 What is Economics about?
 Scarcity and Resource Allocation
 Economic Modelling
 Theory and Evidence
 Graphing Data
 Rationality
 Strategic behaviour
1
Questions
1.
What is Economics about?
Scarcity/Rationing
2.
Why do we focus on a market economy?
3.
How does the market economy function?
4.
What do we mean by supply and demand?
(see diagrams)
5.
What do we mean by shifts in supply and demand?
(see diagrams)
6.
What do we mean by a market?
(see diagrams)
7.
What do we mean by market equilibrium?
(see diagrams)
8.
What are the properties of market equilibria?
 Comparative static analysis (see diagrams)
 Stability
 Existence (see diagrams)
 Uniqueness (see diagrams)
 'Efficiency'
 Failure
 Regulation/intervention/competitive/industrial policies
(see diagrams)
9.
Notice the importance of the slopes of the S and D curves.
2
10. Economic modelling
 Observe
 Theorise
 Collect and analyse data
11. Theories, theoretical models
 Assumptions (eg profit-maximisation, rationality)
 Logical deductions (mathematical/graphical analysis)
12. Observation
 Data (eg, human capital theory: see diagram)
 Analysis
13. Why do economists disagree?
14. Rationality: non-strategic and strategic environments
(see 'Lecture Game' example, etc)
Now read up on the following:
(i)
What is opportunity cost
(ii)
How to distinguish
normative economics
between
positive
(iii) What ceteris paribus means
(iv) How to graph basic economic relationships
3
and
Diagrams for Topic 1
Figure 1
Demand
Price per
place
Demand
for places
Number
of
students
4
Figure 2
Demand shift
Price per
place
Dw(Pw¦ . . . . . R2. . )
Dw(Pw¦ . . . . . R1. . )
Number
of
students
5
Figure 3
Supply
Price per
place
Supply of places
Number
of
students
6
Figure 4
Price
per
place
Supply shift
Sw(Pw¦ . . . . . C1. . )
Sw(Pw¦ . . . . . C2. . )
Number
of
students
7
Figure 5 Supply and Demand
Price
per
place
Supply of places
P0
Demand for places
S0
D0
8
Number
of
students
Figure 6
Market equilibrium
Price
per
place
Supply of places
PE
Demand for places
Number
of
students
QE
9
Figure 7
Comparative static analysis of market equilibrium
Price
per
place
SS
PE
DD2
DD
Number
of
students
QE
What happens to the market equilibrium if the Demand curve shifts
outwards?
10
Figure 8
Stability
Price
per
place
Supply of places
Demand for places
Number
of
students
11
Figure 9
Existence?
Price
per
place
Supply of places
Demand for places
Number
of
students
12
Figure 10 Uniqueness?
Price
per
place
Supply of places
Demand for places
Number
of
students
13
Figure 11 Intervention
Price
per
place
Supply of places
Demand for places
Number
of
students
14
Figure 11b
Intervention
Price
per
place
Price Cap
Pm
ED
Number
of
students
The price cap (or ceiling) reduces supply and generates an excess
demand. Less of the good/service is traded than would be the case
in the market equilibrium without intervention.
Can you work out what would happen with a price floor?
15
Figure 12 The importance of the slopes of the supply and demand
curves
SS1
Price
per
place
SS2
PE
DD
Number
of
students
 Consider what happens when the Demand curve shifts to the
right.
16
Figure 12 The importance of the slopes of the supply and demand
curves: the demand curve shifts out.
SS1
Price
per
place
SS2
DD2
DD
Number
of
students
 Consider what happens when the Demand curve shifts to the
right.
 How does the impact on the equilibrium vary across the two
types of supply curve?
 Supplementary question for self-study:
What is the implication of this analysis for the impact
of price ceilings/floors? I.e., how does the impact of a
maximum fee for studying at Warwick University
affect the supply/demand/equilibrium outcomes, and
how does the impact depend upon the elasticities of
supply and demand?
17
Figure 13
Earnings
Schooling
18
Figure 13 Earnings function
Earnings
Schooling
19
Figure 13 Earnings function: men and women
Earnings
Men
Women
Schooling
20
Figure 14 The Lecture Game
A; LECTURER
ATTEND
ATTEND (10, 10)
SKIVE
(9, 5)
SKIVE
(5, 5)
B: STUDENT
(5, 9)
Figure 15 Prisoners Dilemma
A
Collude
Collude
(4, 4)
Silent
(1, 5)
Silent
(5, 1)
(2, 2)
B
21
EC107 ECONOMICS 1
1999-2000
DEPARTMENT OF ECONOMICS
UNIVERSITY OF WARWICK
Topic 2
 Market equilibrium
 Stability revisited
 Elasticity
 Tax
 Tax incidence
 Tax incidence and elasticity
22
Questions
1.
What is meant by stability of market equilibrium?
(See diagram)
2.
What is meant by the elasticity of demand?
(See notes on definitions)
3.
What is the impact of a tax?
(See diagram)
4.
What is meant by tax incidence?
(See diagram)
5.
How does tax incidence depend on the price elasticity
of demand?
(See diagram)
Now read up on the following:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Cross-price elasticities
Income elasticities
Luxuries and necessities
Normal and inferior goods
Substitutes and complements
Elastic, inelastic and unit-elastic demand
Elasticity of supply
By now, you should have read:
Begg, Fischer and Dornbusch, chs 1, 2, 3 and 5
and/or
Parkin, Powell and Matthews, ch. 1, 2, 3, 4, 5 and 6.
23
Diagrams for Topic 2
Figure 2.1 Market equilibrium
S
Price
D
Quantity
24
Figure 2.1 Market equilibrium and stability
Price
ED
Quantity
25
Figure 2.1 Market equilibrium and stability
Price
ED
Quantity
26
Figure 2.1 Market equilibrium and stability
6.
Price
ED
Quantity
27
What is meant by the elasticity of demand?
Meaning:
The elasticity of demand - with respect to changes in the own-price
of the good - is a measure of the sensitivity of demand to changes
in price.
Definition:
The own-price elasticity of demand for a good is defined as the
percentage change in quantity of the good demanded following a
given percentage change in price. (Hint: think about the effect of a
price change in a simple demand curve diagram.)
Technical definition:
P.E.D. = P D = (percentage change in quantity demanded)
/(percentage change in price)
or,
Q
Q
x100
Q
Q



P D P
P
x100
P
P
or,
 
P D
Q P
Q P
.

.
Q P P Q
28
Example:
Suppose the price of a good falls by 10%, then the own-price
elasticity of demand for that good is equal to:
 Zero, if demand does not change (i.e., if the percentage change
in demand is zero)
 Minus one (-1 or |1| or 'unit-elastic'), if the percentage change in
demand for the good is exactly 10 percent
 Elastic, if the demand for the good rises by more than 10
percent - eg: if the demand rises by 20 percent, then P D = -2
(or |2| ).
 Inelastic, if the demand for the good rises by less than 10
percent - eg: if the demand rises by 5 percent, then P D = -1/2
(or |1/2| ).
Can you identify the elastic and the inelastic sections of demand in the
diagram below? The axis measures the price elasticity of demand.

-1
29
zero
What is meant by the terms arc and point elasticities?
The arc elasticity is the elasticity of demand between two points on a
demand curve as the price changes from an initial price to a new price.
The point elasticity of demand is the elasticity of demand at a
particular price.
The arc elasticity is easily calculated using the formula above:
Q
Q
x100
Q
Q



P D P
P
x100
P
P
Q is easily calculated as Q1 - Q0. And similarly for price.
The point elasticity of demand is most easily calculated using
calculus: if you know the equation of the demand curve, then from the
formula written as:
 
P D
Q P
Q P
.

.
Q P P Q
you can use differentiation to calculate dQ / dP .
For the simple cases we shall consider, however, you do not
need calculus. For a simple straight line demand curve,
P / Q is just the slope of the demand line and is constant. If
you know the equation for the demand curve you can just
work out Q / P  1/(P / Q) and substitute into the formula
the values of P and Q at the point of interest. (Note: what
happens to P D as price falls down along the demand
curve?)
30
Figure 2.2
What is the impact of a tax?
ST
Price
S
Quantity
31
Figure 2.2 What is the impact of a tax?
ST
Price
S
D
Quantity
32
Figure 2.2 What is the impact of a tax?
ST
Price
S
PC
PE
PP
D
Quantity
QE
33
Figure 2.2 What is the impact of a tax?
ST
Price
S
PC
PE
PP
D
Quantity
QE
You should be able to show that the relative size of the areas shaded
and
depends upon the slope of the demand curve: i.e., on the own-price
elasticity of demand.
34
Can you show in a diagram that the burden on the consumer
( ( PC  P E )Q E ) falls relative to that on the producer ( ( P E  P P )Q E ),
the more elastic is the demand curve?
I.e., the incidence of the tax depends on the elasticity of
demand.
(As an example: what do you think will happen to wage rates
if income tax is raised? And how might this depend on the
elasticity of the demand for labour?)
35
EC107 ECONOMICS 1
1999-2000
DEPARTMENT OF ECONOMICS
UNIVERSITY OF WARWICK
Topic 3
 Preferences and Constraints
 Utility Maximisation
 Income and Substitution Effects
 Application to the Supply of Labour
 Market Demand Curves
Reading
 Begg, Fischer and Dornbusch, ch 6.
 Parkin, Powell and Matthews, ch. 7, 8.
 Hope, ch 1
36
 Preferences and Constraints
Preferences
Suppose your happiness just depends on two items:
Books and Food.
We assume that you have preferences over books and food and that
these preferences satisfy various axioms, such as:
 Non-satiation
Books
B1
F1
 Ordinal ranking
37
F2
Food
 Transitivity
If some basket or 'bundle' of goods, say , is preferred to
some other, say , and if  is preferred to a further bundle,
say , then it follows by transitivity that  is preferred to
. This is regarded as a necessary axiom for consumers to
be thought of as 'rational'. We write it as:
Similarly, transitivity pertains to indifference . . .
 Completeness
This means that any two bundles can be compared (no
matter how far apart or how close together):
Books
B1
F1
38
Food
Axioms like these enable us to represent individuals' preferences
diagrammatically with what are called 'indifference curves'. It
follows from the axioms about preferences that indifference curves
will have the following key properties:
 Slope downwards
 Every point in the diagram will lie on a (unique)
indifference curve
 Indifference curves cannot cross
Let us see why these properties obtain.
Books
B1
F1
Hence, indifference curves slope downwards.
39
Food
Books
I2
I1
Food
Hence, indifference curves cannot cross.
40
If we now add one further assumption about the nature of
preferences - the assumption of the diminishing marginal rate of
substitution - then we also know that indifference cures must have
a further property: they must be convex to the origin.
Books
Food
The marginal rate of substitution (MRS) tells us how many more
books we would need to make up for (ie to leave our level of
happiness/utility unaffected by ) the loss of one unit of food.
The MRS is diminishing if it is the case that the less food we have,
the greater the number of extra books we would need to
compensate for the loss of a given amount of food (the example of
diamonds and water is often used here).
41
Thus, we have the idea of indifference curves to represent
consumer 'utility'. Furthermore, we assume that the consumer will
try to obtain the highest level of utility possible:
Books
Food
The capacity of the consumer to raise their utility depends upon . . .
. . . . . their budget constraint.
42
The budget constraint
Total expenditure, E, must not exceed total money income, M. Or:
E  px X  p yY  M ,
where Y is the number of books bought and X is the amount of
food.
In the absence of savings, we can write this as:
M  px X  p yY
In the diagrams we have been drawing in (X,Y)-space, the
equation for the budget constraint can be represented as:
Y
43
M  px X  p yY
M
py
X
M
px
To see why the intercepts have the values they do, notice that the
budget equation can be re-written as:
Y  (M  px ) / p y
From this, you can work out the slope of the budget equation . . . ?
Hence, you can tell how the budget constraint moves when:





Money income increases
Price of food rises
Price of books falls
Price of food and books rises by the same percent
Money income and both prices all rise by 10%
44
Now we can bring together the analysis of indifference curves and
that of the budget constraint, and thereby see what will determine
the consumer's 'utility-maximising' equilibrium:
Y
Consumer
Equilibrium . . . why?
X
Notice that in the consumer equilibrium, the budget line is a
tangent to the indifference curve. I.e., the two slopes are equal:
thus, the MRS = price ratio.
With this model of consumer behaviour, we can work out how the
consumer might respond to changes in income and/or price.
Consider first changes in income:
45
Effects of changes in income on consumer equilibrium.
What happens to the
consumer's
optimising point
when income falls?
Y
X
Note that the fall in money income is represented by a parallel shift
inwards of the budget line.
 What happens to the level of demand for X and Y?
 Draw the new optimising point.
 Connect the original and new optima and hence derive the ICC.
 Distinguish between normal and inferior goods.
Also, think about the income elasticity of demand (and about
luxury and necessary goods).
46
Effects of changes in income on consumer equilibrium.
What happens to the
consumer's
optimising point
when price of X falls?
Y
X
Note that the fall in the rice of X is represented by an outward
rotation of the budget line: why?
 What happens to the level of demand for X and Y?
 Draw the new optimising point (must it be to the right of the
original?).
 Connect the original and new optima and hence derive the PCC.
 Distinguish between substitutes and complements.
47
We can now derive a demand curve from first principles. We do
this by plotting the PCC into a diagram with price and quantity
axes:
Y
PCC
M/Px1
M/Px2
X
PX
Now just show
prices on this
lower diagram
and hence plot
the demand
curve.
X2
X1
48
X
The demand curve we have just derived is called the
Constant Money Income Demand Curve (CMIDC).
 Why?
 Must it always have a negative slope?
Typically the CMIDC has a negative slope: as the price of a good
falls, ceteris paribus, the demand for it rises. This is because two
effects are going on when the price falls.
First, the lower price means it is now cheaper relative to the other
good than was previously the case.
This generates a substitution effect.
Second, with the lower price, the consumer is better off and so can
afford more of all goods (look at the diagram again).
This is called the income effect.
We can try to distinguish between the income and substitution
effects in a diagram:
49
Distinguishing between the income and substitution effects.
To see the substitution
effect of the price fall
on the demand for X,
shift B2 back in a
parallel way until it
just touches I1
Y
I1
B1
B2
X
Y
The income effect
of the price fall is
then the remainder
of the total effect.
To see this, just plot
the new optimum
on B2
I1
S
X1
B1
B2
X
X2
50
We know that if we plot from the PCC in (X, Y)-space into the
diagram in (PX, X)-space, we can derive the CMIDC. That is, the
CMIDC tells us the total effect of a price change on the demand
for X: made up of both the income and substitution effects. If
instead, we just consider the substitution effect and plot the
resulting demand curve, we obtain the CRIDC:
Constant real income demand curve.
This is the demand curve derived when we consider the effect of a
price change, but exclude the income effect. As it just traces out
the substitution effect, it moves us along the initial indifference
curve. Thus, utility is held constant. As utility is a measure of real
income, the resulting demand curve is called the CRIDC. (Notice
that money income is not held constant along the initial
indifference curve as we trace out the substitution effect. Rather, it
is as though we are giving the consumer a price fall with one hand,
but taking away money income with the other so as to keep their
level of utility constant.)
To see the CRIDC diagrammatically, just plot down from the
substitution effect in the previous diagram into the (PX, X)
diagram.
Then compare the CMIDC and the CRIDC.
 We said CMIDC could have a positive slope. Is this true of
CRIDC?
 Which of the two demand curves is the more elastic? Why?
What does this depend on?
 What is a Giffen good? How is it related to an inferior good?
51
Then market demand curves.
Then labour supply.
52
Demand Analysis: Consumer Theory
Preferences and Constraints
Utility Maximisation
Income and Substitution Effects
Application to the Supply of Labour
Market Demand Curves
Reading:
Begg, Fischer and Dornbusch, ch 6.
Parkin, Powell and Matthews, ch. 7, 8.
Hope, ch 1
Additional reading: Frank, ch 3, 4.
Stiglitz, ch 8, 9.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
What are the properties of indifference curves
What determines consumer choice
How choice responds to changes in price and income
How to derive demand curves
How to distinguish between the constant money and the constant
real income demand curves
How to derive household labour supply curves
53
1. Supply Analysis: Revenues and Costs
Average, Marginal and Total Costs and Revenues
Elasticity Revisited
Choice of Production Technique
Average, Total and Marginal Costs
Economies and Diseconomies of Scale
Short-run and Long-run Decisions
Profit-Maximisation
Reading:
Begg, Fischer and Dornbusch, Ch. 7 and 8
Parkin, Powell and Matthews, ch. 9, 10.
Hope, ch 7.
Additional reading: Frank, ch 9, 10.
Stiglitz, ch 11, 12.
Mankiw, 13.
Griffiths and Wall, ch 3, 4, 7.
Atkinson and Miller, ch 1, 2, 3.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
(iii)
(iv)
(v)
The relationship between demand and the firm’s revenue curves
How to derive cost curves from production functions
The relationship between short-run marginal cost and returns to
labour
The difference betwee long-run and short-run costs
The concept of profit maximisation
2. Market Structure and Firm Behaviour (i)
Pure Monopoly
Perfect Competition
Industry Supply Curves
Reading:
Begg, Fischer and Dornbusch, Ch. 9
Parkin, Powell and Matthews, ch. 11, 12.
Hope, chs 9 and 10
Additional reading: Frank, ch 11, 12.
Stiglitz, ch 14, 16.
Mankiw, 14, 15.
Atkinson and Miller, ch 9.
54
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
What defines monopoly and perfect competition
What determines the firm’s supply decisions
What is meant by ‘equilibrium of the firm’
What is meant by ‘equilibrium of the industry’
What is the importance of barriers to entry
What is meant by monopoly welfare loss
What is meant ‘welfare economics’ and by ‘efficiency’
3. Market Structure and Firm Behaviour (ii)
Imperfect Competition
Oligopoly and Interdependence
Entry Deterrence
Contestability
Game Theory and Strategic Behaviour
Reading:
Begg, Fischer and Dornbusch, Ch. 10
Parkin, Powell and Matthews, ch. 13.
Hope, ch. 11
Additional reading: Frank, ch 13.
Stiglitz, ch 15.
Mankiw, 16.
Griffiths and Wall, ch 5, 6, 7, 8.
Atkinson, Livesey and Milward, ch 5, 6.
Atkinson and Miller, ch 10.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
(iii)
What is meant by oligopoly
How firms and market equilibrium might behave under oligopoly
How game theory might help our understanding of oligopoly
4. The Firm's Factor Markets: (i) The Labour Market
Derived Demand for Labour
Marginal Productivity Analysis
Labour Supply Revisited
Wage Determination
55
Reading:
Begg, Fischer and Dornbusch, Ch. 11 and 12.
Parkin, Powell and Matthews, ch. 14, 15..
Hope, chs 13 and 14
Additional reading: Frank, ch 14.
Mankiw, 14.
Griffiths and Wall, ch 14, 15.
Atkinson, Livesey and Milward, ch 8.
Atkinson and Miller, ch 14, 15.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
(iii)
(iv)
(v)
What is meant by the value of the marginal product of labour
What determines the shape of the labour demand curve
What is meant by monopsony
How does labour demand elasticity depend on the nature of
competition in the product and labour markets
What are the possible effects of the UK government’s current
minimum wage policy?
5. The Firm's Factor Markets: (ii) The Capital Market
Demand and Supply of Capital Services
Investment
Rates of Return
Reading:
Begg, Fischer and Dornbusch, Ch. 13.
Parkin, Powell and Matthews, ch. 16.
Hope ch. 15
Additional reading: Frank, ch 15.
Atkinson and Miller, ch 18, 19.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
What is meant by discounting
What determines whether an investment is profitable
56
6. Issues in Welfare Economics
Efficiency
Pareto Optimality
Market Failure
The Role of Government
Reading:
Begg, Fischer and Dornbusch, Part 3.
Parkin, Powell and Matthews, ch. 18, 20.
Mankiw, ch. 10, 11.
Griffiths and Wall, ch. 10, 11 and 12.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
What is meant by Pareto Optimality
What are the causes, consequences ad policy implications of
externalities and public goods
7. Issues in International Trade
Comparative advantage
Gainers and losers
Inter-industry and intra-industry trade
Tariffs and protection
Reading:
Begg, Fischer and Dornbusch, Ch. 33
Parkin, Powell and Matthews, ch. 3.
Stiglitz, ch 3.
Mankiw, 3, 9.
Griffiths and Wall, ch 25, 26, 28.
Atkinson, Livesey and Milward, ch 24.
Atkinson and Miller, ch 24, 26.
Learning objectives - what you should know and understand after this part
of the lecture course:
(i)
(ii)
What is meant by comparative advantage
What is meant by ‘mutual gains from trade’
57
Readings: general advice
There is no single textbook which can be regarded as a substitute for the lectures.
Lectures are designed to introduce the student not only to important and interesting
economic problems, but also to the different analytical techniques employed by the
economist. Thus, some topics are analysed by verbal reasoning only whilst others are
examined by means of algebraic or other mathematical forms of reasoning. Diagrams,
figures and graphs are used extensively to elucidate problems.
So, whilst no textbook can be regarded as a substitute for the lectures, various books act
as useful complements. The most appropriate of these are the following:
Begg, D., Fischer, S. and Dornbusch, R., ECONOMICS, 5th Edition, McGraw-Hill.
(This book is set at about the same level as the lectures: although the latter may be a little
more demanding in a small number of areas and will cover some material not discussed
in Begg - where this occurs, the lecturer will be careful to direct you to the more
appropriate sources.)
Parkin, M., Powell, M. and Matthews, K., Economics, 3rd Edition, Addison-Wesley.
(This is an alternative to Begg which some students may find more accessible and less
narrowly theoretical.)
Frank, R., Microeconomics and behaviour, 3rd Edition, McGraw-Hill.
(This book gives probably the most similar treatment of the subject of micro-economics
to that given in lectures. Those who have not studied economics and who feel themselves
not very ‘technically-minded’ might prefer to complement this book with Begg et al., for
example.)
Stiglitz, J., Economics, 2nd Edition, Norton.
(This book is aimed at a similar audience to that of Frank, above, but attempts to take
them to a higher level quite quickly. The book is likely to appeal to those who want to
push their understanding of Economics a little beyond that formally required on the
course. A new edition is expected around now.)
Mankiw, N., Principles of microeconomics, Dryden.
(This does not reach the level required in the course, but may provide interesting and
helpful discussion for students who want a less technical treatment of particular areas.)
Hope, S., Applied Economcs, Wiley
(I think this is an excellent book, but it’s very advanced and bridges Economics 1 and
Economics II: only use it if you’re finding the lecture material pretty straightforward. It’ll
give you a head start for Economics II.)
Additionally, there are several books which are useful complements to the above
theoretical texts. These are listed below and focus on real-world applications of
economic theories:
58
Griffiths, A. and Wall, S., APPLIED ECONOMICS, 7th Edition, Longman.
Atkinson, B., Livesey, F. and Milward, R., Applied Economics, Macmillan.
Atkinson, B. and Miller, R., Business Economics, Addison-Wesley.
You should also make every effort to read various topical and relevant publications
which you can find in the Library: such as Economic Review, Economic Policy,
Economics and Business, Oxford Review of Economic Policy, the Economist and the
Financial Times.
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D. Tutorial Programme and Exercise Sheets
As was stated above, the exercise sheet problem sets cover far more material than can be
dealt with in the tutorials. Your tutor will indicate that subset of the material which you
will cover in each meeting and will ask you to prepare certain material in advance. The
questions which you do not cover in tutorials will be left for self-study. If you wish to
raise any questions with your tutor or with the lecturer, then office hours and email
correspondence is available to you.
In answering these exercise sheets, you should consult both your lecture notes and
reading from the various textbooks. As well as the recommended reading, you are
encouraged to search in the library for other readings in economics which you think
might be useful. You can always ask the advice of the lecturer or tutor on the suitability
of the literature you find.
Your tutor will not be expected to provide model answers: the main objective of the
exercise sheets is to get you thinking about the material you are studying, not just to give
you an encyclopedia of ‘correct answers’ to particular problems.
Preliminary exercise
Seminars begin in week 3. Before then, I would like you to attempt to answer the following
questions. Don't worry if you haven't got a clue - this is just a preliminary exercise! The worse
you do the better - as I will set you the same exercise later in the course and hope to show you
the improvement!
I do not expect your class tutor to give time to discussing this exercise in Term 1. Your first
tutorial meeting in week 3 will focus on Exercise 1.
Tick the answers you think are correct.
1.
2.
Economics is the study of:
(a)
(b)
(c)
how to produce the most goods for the most people
how society decides what, how and for whom to produce
how to avoid waste and inefficiency
(a)
(c)
If society's scarce resources are allocated efficiently, there will be some
environmental pollution
If society's scarce resources are allocated efficiently, there will be no
environmental pollution
Environmental pollution has nothing to do with efficient resource allocation.
(a)
By encouraging customers, lower food prices raise revenues of farmers
(b)
3.
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(b)
(c)
By discouraging customers, higher oil prices reduce revenues of oil
producers
Neither of the above
4.
(a)
(b)
(c)
Higher income tax rates are a disincentive to work
Higher income tax rates are an incentive to work
Income tax rates have only a small effect on the incentive to work
5.
Nationalised industries that are efficient:
(a)
might still make losses
(b)
should at least break even
(c)
should make money only on activities providing a wider social service
6.
The introduction of minimum wage legislation in the UK
(a)
would necessarily raise unemployment
(b)
could lead to greater employment
(c)
would have effects which depended on the minimum wage level
You might find it helpful to read through Begg, Fischer and Dornbush,
chapters 1 and 2. You should then try to answer the following questions:
(i)
What is meant by each of the following terms
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
k)
l)
m)
n)
o)
efficiency
opportunity cost
gross domestic product
efficiency
inflation
unemployment
gross domestic product
economic modelling
time-series data
cross-section data
index numbers
econometrics
a scatter diagram
a linear relationship
a non-linear relationship
(ii)
Distinguish between
a)
positive and normative economics
b)
nominal and real variables
c)
current and constant prices
(iii)
What is the intended purpose of economic models?
Why do economists make ‘assumptions’?
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Should an economic model describe reality exactly?
(iv)
What is the opportunity cost of going to see a football match?
What is the opportunity cost of having the afternoon off work in order to see a
football match?
What is the opportunity cost of failing to attend Economics 1 lectures in order to play
football (netball/hockey/whatever pastime of your choice)?
Exercise 1
(for the tutorial of week 3, Term 1)
(Hint: I suggest you focus your tutorial discussion on questions 1
and 3.)
1.
Define very concisely each of the following terms:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
2.
Which of the following would probably lead to a shift in the demand curve for
cinema tickets (and why and how)?
(a)
(b)
(c)
3.
Economic Scarcity
Demand Curve
A Shift in Demand
Supply Curve
Market Equilibrium
Existence of Equilibrium
Uniqueness of Equilibrium
Stability of Equilibrium
Ceteris Paribus Assumptions
A decrease in the price of admission.
An increase in real incomes.
A decrease in the price of video-cassette recorders.
Define and explain the usefulness of the concepts of the price elasticities of
demand and supply.
What do you think is meant by:
i)
The price elasticity of imports
ii)
The income elasticity of imports
iii)
The wage elasticity of labour demand
and why might these be important?
4.
In the market for second-hand portable compact-disc players the demand and
supply curves are represented by the following equations:
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XD
=
130 - 5p
XS
=
- 10 + 5p
where p is measured in £'s per unit and XD and XS in units per year.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
5.
Graph both the supply and demand curves.
Calculate the price elasticity of demand when the price falls from £16 to
£12.
Calculate the price elasticity of demand when the price falls from £15 to
£13.
Calculate the price elasticity of demand at the particular point on the
demand curve where price is equal to £14. What do your answers to (b),
(c) and (d) tell you?
Calculate the price elasticity of demand at the particular point on the
demand curve where price is equal to £12.
Calculate the price elasticity of demand at the particular point on the
demand curve where price is equal to £10. What do your answers to (d),
(e) and (f) tell you?
Indicate on your graph the ranges over which demand is inelastic and
elastic.
Repeat (b) to (g) for the elasticity of the supply curve.
What is the equilibrium price-quantity solution given these demand
curves?
Given the demand function
p = a - bX,
i)
ii)
iii)
Exercise 2
1.
draw the demand curve
find the value of X at which the price elasticity of demand is equal to
(minus) 1.
does the demand curve become more or less elastic as X increases?
Explain your answer.
(for the tutorial of week 5, Term 1)
(Hint: I suggest you give priority to questions 2, 3, 4 and 7.)
Explain fully what is meant by each of the following terms:
a)
b)
c)
d)
Non-satiation
Transitivity of preferences
Ordinal ranking
Indifference
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2.
State whether each of the following statements is true or false:
a)
b)
c)
d)
e)
f)
Indifference curves always slope downwards to the right if the
consumer prefers more to less.
Indifference curves never intersect if the consumer has consistent
preferences.
The slope of the budget line depends only upon the relative
prices of the two goods.
The budget constraint shows the maximum affordable quantity
of one good given the quantity of the other good that is being purchased.
An individual maximises utility where his/her budget line cuts
an indifference curve.
A change in money income alters the slope and position of the
budget line.
3.
Draw both a budget constraint and an indifference curve in X,Y-space to show a
utility-maximising outcome. From this diagram, derive the constant money
income demand curve for X.
4.
Now derive the Constant Real Income Demand Curve. Is this always negativelysloped? Explain your answer. What determines the relative slopes of the CMIDC
and the CRIDC?
5.
State whether each of the following statements is true or false:
a)
All Giffen goods are inferior goods
b)
All inferior goods are Giffen goods,
and explain your answers.
c)
The substitution effect of an increase in the price of a good
unambiguously reduces the quantity demanded of that good.
6.
Examine in detail the relationship between the shape of the indifference curves
and the shape of the CRIDC.
1.
Consider an individual's labour supply decision. Will an increase in income tax
reduce the amount of labour supplied?
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Exercise 3
1.
(for the tutorial of week 7, Term 1)
(Hint: I suggest you give priority to questions 3, 6 and 9.)
Given the demand function
p = a - bX,
i)
ii)
iii)
iv)
v)
vi)
vii)
draw the demand curve
draw the total revenue curve
find the value of X at which the price elasticity of demand is equal to
(minus) 1.
does the demand curve become more or less elastic as X increases?
(You've already considered this in a previous Exercise Sheet)
derive the marginal revenue curve and show the value of X at which
MR = 0. What is the reason for the relationship between your answer
and that for (iii) above?
explain the relationship between price and average revenue.
Total Revenue is maximised when Marginal Revenue is zero and price
elasticity of demand is -1. Explain why.
2.
Profit is measured by Total Revenue (TR) minus Total Cost (TC). When TR = TC
the firm is said to be making a 'normal' profit. Explain how 'normal' profit does not
necessarily mean zero profit.
3.
Profit is maximised when Marginal Revenue equals Marginal Cost. Explain why.
Discuss the general optimising rule of 'equating at the margin', giving further examples of
other applications of this concept.
4.
Why might it be argued that profit-maximisation, as a goal of firm behaviour,
depends on the assumption of ‘owner-control’? Discuss this argument. What alternative
objectives might firms have and how does this depend on the structures of ownership and
control? (Hint: see Griffths and Wall).
5.
Define the following terms:
(i)
(ii)
(iii)
(iv)
(v)
Inputs and output
A production function
Constant returns to labour
Decreasing returns to labour
Increasing returns to labour
Illustrate CRL, DRL and IRL in a diagram with output on the vertical axis and
labour on the horizontal axis.
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6.
Show in a diagram how to derive the marginal product of labour from the
production function. Show also how to derive the (short-run) Total Cost curve from the
production function. From this derive the (short-run) Marginal Cost curve. Examine the
relationship between the MPL and the SMC curves. Explain the relationship between the
two.
7. Define the following terms:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
8.
Short-run
Long-run
Marginal Cost
Average Cost
Fixed Cost
Short-run Average Variable Cost (SAVC)
Short-run Average Fixed Cost (SAFC)
Explain what is meant by:
(i)
(ii)
(iii)
(iv)
Economies of scale
Increasing returns to scale
Constant returns to scale
Marginal returns to labour
9.
Which of the following statements about the short-run marginal cost curve are
not true? (Discuss and consider each case thoroughly.)
(a)
(b)
(c)
(d)
(e)
(f)
10.
Marginal cost equals average cost when average cost is at a minimum.
When average cost is falling, marginal cost will be below average cost.
Marginal cost is greater than average cost when the number of units
produced is greater than the optimum technical output.
Marginal cost will be rising under conditions of diminishing marginal
returns to labour.
Marginal cost is unaffected by changes in factor prices.
Marginal cost depends in part upon fixed costs.
Explain what is meant by:
(a)
(b)
The marginal principle
The sunk cost fallacy.
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Exercise 4
(for the tutorial of week 9, Term 1)
(Hint: I suggest you give priority to questions 3 and 9.)
1.
Explain the relationship between:
(i)
LTC and STC?
(ii)
LAC and SAC?
2.
Show why:
(a) A firm will maximise profits when SMC = MR, so long as AR > SAVC
(b) A perfectly competitive firm's s-run supply curve is given by its SMC curve.
(All or just part of SMC?)
(c) A perfectly competitive firm's l-run supply curve is given by its LMC curve.
(All or just part of LMC?)
(d) In the long-run, fixed costs don't matter.
3.
In a diagram, derive the short-run supply curve (SRSS) for a perfectly competitive
industry. Assume all firms are equally efficient and show a situation in which, given the
industry demand curve and the SRSS you have derived, the typical firm is making a subnormal profit. What behaviour will this induce? What can you conclude about the shape
of the long-run supply curve (LRSS) in this perfectly competitive industry? What
influences the shape of the LRSS? Specify your assumptions.
4.
What defines an equilibrium for a perfectly competitive firm? What defines a
long-run equilibrium for a perfectly competitive industry?
5.
What would be the effects on a perfectly competitive market equilibrium of:
(i)
(ii)
An exogenous increase in market demand
An exogenous increase in costs of production
6.
Explain what is meant by monopoly welfare loss. Are there circumstance under
which monopoly is welfare-enhacing compared to competition?
7.
What is meant by monopolistic competition?
8.
Define the following terms:
(a) Prisoners' Dilemma
(b) Dominant Strategy
(c) Stable Equilibrium
9.
What determines the market structure of an industry?
10.
What is meant by the term Natural Monopoly? What are the policy implications
of natural monopoly?
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Exercise 5
(for the tutorial of week 1, Term 2)
1.
Explain why the profit-maximising level of labour demand occurs where
MFC = MVPL. How does labour demand depend upon the degree of competition in both
the labour and product markets?
2.
Which is the more elastic:
(i) Long-run or short-run labour demand?
(ii) Firm or Industry labour demand?
3.
What is meant by the marginal product of capital?
1. (By referring to ch 13 of BFD - including the Appendix to that chapter.) What is
meant by discounting? Define 'Present Value'. What is the present value of a stream
of income of £100 for three years? How are present value calculations useful in
making investment decisions? Define 'Net Present Value'.
There may be additional questions on the Topics of Welfare Economics and of
International Trade.
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E. Group Projects
You will find the title of this year’s project below. You should do some preliminary thinking and
reading around this topic prior to your first Group Project meeting in week 4. At that first
meeting, you should allocate particular tasks across the members of the group and set targets for
what you intend to achieve prior to your second meeting in week 6. You should make similar
plans for your subsequent meetings in weeks 8, 10 and 12. How you organise the group is up to
you. You should keep a record of the tasks you set to each person and also keep progress notes
on your work. The final report must not exceed 2000 words and must be submitted and presented
at a meeting with your Economics 1 tutor in week 4 of Term 2. At that time, you should also
submit a single sheet of paper describing the allocation of work and responsibilities among the
group. Additionally, you may wish to submit a sheet of paper summarising the thoughts of the
group on how, with the benefit of hindsight, you might have proceeded differently.
A basic reading list is distributed with the project titles. Note, however, that it is the
responsibility of the group to construct your own further readings and references. Further advice
on this is provided.
Title of the microeconomics project
Write a report on the arguments for and against the introduction of tuition fees for UK university
courses and on the likely effects of such a policy.
In your report, you might consider the following issues (note though that this advice is not
prescriptive: you might write a good report without focussing on these issues):
1.
Studying at university is like making an investment: it is costly, but there are returns
later.
2.
Whether or not there are returns depends on what and where you study.
3.
The tuition fee introduced in the UK is a flat rate fee: it doesn’t vary by subject and
institution. This might change in the future.
4.
Is the impact of fees likely to vary across different students?
5.
Can we address the issue of fees without taking account of how students are supported
through university? I.e., should we address the grants vs. loans vs. graduate tax debate?
6.
Should the state subsidise students?
Reading:
1.
The Dearing Report
2.
The Government White Paper introducing tuition fees.
3.
Your textbooks
4.
(Serious) newspapers and economics-related journal: including the Times Higher
Education Supplement. Especially those published at the time of Dearing and of the
passing of the Bill.
5.
Economics journals referred to elsewhere on your reading list.
6.
Your microeconomics course lecturer is conducting research into issues relevant for this
topic. You might consult his web-sites.
69
F. Essays
You will write two essays in the year. The first is on microeconomcis and should be
submitted to your tutor in week 5 of Term 2. The second essay, on macroeconomics, is
due in week 4 of Term 3. The essay titles for the second essay will be distributed at the
start of Term 2. The titles for the first essay are listed below.
Essay 1
Answer one of the following essay questions in no more than 2000 words. You should
hand in your essay to your tutor at your week 5 tutorial in Term 2.
1.
“Under perfect competition, the supply curve is given by the marginal cost
curve.”
Explain this statement. What can you say about the supply curve under
monopoly?
2.
What is meant by the term ‘tax incidence’? Show how the incidence of income
tax depends on ‘elasticities’. What insights do you learn from your analysis?
3.
“Oligopoly is necessarily an inefficient form of market structure.”
Examine this statement.
Guidance on writing essays for the Economics 1 module.
1.
2.
3.
Structure
Provide a brief but relevant introduction and an effective conclusion.
Give the argument you develop a logical and coherent structure
Analysis
Use the analytical skills you have been developing on this module – show that
you have a good grasp of the necessary techniques
A good essay will provide a synthesis of the relevant literatures – written in your
own words!1
Use diagrams! There are few essays in Economics which do not benefit from
graphical exposition. But diagrams on their own are not enough: make them clear
and describe them in words.
Evidence, examples and referencing
1
The University of Warwick takes a serious attitude to work which is plagiarised from other sources. You
will have received advice from your Department about this. Consult your tutor if in doubt.
70
Show you have read and thought around the subject. Provide examples and
applications.
Cite sources, use quotation marks when you use the words of others (but too
many quotations) and provide a bibliography. The style for referencing is as
follows.
Suppose you have written:
Ferguson (1999, p.24) provides evidence on the elasticity of labour supply.
Then, at the end of the essay you should include in your bibliography:
Ferguson, A.,1999, “The elasticity of labour supply in the aftermath of the
Bosman ruling,” Scottish Journal of Economics and Control, vol. 1, no. 1, pp. 111.
G. Assessment
Assessment on the Economics 1 module is made up entirely of a 3-hour summer
examination.
Your work on exercise sheets, personal essays and group projects is not assessed.
However, working effectively on those items will prepare you well for the summer
examination. Examination questions will reflect material covered in tutorials, essays and
group projects: not just lecture and reading material. You should also note that tutors are
required to produce reports on your attendance and performance. Evidence of this kind is
available to your personal tutor and to the end-of-year examinations boards.
71
H. Contacting the teaching staff and fellow students
You should consult Tina Jansen in the Department of Economics for information
concerning the office hours of the staff teaching Economics 1.
Robin Naylor’s office hour is Tuesday at 2pm. In the first instance, you should talk to
Robin at the end of a lecture. Robin always finishes lectures at 10 minutes to the hour and
is available for questions for those 10 minutes, at least.
If you have difficulty attending an office hour, you should email the member of staff you
are seeking. They will answer your query as soon as possible, and by the end of their next
office hour - at the very latest.
Robin Naylor’s email address is:
robin.naylor@warwick .ac.uk
In your first tutorial meeting, you should each make a note of the names of the other
students in your tutorial group and of how to contact them (e.g., find out where their
pigeonholes are – they may use a different set of pigeonholes from you). Find out if you
can each be contacted via email.
I. Web-sites
The course has an active web-site from where you can download a lot of useful
information. The site is fairly new and is involving on a daily basis: so you might want to
browse it from time to time: bookmark it! The web-site can be found at:
http://www.warwick.ac.uk/staff/Robin.Naylor/economics.1.html
J. Other information
If you are having any trouble with module Economics 1, please consult the lecturer, who
will be happy to try to help you. If you feel you need specific help, the chances are that
you are not alone and that there is some support offered. For example, not all students
have the same quantitative background. If you are doing a quantitative module either in
the Business School (WBS) or in the Department of Economics, then you will be
covering all the quantitative material you will need for Economics 1. If you are a student
in WBS and are not taking a quantitative module, and if you did little mathematics before
coming to Warwick, then you should note that supplementary classes are given by WBS
and you are strongly recommended to make use of this.
Robin Naylor, September 1999
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