Econ 281
Intermediate Microeconomics
•Consumer Behavior
•Theory of Production and Cost
•Various Market Structures
Lorne Priemaza, M.A.
Lorne.priemaza@ualberta.ca
Various material courtesy of Katharine Rockette and
Wiley & Sons INC.
Chapter 1
What is economics?
Microeconomics and
Macroeconomics
Economic Tools
Positive and Normative Analysis
What Is Economics?
• Economics is the science that deals with
the allocation of limited resources to
satisfy unlimited wants.
Limited Resources
Choices
Unlimited Wants
Outcome
Microeconomics and Macroeconomics
• Microeconomics
-from the Greek mikros meaning small
-studies economic behavior of individual
decision makers (people, firms, etc.)
-What price should Apple charge for
Ipods?
-How much House should Kim watch?
-How does owning an Ipod and watching
House affect Jon’s utility?
Microeconomics and Macroeconomics
• Macroeconomics
-from the Greek makros meaning large
-studies aggregate economic behavior
(nation, world, business cycles, etc.)
-What should the tax on MP3 players be?
-How do tv shows such as House affect
productivity and unemployment?
-How does MP3 and tv demand fluctuate?
Economics and Models
• “Economists work with models.”
-Life is too complicated for an economist
to analyze all at once
-In order to analyze one aspect of life,
economists build a simplified model to
represent that aspect of life
-The results of the model are then tested
against real life
-Models require assumptions
Economics and Assumptions
• “Assume there’s a can opener!”
-Every economic model relies on
assumptions (much like a house relies
on foundations)
-ie: Assume people are rational; assume
firm A understands people’s tastes
-If the assumptions are invalid, the model
suffers
-ie: Assume all students read the text
Exogenous and Endogenous Variables
• Exogenous Variables
-values that are taken as given
-values that are decided outside the
model
Ie: GIVEN that Joe’s costs are $10 per
shoe (exogenous variable), how much
should he sell shoes for?
Exogenous and Endogenous Variables
• Endogenous Variables
-values that are determined within the
model
Ie: What price (endogenous variable)
should Joe charge for shoes and what
quantity demanded (endogenous
variable) will he face?
Exogenous and Endogenous Variables
• Relationship Model
John is trying to woo his sweetheart
Jenni.
-Jenni’s feelings towards John are
exogenous
-John’s attempts to woo Jenni are
endogenous
-Jenni’s reaction is endogenous
Mathematical Tools
-Economic agents react rationally or
irrationally given their available
information.
-Economists assume agents react
rationally to maximize their utility/profit
or minimize their work/cost using:
Constrained Optimization
Equilibrium Analysis
Comparative Statics
Mathematical Tools
• Constrained Optimization
“If I had one thing I would be happy –
everything.”
-Generally, people cannot be satisfied
with everything, there are limits to
buying power/production, etc.
-Constrained Optimization maximizes
utility, cost, etc. given a constraint
(money, production function, etc)
Constrained Optimization Example
Dr. House enjoys two things: riding his
motorcycle and saving lives.
Unfortunately, he cannot do both at the
same time. Therefore Greg’s model is:
Max U(Riding,Lives) ->Objective Function
Subject to the constraint (s.t.)
Hour Per Day = 8 = Riding + Lives
House Optimization Example
One may say House should spend his full 8 hours
on riding or saving lives; whichever he likes
more.
But House probably enjoys the first few hours of
riding his bike or saving lives more than the last
few hours.
We’re concerned with MARGINAL happiness.
(Happiness gained from the last hour’s activity)
House Example
Assume House gets the following
satisfaction from riding his bike or saving
lives:
4 Hours
2 Hours
8 Hours
6 Hours
Riding
4
7
9
10
Saving
Lives
3
6
7
8
What should House do to maximize his
happiness? (Remember that he’s planning
his day 2 hours at a time – marginally)
Example: House’s Happiness
R
Riding + Saving Lives = 8
8
4
House will pick the
mixture of riding
and saving lives
that maximizes his
happiness, subject
to the fact he only
has 8 hours.
U2(Riding, Saving lives)
U1(Riding, Saving Lives)
0
4
8
SL
Dealing with the marginal
Assume that you bought a lemon car – a 2002
Pontiac Sunfire that has caused you nothing
but problems. You paid $8,000 for it and have
spent $2000 in repairs over the last year.
Your kartoflemonometer just broke and will cost
$1000 to fix. After this last job you’ve basically
replaced the entire car. On the other hand,
you can buy a reliable 2002 Ford Escape for
$7000.
What do you do?
Dealing with the marginal
If you fix your Pontiac, it will have cost you
a total of $11,000 to buy a car that works,
whereas the Ford would have cost you a
total of $7000.
But right now you already have the Pontiac.
To get a car that works, you need an
ADDITIONAL $1,000 or an ADDITIONAL
$7,000. You will fix the Pontiac.
Rational people deal with marginal
decisions.
Mathematical Tools
• Equilibrium Analysis
-Equilibrium is a state that will continue
indefinitely as long as exogenous
factors don’t change
-If a variable is higher than equilibrium,
market forces will pull it down,
-If a variable is lower than equilibrium,
market forces will pull it up
Price
Example: The Market for Iphones
Surplus
P1
P*
•
P2
Shortage
Supply
If price is too high,
supply will exceed
demand and price
will fall.
If price is too low,
demand will exceed
supply and price
will rise
Demand
Q*
Quantity
Mathematical Tools
• Comparative Statistics
-In the real world, many exogenous
variables are moving at the same time;
affecting many endogenous variables
-Comparative Statistics aims to measure
the effect a change in one exogenous
variable on one endogenous variable.
Comparative Statistics Example
Originally, assume that the chicken market is in
equilibrium, with Qsupply = QDemand. Originally,
we have equilibrium price and quantity.
Assume that due to a cold winter in chickenland
chicken reproduction has increased. Analyze
the effect of colder weather on chicken prices
and chickens sold.
Example: Chicken
Price per pound
Old Supply
New Supply
POld
•
PNew
•
Demand (P,I)
QOld
QNew
Cold
weather has
caused a
decrease in
chicken
prices and
and increase
in chickens
sold.
Quantity, pounds
Positive and Normative Analysis
• In order to carry out effective policy, the
policy maker must understand how the
economy works
• The is called POSITIVE ECONOMICS;
The economics of facts & theory
-ie: Minimum wage increase causes
unemployment increase
Positive and Normative Analysis
• In order to conduct policy, the policy maker
must have some goals in mind
• NORMATIVE ECONOMICS is the
study of what the goals of the economy
should be
-ie: We should lower the minimum wage in
order to lower unemployment
Positive and Normative Analysis
• Positive economics is important to understand
the economy
• Normative economics is important to policy
makers
• Classify the following:
– “When the price of the Xbox 360
rises, more people buy the
Playstation 3.”
– “We should buy Lorne a Playstation
3 to increase his utility.”