Microeconomics A

Anna Kukla-Gryz
E-mail: [email protected]
Requirements for passing the course
 Passing the course, two elements:
1st element: exam (70 % of the total
points)
2nd element: grade from tutorials (30 % of
the total points).
To pass the course you need:
 at least 50 % of the total points from the
exam AND
 at least 50 % of the total points from the
tutorials’ final class test and at least 50 %
of all the points from the tutorials.
 Exam
 The exam will be held on the exam period,
 The exam – multiple choice test (five answers
proposed to each question, only one is correct).
 The test must be passed with a positive result (at
least 50% of the total points).
 Exam Retake
 In the retake exam period there will be retake
exam organized, taking the same form as the
normal (first) exam.
 Other rules
 All tests are organized according to
the rules of "Zero tolerance for
cheating".

 There are no other possibilities

(neither new dates nor rules) for
passing the course.
 Grades

Points Grade
<0,50) 2
<50,60) 3
<60,70) 3,5
<70,80) 4
<80,90) 4,5
<90,100> 5
 Readings
 Varian H. R., Intermediate Microeconomics: A Modern
Approach 8th Edition, W. W. Norton & Co Ltd., New York,
London, 2006

 Bergstrom T. C., Varian, H. R., Workouts in Intermediate

Microeconomics, W. W. Norton & Co Ltd., New York,
London, 2006
 Extra Reading
 Besanko, D., Braeutigam, R. R., Microeconomics, John
Wiley&Sons, 2008
 Browning, E. K., Zupan, M. A., Microeconomics: Theory and
Applications, John Wiley&Sons, 2009
 Case, K. E., Fair, R. C., Principles of Microeconomics, Prentice
Hall, 2006
 Hubbard, G., O'Brien, A. P., Microeconomics, Prentice Hall,
2007
 Jehle, G. A., Reny, P. J., Advanced Microeconomic Theory,
Addison Wesley, 2000
 Mansfield E., Yohe G., Microeconomics: Theory and
Applications, W. W. Norton & Co, 2004
 McConnell, C. R., Brue, S. L., Microeconomics, Irwin/McGraw-
Hill, 2008
 Nicholson, W., Microeconomic Theory: Basic
Principles and Extensions, South-Western College
Pub, 2004
 O'Sullivan, A., Sheffrin, S., Perez, S.,
Microeconomics: Principles, Applications, and Tools,
Prentice Hall, 2006
 Perloff, J. M., Microeconomics: Theory and
Applications with Calculus, Addison-Wesley, 2007
 Pindyck, R. S., Rubinfeld, D. L., Microeconomics,
Pearson Education, Inc., New Jersey, 2005
 Mas-Colell A., Whinston M. D., Green J.,
Microeconomic Theory, Oxford University Press, New
York, Oxford 1995
 Mathematics
 Sydsaeter, K. P., Hammond, A., Essential
Mathematics for Economic Analysis, Prentice Hall,
2008
 Sydsaeter, K. P., Hammond, A., Seierstad, A.,
Strom., A., Further Mathematics for Economic
Analysis, Prentice Hall, 2008
 Introduction
 What are the key themes of
microeconomics?

 Why study microeconomics?

©2005 Pearson Education, Inc. Chapter 1 11

 Themes of Microeconomics
 Microeconomics deals with limits
– Limited budgets
– Limited time
– Limited ability to produce

 How do we allocate scarce resources?

©2005 Pearson Education, Inc. Chapter 1 12

 Themes of Microeconomics
 Workers, firms and consumers must
make trade-offs
– Do I work or go on vacation?
– Do I purchase a new car or save my
money?
– Do we hire more workers or buy new
machinery?
 How are these trade-offs best made?

©2005 Pearson Education, Inc. Chapter 1 13

 Themes of Microeconomics
 Prices
– How are prices determined?
 Centrally planned economies – governments
control prices
 Market economies – prices determined by
interaction of market participants
– Markets – collection of buyers and sellers whose
interaction determines the prices of goods

©2005 Pearson Education, Inc. Chapter 1 18

 Theories and Models
 Economics is concerned with explanation
of observed phenomena
– Theories are used to explain observed
phenomena in terms of a set of basic
rules and assumptions:
 The Theory of the Firm
 The Theory of Consumer Behavior

©2005 Pearson Education, Inc. Chapter 1 19

 Theories and Models
 Theories are used to make
predictions
– Economic models are created from
theories
– Models are mathematical
representations used to make
quantitative predictions

©2005 Pearson Education, Inc. Chapter 1 20

 Theories and Models
Theories are invariably imperfect –
but gives much insight into
observed phenomena

©2005 Pearson Education, Inc. Chapter 1 21

 Positive & Normative Analysis
 Positive Analysis – statements that describe
the relationship of cause and effect
– Questions that deal with explanation and
prediction
 What will be the impact of an import
quota on foreign cars?
 What will be the impact of an increase in
the gasoline excise tax?

©2005 Pearson Education, Inc. Chapter 1 22

 Positive & Normative Analysis
 Normative Analysis – analysis examining
questions of what ought to be
– Often supplemented by value judgments
 Should the government impose a
larger gasoline tax?
 Should the government decrease the
tariffs on imported cars?

©2005 Pearson Education, Inc. Chapter 1 23

 Opportunity Costs
 Suppose you want to spend a day at
the beach with your friends. The cost
of spending the day at the beach
with your friends is £30 (this
includes the cost of transportation,
the cost of food and drink and so
on).
 Opportunity Costs cont.
 Suppose that you really like spending
a day with your friends and that you
will be willing to pay £60 to do so. This
is the maximum amount you are
willing to pay for that activity and it
represents its benefit in monetary
terms. Given these two facts, should
you go to the beach with your friends?
 Opportunity Costs cont.
 At first sight the answer appears to
be yes. The benefit is larger than the
cost.

However, the cost of going to the beach is

not only £30. By deciding to go to the
beach you are losing the opportunity of
doing something else.
 Opportunity Costs cont.
 Suppose that the best alternative of
going to the beach is to work at the
campus shop at your university. A
day of work at the campus shop
gives you £70. This represents the
benefit, in monetary terms, of
working at the campus shop.
 Opportunity Costs cont.
 Suppose you like working at the
campus shop but only if they pay
you at least £30. This is the minimum
payment that will make you work at
the shop. If they pay you less than
£30, then you will be unwilling to
work there. What is the value of
working at the campus shop for you?
 Opportunity Costs cont.
 The answer is simply £70 minus £30;
that is, £40.
 If faced with the choice between
‘going to the beach with your friends’
and ‘working at the campus shop’,
you need to take into account that by
choosing one alternative you are
giving up the other.
 Opportunity Costs cont.
 Therefore the cost of spending the day
at the beach is not only the explicit
cost of £30; it also reflects the implicit
cost given by the best alternative you
are sacrificing. In this case, the value
of the best alternative is £40. This
represents the opportunity cost of
‘going to the beach with your friends’.
 Opportunity Costs cont.
 If we take into account this
opportunity cost, then the cost of
‘going to the beach with your friends’
is £30, which is the explicit cost, plus
£40, which is the opportunity cost,
meaning it is £70.
 Opportunity Costs cont.
 Given that the benefit of ‘going to the
beach with your friends’ is £60 and it
is lower than the cost (explicit cost
plus the opportunity cost), as a
rational individual you should
choose not to do it; instead you
should work at the campus shop.
 Opportunity Costs cont.
 While this example appears very simple,
the basic principle behind it is very
general. Every individual, firm,
government and, therefore, every
society, when making choices must
compare the benefits and costs of those
choices. Failing to take into account
opportunity costs in our decision
process will result in wrong choices.
 Budgetary and Other Constraints
on Choice

Source: Hal R. Varian
 Consumption Choice Sets
 A consumption choice set is the
collection of all consumption choices
available to the consumer.
 What constrains consumption
choice?
– Budgetary, time and other
resource limitations.
 Budget Constraints
 A consumption bundle containing x1 units
of commodity 1, x2 units of commodity 2
and so on up to xn units of commodity n
is denoted by the vector (x1, x2, … , xn).

Photo taken from Printerest.com

 Commodity prices are p1, p2, … , pn.

 Budget Constraints
 Q: When is a consumption bundle
(x1, … , xn) affordable at given prices
p1, … , pn?
 Budget Constraints
 Q: When is a bundle (x1, … , xn)
affordable at prices p1, … , pn?
 A: When
p1x1 + … + pnxn  m
where m is the consumer’s
(disposable) income.
 Budget Constraints
 The bundles that are only just
affordable form the consumer’s
budget constraint. This is the set

{ (x1,…,xn) | x1  0, …, xn  and

p1x1 + … + pnxn  m }.
 Budget Constraints
 The consumer’s budget set is the set
of all affordable bundles;
B(p1, … , pn, m) =
{ (x1, … , xn) | x1  0, … , xn 0 and
p 1 x1 + … + p n xn  m }
 The budget constraint is the upper
boundary of the budget set.
 Budget Set and Constraint for
x2 Two Commodities
Budget constraint is
m /p2
p1x1 + p2x2 = m.

m /p1 x1
 Budget Set and Constraint for
x2 Two Commodities
Budget constraint is
m /p2
p1x1 + p2x2 = m.

m /p1 x1
 Budget Set and Constraint for
x2 Two Commodities
Budget constraint is
m /p2
p1x1 + p2x2 = m.

Just affordable

m /p1 x1
 Budget Set and Constraint for
x2 Two Commodities
Budget constraint is
m /p2
p1x1 + p2x2 = m.
Not affordable
Just affordable

m /p1 x1
 Budget Set and Constraint for
x2 Two Commodities
Budget constraint is
m /p2
p1x1 + p2x2 = m.
Not affordable
Just affordable
Affordable

m /p1 x1
 Budget Set and Constraint for
x2 Two Commodities
Budget constraint is
m /p2
p1x1 + p2x2 = m.

the collection
of all affordable bundles.
Budget
Set
m /p1 x1
 Budget Set and Constraint for
x2 Two Commodities
p1x1 + p2x2 = m is
m /p2
x2 = -(p1/p2)x1 + m/p2
so slope is -p1/p2.

Budget
Set
m /p1 x1
 Budget Constraints
 If n = 3 what do the budget constraint
and the budget set look like?
 Budget Constraint for Three
Commodities
x2
m /p2 p1x1 + p2x2 + p3x3 = m

m /p3
x3

m /p1
x1
 Budget Set for Three
Commodities
x2 { (x1,x2,x3) | x1  0, x2  0, x3 0 and
m /p2 p1x1 + p2x2 + p3x3  m}

m /p3
x3

m /p1
x1
 Budget Constraints
 For n = 2 and x1 on the horizontal
axis, the constraint’s slope is -p1/p2.
What does it mean?
p1 m
x2   x1 
p2 p2
 Budget Constraints
 For n = 2 and x1 on the horizontal axis,
the constraint’s slope is -p1/p2. What
does it mean?
p1 m
x2   x1 
p2 p2
 Increasing x1 by 1 must reduce x2 by
p1/p2.
 Budget Constraints
x2
Slope is -p1/p2

-p1/p2
+1

x1
 Budget Constraints
x2
Opp. cost of an extra unit of
commodity 1 is p1/p2 units
foregone of commodity 2.
-p1/p2
+1

x1
 Budget Constraints
x2
Opp. cost of an extra unit of
commodity 1 is p1/p2 units
foregone of commodity 2. And
+1 the opp. cost of an extra
unit of commodity 2 is
-p2/p1 p2/p1 units foregone
of commodity 1.

x1
 Budget Sets & Constraints;
Income and Price Changes
 The budget constraint and budget
set depend upon prices and income.
What happens as prices or income
change?
 How do the budget set and budget
constraint change as income m
x2 increases?

Original
budget set
x1
Higher income gives more choice
x2 New affordable consumption
choices
Original and
new budget
constraints are
parallel (same
Original slope).
budget set
x1
 How do the budget set and budget
constraint change as income m
x2 decreases?

Original
budget set
x1
 How do the budget set and budget
constraint change as income m
x2 decreases?
Consumption
bundles
that are no longer
affordable.
Old and new
New, smaller constraints
budget set are parallel.
x1
 Budget Constraints - Income
Changes
 Increases in income m shift the
constraint outward in a parallel
manner, thereby enlarging the
budget set and improving choice.
 Budget Constraints - Income
Changes
 Increases in income m shift the
constraint outward in a parallel
manner, thereby enlarging the
budget set and improving choice.
 Decreases in income m shift the
constraint inward in a parallel
manner, thereby shrinking the
budget set and reducing choice.
 Budget Constraints - Income
Changes
 No original choice is lost and new
choices are added when income
increases, so higher income cannot
make a consumer worse off.
 An income decrease may (typically
will) make the consumer worse off.
 Budget Constraints - Price
Changes
 What happens if just one price
decreases?
 Suppose p1 decreases.
 How do the budget set and budget
constraint change as p1 decreases
x2 from p1’ to p1”?
m/p2

-p1’/p2

Original
budget set
m/p1’ m/p1” x1
 How do the budget set and budget
constraint change as p1 decreases
x2 from p1’ to p1”?
m/p2
New affordable choices

-p1’/p2

Original
budget set
m/p1’ m/p1” x1
 How do the budget set and budget
constraint change as p1 decreases
x2 from p1’ to p1”?
m/p2
New affordable choices
Budget constraint
-p1’/p2 pivots; slope flattens
from -p1’/p2 to
Original -p1”/p2
-p1”/p2
budget set
m/p1’ m/p1” x1
 Budget Constraints - Price
Changes
 Reducing the price of one
commodity pivots the constraint
outward. No old choice is lost and
new choices are added, so reducing
one price cannot make the consumer
worse off.
 Budget Constraints - Price
Changes
 Similarly, increasing one price pivots
the constraint inwards, reduces
choice and may (typically will) make
the consumer worse off.
 Sales Taxes
 An sales tax levied at a rate of 5%
increases prices by 5%, from p to
(1+005)p = 105p.

 An sales tax levied at a rate of t

increases prices by tp from p to
(1+t)p.
 Sales Taxes
 A sales tax levied at rate t on each
good changes the constraint from
p1x1 + p2x2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
 Sales Taxes
 A sales tax levied at rate t changes
the constraint from
p1x1 + p2x2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
i.e.
p1x1 + p2x2 = m/(1+t).
 Sales Taxes
x2
m p1x1 + p2x2 = m
p2

m x1
p1
 Sales Taxes
x2
m p1x1 + p2x2 = m
p2
m p1x1 + p2x2 = m/(1+t)
( 1  t ) p2

m m x1
( 1  t ) p1 p1
 Sales Taxes
x2
m
p2 Equivalent income loss
is
m m t
m  m
( 1  t ) p2 1 t 1 t

m m x1
( 1  t ) p1 p1
 Sales Taxes
x2 A sales tax levied at rate t
on all goods
m
is equivalent to an income
p2
tax levied at rate t
m .
1 t
( 1  t ) p2

m m x1
( 1  t ) p1 p1
 The Food Stamp Program
 Food stamps are coupons that can
be legally exchanged only for food.
 How does a commodity-specific gift
such as a food stamp alter a family’s
budget constraint?
 The Food Stamp Program
 Suppose m = $100, pF = $1 and the
price of “other goods” is pG = $1.
 The budget constraint is then
F + G =100.
 The Food Stamp Program
G
F + G = 100; before stamps.
100

100 F
 The Food Stamp Program
G
F + G = 100: before stamps.
100

100 F
 The Food Stamp Program
G
F + G = 100: before stamps.
100 Budget set after 40 food
stamps issued.

40 100 140 F
 The Food Stamp Program
G
F + G = 100: before stamps.
100 Budget set after 40 food
stamps issued.
The family’s budget
set is enlarged.

40 100 140 F
 The Food Stamp Program
 What if food stamps can be traded
on a black market for $0.50 each?
 The Food Stamp Program
G
F + G = 100: before stamps.
120
100 Budget constraint after 40
food stamps issued.
Budget constraint with
black market trading.

40 100 140 F
 The Food Stamp Program
G
F + G = 100: before stamps.
120
100 Budget constraint after 40
food stamps issued.
Black market trading
makes the budget
set larger again.

40 100 140 F
 Sample problem tests

etc. Problems taken from Varian Test Bank