Optimization: Trying to Choose the

Best Feasible Option

Two Optimization Techniques/Approaches:
1. Total Value
Net Benefit = Total Benefit – Total Cost
2. Marginal Analysis (the change in the net benefit of one
option compared to another)
∆(Net Benefit) = ∆(Total Benefit) – ∆(Total Cost)

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Optimization Application: Renting the
Optimal Apartment
Optimization using total value
1. Translate all costs and benefits into common units, like
dollars (or liras) per month.
2. Calculate the total net benefit of each alternative.
3. Pick the alternative with the highest net benefit

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Optimization Using Marginal Analysis

Marginal Analysis:
1. Translate all costs and benefits into common units, like
dollars per month.
2. Calculate the marginal consequences of moving between
alternatives.
3. Choose the best alternative with the property that moving
to it makes you better off and moving away from it makes
you worse off.

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Optimization Using Marginal Analysis

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Optimization Using Marginal Analysis

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How Do Buyers Behave?
Quantity Demanded
The amount of a good that buyers are willing to purchase
at a given price.
Demand Schedule
A table that reports the quantity demanded at different
prices, holding all else equal.
Demand Curve
Plots the quantity demanded at different prices.

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How Do Sellers Behave?
Quantity Supplied
The amount of a good that sellers are willing to sell at a
given price.
Supply Schedule
A table that reports the quantity supplied at different prices.
Supply Curve
Plots the quantity supplied at different prices.

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How Do Buyers Behave?
Exhibit 4.2 Aggregation of Demand Schedules and Demand
Curves

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How Do Buyers Behave?
Exhibit 4.4 Shifts of the Demand Curve versus Movement
along the Demand Curve

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How Do Buyers Behave?
Exhibit 4.4 Shifts of the Demand Curve versus Movement
along the Demand Curve

Demand Shifts when one of

the following changes:
1. tastes and preferences
2. income and wealth
3. availability and prices of
related goods
4. number and scale of
buyers
5. buyers’ expectations about
the future
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How Do Sellers Behave?
Exhibit 4.7 Aggregation of Supply Schedules and Supply
Curves

@$10/barrel, neither Chevron nor Exxon is able to cover its AVC, i.e., $10 < AVC, so they
are not supplying any oil to the market! This is Chapter 6 material!!!

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How Do Sellers Behave?
Exhibit 4.7 Aggregation of Supply Schedules and Supply
Curves

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How Do Sellers Behave?
Exhibit 4.9 Shifts of the Supply Curve versus Movement
along the Supply Curve

Supply shifts when one of the

following changes:
1. input prices
2. technology
3. number and scale of sellers
4. sellers’ expectations about
the future

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How Do Sellers Behave?
Exhibit 4.9 Shifts of the Supply Curve versus Movement
along the Supply Curve
The only reason for a
movement along the supply
curve:
A change in the product’s own
price

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Supply and Demand in Equilibrium
Exhibit 4.10 Demand Curve and Supply Curve for Oil

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Supply and Demand in Equilibrium
Excess Demand
Occurs when consumers want more than suppliers provide
at a given price. This situation results in a shortage.
Excess Supply
Occurs when suppliers provide more than consumers want
at a given price. This situation results in a surplus.

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Supply and Demand in Equilibrium
Both the Demand Curve and Supply Curve Shift Right

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Supply and Demand in Equilibrium
The Demand Curve Shifts Right and the Supply Curve
Shifts Left

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Supply and Demand in Equilibrium
The Demand Curve Shifts Left and the Supply Curve
Shifts Right

P comes down for sure.

I cannot say the same for Q. Because, we have two opposing moves, so change
in Q is kind of obscure…

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Supply and Demand in Equilibrium
Both the Demand Curve and the Supply Curve Shift Left

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Consumer Theory
Consumer Equilibrium Condition:

If , buy more than

If , buy more than

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Consumer Theory

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Consumer Theory

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Consumer Theory

If socks cost $15 instead of $10…

As shorts are more beneficial than socks (on a per dollar basis), buy
one more jogging short and one fewer pair of socks

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Consumer Theory

As rice are more beneficial per dollar than beans, buy more rice and
less beans

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Demand Elasticities
Elasticity
A measure of how sensitive one variable is to changes in
another

Three measures of elasticity:

1. Price elasticity of demand
2. Cross-price elasticity of demand
3. Income elasticity of demand

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Demand Elasticities

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Demand Elasticities

𝑑 𝑑
𝑃 𝑦 ↑ ⇒ 𝑄 𝑦 ↓ , 𝑎𝑡 𝑡h𝑒 𝑠𝑎𝑚𝑒 𝑡𝑖𝑚𝑒 𝑖𝑓 𝑄 𝑥 ↑
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Demand Elasticities

Δ𝑄𝐷
𝐼 % Δ𝑄 𝐷 𝑄 𝐷 Δ𝑄 𝐷 𝐼
Incomeelasticity ofdemand ( 𝜀𝐷)= = = ∙
% Δ𝐼 Δ𝐼 Δ𝐼 𝑄𝐷
𝐼
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Demand Elasticities
If demand is inelastic, when price increases, quantity
decreases—a little:

The price increase pushes total revenue up, the quantity

decrease pushes total revenue down, but the price increase
is more than the quantity decrease, so the final result is that
total revenue increases.

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Demand Elasticities
If demand is elastic, when price increases, quantity
decreases—a little:

The price increase pushes total revenue up, the quantity

decrease pushes total revenue down, but the price increase
is less than the quantity decrease, so the final result is that
total revenue decreases.

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Demand Elasticities
How price elasticity of demand relates to total revenues
Price
Increasing Decreasing
Elasticity of Value
price price
Demand
Decreases Increases
Elastic
Revenue Revenue
Unitary
No change No change
Elastic
Increases Decreases
Inelastic
Revenue Revenue

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Demand Elasticities

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Demand Elasticities

% Δ 𝑄𝐷 % Δ 𝑄𝐷
Price elasticity of demand ( 𝜀 𝐷 )= ⇒ − 1.6= ⇒ % Δ 𝑄 𝐷= ( −1.6 ) ∙ 15 %=− 24 %
% Δ𝑃 15 %

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Demand Elasticities

% Δ 𝑄𝐷
Price elasticity of demand ( 𝜀 𝐷 )= =0 ⇒ % Δ 𝑄 𝐷 =0 %
% Δ𝑃

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Sellers in a Perfectly Competitive
Market
Conditions of a perfectly competitive market:
1. No buyer or seller in the market is big enough to
influence the market price.
2. Sellers in the market produce identical goods.
3. There is free entry and exit in the market.

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The Seller’s Problem
Goal of the Seller: Maximize Profit
To achieve this goal, sellers must solve 3 problems:
1. How to make the product
2. What is the cost of making the product?
3. How much can the seller get for the product in the
market?

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The Seller’s Problem
Exhibit 6.3 Costs of Production with Additional Cost
Concepts for the Wisconsin Cheeseman

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The Seller’s Problem

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The Seller’s Problem

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The Seller’s Problem
The goal of the seller is to maximize profits
Profit

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The Seller’s Problem
Exhibit 6.6 Movement of Production Toward Equilibrium

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The Seller’s Problem
With this marginal decision making in mind, it’s
straightforward to see how a firm maximizes its profits. It
should expand production until:

The profit-maximizing rule for perfect competition

How can we compute the level of profits?

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The Seller’s Problem
Exhibit 6.7 Visualizing the Wisconsin Cheeseman’s Profits
with MC, MR, and ATC

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The Seller’s Problem
How can we compute profits?
Step 1: determine optimal Quantity ()
Step 2: determine at the optimal Quantity
Step 3: compare and
When , we have economic profits
When , we have economic losses
When , we break even

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The Seller’s Problem
Exhibit 6.7 Visualizing the Wisconsin Cheeseman’s Profits
with MC, MR, and ATC

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From the Seller’s Problem to the
Supply Curve
Exhibit 6.8 Impact of Price Changes on the Wisconsin
Cheeseman

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From the Seller’s Problem to the
Supply Curve

But is that always the case?

Is it true for all prices?
In other words, is there a price so low, that the firm would not
supply the market?

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Supply Elasticity

% Δ Qs
Price elasticity of supply (ε s ) =
%ΔP

The price elasticity of supply will tend to be positive because

as price increases, firms tend to increase their quantity
supplied.

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Supply Elasticity

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Supply Elasticity

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