ba 210 introduction to microeconomics

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Deep ThoughtDeep Thought

BA 210 Lesson I.1 Introduction

I can picture in my mind I can picture in my mind a a world without war, a world world without war, a world without hate. And I can without hate. And I can picture us attacking that picture us attacking that world, because they’d never world, because they’d never expect it. --- by Jack Handeyexpect it. --- by Jack Handey..

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AcknowledgementsAcknowledgementsMuch of the course content is Much of the course content is adapted from the textbook adapted from the textbook MicroeconomicsMicroeconomics by Paul by Paul Krugman, Nobel Laureate (and Krugman, Nobel Laureate (and former teacher of Jon Burke), former teacher of Jon Burke), second edition, published by second edition, published by Worth Publishers Worth Publishers © 2009© 2009..

The PowerPoint slides for the The PowerPoint slides for the lessons are your primary text. lessons are your primary text. Read the Krugman text for Read the Krugman text for more details as you see fit.more details as you see fit.

Welcome to BA 210 Introduction to Welcome to BA 210 Introduction to MicroeconomicsMicroeconomics

BA 210 Lesson I.1 IntroductionBA 210 Lesson I.1 Introduction

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Getting acquaintedGetting acquainted

What is Microeconomics? What is Microeconomics?

Microeconomics is a list of assumptions and their consequences Microeconomics is a list of assumptions and their consequences that helps consumers make satisfying choices, helps managers that helps consumers make satisfying choices, helps managers make profitable decisions, and helps governments make effective make profitable decisions, and helps governments make effective public policies. Economists follow the path of pure logic, and public policies. Economists follow the path of pure logic, and leave passions and emotions for the people they try to help. leave passions and emotions for the people they try to help.

BA 210 Lesson I.1 IntroductionBA 210 Lesson I.1 Introduction


4BA 210 Lesson I.1 IntroductionBA 210 Lesson I.1 Introduction

Getting startedGetting started

Read and bookmark the online course syllabus.Read and bookmark the online course syllabus.http://faculty.pepperdine.edu/jburke2/ba210/index.htmIt serves as a contract specifying our obligations to each other. It serves as a contract specifying our obligations to each other. (You may need Internet Explorer.) In particular, note:(You may need Internet Explorer.) In particular, note:

• High School Algebra is a prerequisite, so review as needed.High School Algebra is a prerequisite, so review as needed.•Before each class meeting, download and read the Before each class meeting, download and read the PowerPoint lesson, as presented under the “Schedule” link.PowerPoint lesson, as presented under the “Schedule” link.•After each class meeting, answer any assigned homework After each class meeting, answer any assigned homework questions. And answer some of the review questions at the questions. And answer some of the review questions at the end of the PowerPoint lesson. If you get stuck on some end of the PowerPoint lesson. If you get stuck on some question, review as needed the PowerPoint lesson or the question, review as needed the PowerPoint lesson or the Krugman text or my answers.Krugman text or my answers.


http://faculty.pepperdine.edu/jburke2/ba210/index.htm

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Lesson OverviewLesson Overview


Chapter 1 First PrinciplesChapter 1 First PrinciplesYou may dislike Microeconomics, if …You may dislike Microeconomics, if …What is Theory?What is Theory?Microeconomic AssumptionsMicroeconomic AssumptionsTesting SelfishnessTesting SelfishnessRevealed PreferenceRevealed PreferenceControversy: Who is poor? Controversy: Who is poor? SummarySummaryReview QuestionsReview Questions

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You may dislike Microeconomics, if …You may dislike Microeconomics, if …


You may dislike Microeconomics, if …You may dislike Microeconomics, if …

You hold to You hold to economic dogmaeconomic dogma. Many lifelong Democrats and . Many lifelong Democrats and many lifelong Republicans hold established beliefs about public many lifelong Republicans hold established beliefs about public policies that are not to disputed, doubted, or diverged from.policies that are not to disputed, doubted, or diverged from.

You are a You are a political hack political hack personally identified with a political personally identified with a political party, and are driven more by success of the party than by party, and are driven more by success of the party than by personal conviction about the effectiveness of a particular public personal conviction about the effectiveness of a particular public policy.policy.

Your concern for public policy is driven more by Your concern for public policy is driven more by self interest self interest than by personal conviction.than by personal conviction.

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What is Theory?What is Theory?


Theory helps you understand facts. Economic theorizing is often Theory helps you understand facts. Economic theorizing is often attempted, but is not always logical. attempted, but is not always logical.

For instance, you might argue the government should reform For instance, you might argue the government should reform health care because of the fact that poor people get worse care health care because of the fact that poor people get worse care than rich people. That poor people get worse care is a fact; no than rich people. That poor people get worse care is a fact; no theory is needed. But when you conclude that health care should theory is needed. But when you conclude that health care should be reformed, you theorize. be reformed, you theorize.

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Common arguments for reforming health care implicitly assume Common arguments for reforming health care implicitly assume some type of equality among people is socially desirable. But some type of equality among people is socially desirable. But what should be equal? For example, it may seem reasonable to what should be equal? For example, it may seem reasonable to assume that equality of happiness among people is socially assume that equality of happiness among people is socially desirable. However, it does not seem reasonable that equality of desirable. However, it does not seem reasonable that equality of consumption is socially desirable, as if Barack should eat just as consumption is socially desirable, as if Barack should eat just as many bananas as Bill. So if we treat medical care like bananas, it many bananas as Bill. So if we treat medical care like bananas, it may not seem reasonable to assume that equality of medical care may not seem reasonable to assume that equality of medical care is socially desirable.is socially desirable.

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Put another way, suppose there were equal health care between Put another way, suppose there were equal health care between rich and poor. What would happen? rich and poor. What would happen?

How would you respond if Bill Gates offered a million dollars for How would you respond if Bill Gates offered a million dollars for some of your care? For example, would you sell him your place some of your care? For example, would you sell him your place in line for a blood test? to set a broken bone? for an artificial in line for a blood test? to set a broken bone? for an artificial heart?heart?

Is equal health care with the rich the best thing you can give the Is equal health care with the rich the best thing you can give the poor? What would the poor prefer? poor? What would the poor prefer?

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Microeconomic AssumptionsMicroeconomic Assumptions


Microeconomic Theory Microeconomic Theory is founded on three Assumptions. Those is founded on three Assumptions. Those assumptions are a checklist for when microeconomics can help assumptions are a checklist for when microeconomics can help consumers make satisfying choices, help managers make consumers make satisfying choices, help managers make profitable decisions, and help governments make effective public profitable decisions, and help governments make effective public policies. policies.

11BA 210 Lesson I.1 Introduction

To make precise assumptions, we must first speak the same language. In price theory, words like “commodity” and “utility” take more precise definitions than in common usage.



The Definition of Commodities and GoodsThe Definition of Commodities and Goods

The basic object in economic theory is a The basic object in economic theory is a commoditycommodity, defined to , defined to be anything that can be be anything that can be measuredmeasured and and tradedtraded between people. between people. Commodities can be physical Commodities can be physical goodsgoods, like apples or Cuban cigars; , like apples or Cuban cigars; or or servicesservices, like haircuts or medical care. Some commodities are , like haircuts or medical care. Some commodities are undesirable, like smog, but their opposites, like clean air, are undesirable, like smog, but their opposites, like clean air, are desirable. This class mostly considers desirable commodities, desirable. This class mostly considers desirable commodities, which we also call which we also call goodsgoods..

Name some commodities. Are kids commodities? Is time a Name some commodities. Are kids commodities? Is time a commodity? How do you measure time? trade time? commodity? How do you measure time? trade time?



I don't care too much for money, money can't buy me loveI don't care too much for money, money can't buy me love--- --- The BeatlesThe Beatles..

Assumption 1: Anything that affects happiness or satisfaction is Assumption 1: Anything that affects happiness or satisfaction is a commodity.a commodity.

Economics thus considers how people’s happiness is effected by Economics thus considers how people’s happiness is effected by cars, kids, and free time. But economics does not directly cars, kids, and free time. But economics does not directly consider whether kids are loved by their parents, since love is not consider whether kids are loved by their parents, since love is not a commodity. a commodity.



Don’t confuse Don’t confuse assumptions with presumptions. You “presume” assumptions with presumptions. You “presume” when you believe a proposition is a fact; you “assume” when you when you believe a proposition is a fact; you “assume” when you accept a proposition as a fact for a particular purpose. accept a proposition as a fact for a particular purpose.

Microeconomists assume anything that affects happiness is a Microeconomists assume anything that affects happiness is a commodity because the microeconomic way of logical thinking commodity because the microeconomic way of logical thinking does not yield helpful conclusions about non-commodities like does not yield helpful conclusions about non-commodities like love. love.

If you are love sick or sick of love, see a psychologist, not a If you are love sick or sick of love, see a psychologist, not a microeconomist.microeconomist.



The Definition of Consumption and ConsumerThe Definition of Consumption and Consumer

Consumption is when a commodity is used; a consumer does the Consumption is when a commodity is used; a consumer does the consumption. consumption.

A consumer can be an individual, or a household, or a family A consumer can be an individual, or a household, or a family dynasty (Kennedy’s), or an institution (Pepperdine University), dynasty (Kennedy’s), or an institution (Pepperdine University), or a country (United States), or all humankind. or a country (United States), or all humankind.

The default definition of a consumer is a The default definition of a consumer is a householdhousehold, which is a , which is a person or a group of people living in the same residence.person or a group of people living in the same residence.



The Definition of UtilityThe Definition of Utility

Through consumption, a consumer generates happiness and Through consumption, a consumer generates happiness and satisfies his needs, wants, and desires. The happiness or satisfies his needs, wants, and desires. The happiness or satisfaction generated is measured by the quantity of utility.satisfaction generated is measured by the quantity of utility.

The definition of utility separates microeconomics from The definition of utility separates microeconomics from psychology, which treats needs, wants, and desires differently. psychology, which treats needs, wants, and desires differently. Combining needs, wants, and desires simplifies microeconomics.Combining needs, wants, and desires simplifies microeconomics.

If your job meets your physical needs but leaves you feeling If your job meets your physical needs but leaves you feeling empty because you have not realized your own maximum empty because you have not realized your own maximum potential, see a psychologist, not a microeconomist.potential, see a psychologist, not a microeconomist.



The best things in life are freeThe best things in life are freeBut you can give them to the birds and beesBut you can give them to the birds and beesI want money I want money --- --- The Flying LizardsThe Flying Lizards..http://www.stlyrics.com/lyrics/empirerecords/moneythatswhatiwant.htm

Assumption 2: Individual households are perfectly selfish or Assumption 2: Individual households are perfectly selfish or self-interested, concerned only with the utility they get from their self-interested, concerned only with the utility they get from their own consumption of commodities.own consumption of commodities.

Parents can care about kids within their own household, but Parents can care about kids within their own household, but not about kids in other households.not about kids in other households. Is that the way households should be?Is that the way households should be? Is that the way most households are?Is that the way most households are?


http://www.stlyrics.com/lyrics/empirerecords/moneythatswhatiwant.htm


The assumption of perfect selfishness The assumption of perfect selfishness might, at first, seem harsh might, at first, seem harsh and extreme. — Would you care if your neighbor’s car were and extreme. — Would you care if your neighbor’s car were stolen? stolen?

But while selfishness rules out benevolence (like concern for the But while selfishness rules out benevolence (like concern for the poor), it also rules out malevolence. — Would you care if your poor), it also rules out malevolence. — Would you care if your neighbor just got a car that is twice as good as yours? neighbor just got a car that is twice as good as yours?

Thus, the assumption of perfect selfishness takes a middle Thus, the assumption of perfect selfishness takes a middle ground, with real people on either side. Perhaps, the ground, with real people on either side. Perhaps, the approximation errors from ignoring benevolence offset the approximation errors from ignoring benevolence offset the approximation errors from ignoring malevolence.approximation errors from ignoring malevolence.



““nosce te ipsum” (know yourself) nosce te ipsum” (know yourself) --- The Oracle from --- The Oracle from The MatrixThe Matrix

Assumption 3: People are rational. They are perfect calculators Assumption 3: People are rational. They are perfect calculators and flawless followers of those choices that are in their own best and flawless followers of those choices that are in their own best interests.interests.

Rationality is a debatable assumption: Rationality is a debatable assumption: Do you know what makes you happy?Do you know what makes you happy? Ever made a bad choice?Ever made a bad choice?Do you know exactly how much money you have in your Do you know exactly how much money you have in your pocket? Or how much you could get from your parents?pocket? Or how much you could get from your parents?


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Testing SelfishnessTesting Selfishness


To test the assumption of perfect selfishnessTo test the assumption of perfect selfishness, ask:, ask:do citizens vote in their self interest? do citizens vote in their self interest?

Which American political party favors the rich?Which American political party favors the rich? Are Republicans richer than Democrats?Are Republicans richer than Democrats?

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Testing SelfishnessTesting Selfishness


Extra Credit: Take a survey of the selfishness of at least 10 Extra Credit: Take a survey of the selfishness of at least 10 random people. Ask what percent of their salary that they random people. Ask what percent of their salary that they donated to charity this year or that they gave to someone outside donated to charity this year or that they gave to someone outside their household or family. Ignore answers like “I only gave 1 their household or family. Ignore answers like “I only gave 1 percent, but I would like to have given more” or “next year, I percent, but I would like to have given more” or “next year, I plan to give more”. It is important you measure the selfishness plan to give more”. It is important you measure the selfishness of an entire household or family. Parents giving to children does of an entire household or family. Parents giving to children does not count. It is also important you conduct a random survey. Do not count. It is also important you conduct a random survey. Do not, for example, go to church and pole missionaries or pole the not, for example, go to church and pole missionaries or pole the Amish. Amish.

Based on your survey, is the assumption of perfect selfishness Based on your survey, is the assumption of perfect selfishness realistic? If not 100 percent true, is the assumption of perfect realistic? If not 100 percent true, is the assumption of perfect selfishness at least 95 percent true?selfishness at least 95 percent true?

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Revealed PreferenceRevealed Preference


Are Americans happier than Italians? Are Americans happier today than 30 years ago? Of course, any answer is debatable: some may believe that Americans are inherently different from Italians and so cannot be compared. Microeconomics aims to make comparisons through the assumption that commodities are all that matter. Namely, to determine which country or which year is better, compare the consumption of commodities.

Even using microeconomics, however, such comparisons may be hard. For example, while Americans have bigger houses than Italians, they may consume less (quality) food. So we need to know whether extra housing is worth sacrificing food. Likewise, while houses are larger today than 30 years ago, there may be less leisure time. The theory of revealed preferences helps make such hard consumption comparisons. The key is to ask whether one consumption item or bundle of items (like 1500 square feet of housing and 3 hours of leisure) was available when the other consumption bundle (like 1400 square feet of housing and 4 hours of leisure) was chosen; if so, then the chosen bundle is preferred.

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Question: Are Americans happier than Italians? Question: Are Americans happier than Italians? Consider typical Consider typical monthly consumption:monthly consumption:

American Italian

Price of Housing $1 € 2Price of Food $2 € 1

Square Feet of Housing 1500 800Quantity/quality of food 100 200

Who is happier?

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Answer: Answer: Typical Americans consumers spend Typical Americans consumers spend 1 × 1500 + 2 × 100 = 1700 dollars1 × 1500 + 2 × 100 = 1700 dollarswith which they could afford Italian consumption, since it costs with which they could afford Italian consumption, since it costs only only 1 × 800 + 2 × 200 = 1200 dollars.1 × 800 + 2 × 200 = 1200 dollars.Conclusion: Americans are happier.Conclusion: Americans are happier.Note: Italians cannot afford American consumption. Typical Note: Italians cannot afford American consumption. Typical Italian consumers spend Italian consumers spend 2×800 + 1×200 = 1800 euros2×800 + 1×200 = 1800 euros, but , but American consumption would cost American consumption would cost 2×1500 + 1×100 = 3100 2×1500 + 1×100 = 3100 euroseuros

American Italian

Price of Housing $1 € 2Price of Food $2 € 1

Square Feet of Housing 1500 800Quantity/quality of food 100 200

Who is happier?

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Question: Are Americans happier today than 30 years ago? Question: Are Americans happier today than 30 years ago? Consider typical monthly consumption:Consider typical monthly consumption:

Today 30 Years Ago

Price of Housing $1 $2Price of Food $2 $1

Price of Clothing $30 $30Square Feet of Housing 1500 1400

Quantity/quality of food 100 150Quantity/quality of clothing 2 3

Who is happier?

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Answer: Answer: Today’s consumers spend Today’s consumers spend 1 × 1500 + 2 × 100 + 30 × 2 = 1760 dollars1 × 1500 + 2 × 100 + 30 × 2 = 1760 dollarswith which they cannot afford the consumption of 30 years ago, since it would with which they cannot afford the consumption of 30 years ago, since it would cost (at today’s prices)cost (at today’s prices)1 × 1400 + 2 × 150 + 30 × 3 = 1790 dollars1 × 1400 + 2 × 150 + 30 × 3 = 1790 dollars..30-years-ago consumers spend (at prices from 30 years ago) 30-years-ago consumers spend (at prices from 30 years ago) 2 × 1400 + 1 × 150 + 30 × 3 = 3040 dollars2 × 1400 + 1 × 150 + 30 × 3 = 3040 dollarswith which they cannot afford the consumption of today’s consumers, since it with which they cannot afford the consumption of today’s consumers, since it would cost (at prices from 30 years ago) would cost (at prices from 30 years ago) 2 × 1500 + 1 × 100 + 30 × 2 = 3160 dollars2 × 1500 + 1 × 100 + 30 × 2 = 3160 dollars..Revealed preference is inconclusive in this case.Revealed preference is inconclusive in this case.

Today 30 Years Ago

Price of Housing $1 $2Price of Food $2 $1

Price of Clothing $30 $30Square Feet of Housing 1500 1400

Quantity/quality of food 100 150Quantity/quality of clothing 2 3

Who is happier?

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Controversy: Who is Poor? Controversy: Who is Poor?



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Controversy: Who is Poor? Controversy: Who is Poor? The standard definition of “poor” in the U.S increases with the The standard definition of “poor” in the U.S increases with the size of a family.size of a family.

Persons in Family Threshold

1 $10,8302 $14,5703 $18,3104 $22,0505 $25,790

2009 U.S. Poverty Levels

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In particular, two adults are “poor” if theirIn particular, two adults are “poor” if theiryearly income is $14,570 or less. Make yearly income is $14,570 or less. Make sense? sense?


1 $10,8302 $14,5703 $18,3104 $22,0505 $25,790


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Question: Question: Compare two families. A small Compare two families. A small family of two adults with an income of family of two adults with an income of $15,000 per year; they are not considered $15,000 per year; they are not considered ““poor”. A big family of two adults and poor”. A big family of two adults and 3 small kids with an income of $16,220; 3 small kids with an income of $16,220; they are considered “poor”.they are considered “poor”.

Is the “poor” big family happier than the non-“poor” small Is the “poor” big family happier than the non-“poor” small family? family?


1 $10,8302 $14,5703 $18,3104 $22,0505 $25,790


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Answer: Answer: The “poor” big family is happier if you treat kids as a The “poor” big family is happier if you treat kids as a consumption commodity; the two adults in the “poor” big family consumption commodity; the two adults in the “poor” big family could have used birth control and, with their higher income, could have used birth control and, with their higher income, chosen the consumption of the non-“poor” small family but chosen the consumption of the non-“poor” small family but rejected it. rejected it.


1 $10,8302 $14,5703 $18,3104 $22,0505 $25,790


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Even if policymakers did not adjust for family size, measuring Even if policymakers did not adjust for family size, measuring poverty by income is still controversial because it does not poverty by income is still controversial because it does not account for the consumption of leisure, or free time. Many account for the consumption of leisure, or free time. Many people have low incomes because they are unemployed, meaning people have low incomes because they are unemployed, meaning they have more leisure. Some “poor” families can be happier they have more leisure. Some “poor” families can be happier than non-“poor” families if you treat leisure as a consumption than non-“poor” families if you treat leisure as a consumption commodity.commodity.

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Controversy: Who is Poor?Controversy: Who is Poor?


Question: Question: Compare two single-adult Compare two single-adult households. Adult A is unemployed with anhouseholds. Adult A is unemployed with anincome of $0 per year; he is considered income of $0 per year; he is considered ““poor”. Adult B works 8 hours every day atpoor”. Adult B works 8 hours every day at$10 per hour; his income is $29,200 per $10 per hour; his income is $29,200 per year; he is not considered “poor”.year; he is not considered “poor”.

Who is happier?Who is happier?


1 $10,8302 $14,5703 $18,3104 $22,0505 $25,790


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Answer: Answer: Revealed preference can determine who is happier if we Revealed preference can determine who is happier if we knew how much money the unemployed Adult A would earn if knew how much money the unemployed Adult A would earn if he chose to work, and we knew the prices each adult has to pay he chose to work, and we knew the prices each adult has to pay for consumption goods. for consumption goods.

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To keep the problem simple, suppose Adult A could make $12 To keep the problem simple, suppose Adult A could make $12 per hour. Consider the hypothetical case where the only two per hour. Consider the hypothetical case where the only two goods are leisure and housing. Measure the consumption of those goods are leisure and housing. Measure the consumption of those two goods two goods dailydaily. Suppose Adult A lives in Los Angeles and . Suppose Adult A lives in Los Angeles and faces a housing price of $0.11 per square foot, and Adult B lives faces a housing price of $0.11 per square foot, and Adult B lives in Chicago and faces a housing price of $0.10 per square foot. in Chicago and faces a housing price of $0.10 per square foot. Here is the price and consumption data of the two adults, where Here is the price and consumption data of the two adults, where the price of each hour of leisure is dollars lost from not working the price of each hour of leisure is dollars lost from not working that hour:that hour:

Adult A Adult B

Price of Housing $0.11 $0.10Price of Leisure $12 $10

Square Feet of Housing 0 800Hours of Leisure 24 16

Who is Poor? Who is happier?

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Adult A has 24 hours of Adult A has 24 hours of leisure since he does not work.leisure since he does not work.He has zero income, and soHe has zero income, and socannot afford any housing.cannot afford any housing.Adult B has 16 hours of Adult B has 16 hours of leisure since he works 8 hours per day. He has income $80, and leisure since he works 8 hours per day. He has income $80, and so can afford 800 square feet of housing.so can afford 800 square feet of housing.

Can Adult A afford the consumption of Adult B? Adult A spendsCan Adult A afford the consumption of Adult B? Adult A spends$0.11 $0.11 xx 0 + $12 0 + $12 xx 24 = $288 per day. 24 = $288 per day. And to consume like Adult B would cost Adult AAnd to consume like Adult B would cost Adult A$0.11 $0.11 xx 800 + $12 800 + $12 xx 16 = $280 per day. 16 = $280 per day. So, yes, Adult A can afford the consumption of Adult B. The So, yes, Adult A can afford the consumption of Adult B. The fact that Adult A rejects the consumption of B means Adult A is fact that Adult A rejects the consumption of B means Adult A is happier.happier.

Adult A Adult B

Price of Housing $0.11 $0.10Price of Leisure $12 $10

Square Feet of Housing 0 800Hours of Leisure 24 16

Who is Poor? Who is happier?

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SummarySummary1. The basic object in economic theory is a commodity, defined

to be anything that can be measured and traded between people.

2.2. Microeconomic Theory Microeconomic Theory is founded on three Assumptions. is founded on three Assumptions. Those assumptions are a checklist for when microeconomics Those assumptions are a checklist for when microeconomics can help consumers, managers, or policymakers.can help consumers, managers, or policymakers.

3.3. Assumption 1: Anything that affects happiness or Assumption 1: Anything that affects happiness or satisfaction is a commodity.satisfaction is a commodity.

4.4. The default definition of a consumer is a The default definition of a consumer is a householdhousehold, which is , which is a person or a group of people living in the same residence.a person or a group of people living in the same residence.


SummarySummary

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Summary (continued)Summary (continued)5.5. Through consumption, a consumer generates happiness and Through consumption, a consumer generates happiness and

satisfies his needs, wants, and desires. The happiness or satisfies his needs, wants, and desires. The happiness or satisfaction generated is measured by the quantity of utility.satisfaction generated is measured by the quantity of utility.

6.6. Assumption 2: Individual households are perfectly selfish or Assumption 2: Individual households are perfectly selfish or self-interested, concerned only with the utility they get from self-interested, concerned only with the utility they get from their own consumption of commodities.their own consumption of commodities.

7.7. Assumption 3: People are rational. They are perfect Assumption 3: People are rational. They are perfect calculators and flawless followers of those choices that are in calculators and flawless followers of those choices that are in their own best interests.their own best interests.

8.8. Revealed preferences asks whether one consumption item or Revealed preferences asks whether one consumption item or bundle of items was available when another consumption bundle of items was available when another consumption bundle was chosen; if so, then the chosen bundle is preferred. bundle was chosen; if so, then the chosen bundle is preferred.


SummarySummary

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Review QuestionsReview Questions


Review QuestionsReview Questions You should try to answer some of the following questions You should try to answer some of the following questions before the next class. before the next class. You will not turn in your answers, but students may request You will not turn in your answers, but students may request to discuss their answers to begin the next class. to discuss their answers to begin the next class. Your upcoming Exam 1 and cumulative Final Exam will Your upcoming Exam 1 and cumulative Final Exam will contain some similar questions, so you should eventually contain some similar questions, so you should eventually consider every review question before taking your exams.consider every review question before taking your exams.

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Each of the following 4 questions about revealed preference Each of the following 4 questions about revealed preference assumes there are only three goods that matter: computers, food assumes there are only three goods that matter: computers, food and movies. The first question is so simple that you do not need and movies. The first question is so simple that you do not need to use revealed-preference theory. And the final question is so to use revealed-preference theory. And the final question is so hard that revealed-preference theory gives no conclusions.hard that revealed-preference theory gives no conclusions.

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Question 1: Question 1: Consider the following price and consumption Consider the following price and consumption information for the typical Japanese consumer:information for the typical Japanese consumer:

1980 2010

Price of Computers ¥4 ¥8Price of Food ¥2 ¥4

Price of Movies ¥1 ¥2Consumption of Computers 1 1

Consumption of Food 2 2Consumption of Movies 3 3

Which year is preferred?

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Answer 1: Answer 1: Step 1: Compare Step 1: Compare consumptions. Here, the two consumptions. Here, the two year’s consumptions, (1, 2, 3) year’s consumptions, (1, 2, 3) and (1, 2, 3), are identical. and (1, 2, 3), are identical. [In vector notation, consumption[In vector notation, consumption(1, 2, 3) denotes consumption (1, 2, 3) denotes consumption of 1 computer, 2 units of food, and 3 movies.]of 1 computer, 2 units of food, and 3 movies.]

Hence, since microeconomics assumes that consumption alone Hence, since microeconomics assumes that consumption alone determines utility, that utility is the same in either year; that is, determines utility, that utility is the same in either year; that is, neitherneither year is preferred to the other. year is preferred to the other.

1980 2010

Price of Computers ¥4 ¥8Price of Food ¥2 ¥4

Price of Movies ¥1 ¥2Consumption of Computers 1 1



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Question 2: Question 2: Consider the following price and consumption Consider the following price and consumption information for the typical English consumer:information for the typical English consumer:

1980 2010

Price of Computers £4 £2Price of Food £2 £2

Price of Movies £1 £2Consumption of Computers 1 2



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Answer 2: Answer 2: Step 1: Compare Step 1: Compare consumptions. consumptions. Here, the two Here, the two year’s consumptions, (1, 2, 3) year’s consumptions, (1, 2, 3) and (2, 2, 2), are incomparable: and (2, 2, 2), are incomparable: the former has less of good 1; the former has less of good 1; the latter, less of good 3. Hence, the latter, less of good 3. Hence, continue the analysis.continue the analysis.Step 2: Ask whether 1980’s consumption, (1, 2, 3), was Step 2: Ask whether 1980’s consumption, (1, 2, 3), was affordable in 2010? affordable in 2010? Answer: In 2010 you had income Answer: In 2010 you had income determined by the budget equation,determined by the budget equation,y = py = p11xx11 + p + p22xx22 + p + p33xx33 = 2 × 2 + 2 × 2 + 2 × 2 = 12 = 2 × 2 + 2 × 2 + 2 × 2 = 12while the cost of 1980’s consumption would have beenwhile the cost of 1980’s consumption would have beenpp11xx11 + p + p22xx22 + p + p33xx33 = 2 × 1 + 2 × 2 + 2 × 3 = 12 = 2 × 1 + 2 × 2 + 2 × 3 = 12Thus you could have had 1965’s consumption in 1990. Hence: Thus you could have had 1965’s consumption in 1990. Hence: Stop the analysis. Conclusion: 2010 is preferred to 1980.Stop the analysis. Conclusion: 2010 is preferred to 1980.

1980 2010

Price of Computers £4 £2Price of Food £2 £2

Price of Movies £1 £2Consumption of Computers 1 2



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Question 3: Question 3: Consider the following price and consumption Consider the following price and consumption information for the typical Vietnamese consumer:information for the typical Vietnamese consumer:

1980 2010

Price of Computers 4 ₫ 8 ₫Price of Food 2 ₫ 4 ₫

Price of Movies 1 ₫ 2 ₫Consumption of Computers 1 2



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Answer 3: Answer 3: Step 1: Compare Step 1: Compare consumptions. consumptions. Here, the two Here, the two year’s consumptions, (1, 2, 9) year’s consumptions, (1, 2, 9) and (2, 2, 2), are incomparable: and (2, 2, 2), are incomparable: the former has less of good 1; the former has less of good 1; the latter, less of good 3. Hence, the latter, less of good 3. Hence, continue the analysis.continue the analysis.Step 2: Ask whether 1980’s consumption, (1, 2, 9), was Step 2: Ask whether 1980’s consumption, (1, 2, 9), was affordable in 2010? affordable in 2010? Answer: In 2010 you had income Answer: In 2010 you had income determined by the budget equation,determined by the budget equation,y = py = p11xx11 + p + p22xx22 + p + p33xx33 = 2 × 2 + 2 × 2 + 2 × 2 = 12 = 2 × 2 + 2 × 2 + 2 × 2 = 12while the cost of 1980’s consumption would have beenwhile the cost of 1980’s consumption would have beenpp11xx11 + p + p22xx22 + p + p33xx33 = = 2 × 1 + 2 × 2 + 2 × 9 = 242 × 1 + 2 × 2 + 2 × 9 = 24Thus you could not have had 1980’s consumption in 2010. Thus you could not have had 1980’s consumption in 2010. Hence: Continue the analysis. Hence: Continue the analysis.

1980 2010





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Step 3: Ask whether 2010’s consumption, (2, 2, 2), was Step 3: Ask whether 2010’s consumption, (2, 2, 2), was affordable in 1980? affordable in 1980? Answer: In 1980 you had income Answer: In 1980 you had income determined by the budget equation,determined by the budget equation,y = py = p11xx11 + p + p22xx22 + p + p33xx33 = = 4 × 1 + 2 × 2 + 1 × 9 = 174 × 1 + 2 × 2 + 1 × 9 = 17while the cost of 1980’s consumption would have beenwhile the cost of 1980’s consumption would have beenpp11xx11 + p + p22xx22 + p + p33xx33 = = 4 × 2 + 2 × 2 + 1 × 2 = 144 × 2 + 2 × 2 + 1 × 2 = 14Thus you could have had 2010’s consumption in 1980. Thus you could have had 2010’s consumption in 1980. Conclusion: 1980 is preferred to 2010.Conclusion: 1980 is preferred to 2010.

1980 2010





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Question 4: Question 4: Consider the following price and consumption Consider the following price and consumption information for the typical Korean consumer:information for the typical Korean consumer:

1980 2010

Price of Computers ₩4 ₩2Price of Food ₩2 ₩2

Price of Movies ₩1 ₩2Consumption of Computers 1 2



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Answer 4: Answer 4: Step 1: Compare Step 1: Compare consumptions. consumptions. Here, the two Here, the two year’s consumptions, (1, 2, 4) year’s consumptions, (1, 2, 4) and (2, 2, 2), are incomparable: and (2, 2, 2), are incomparable: the former has less of good 1; the former has less of good 1; the latter, less of good 3. Hence, the latter, less of good 3. Hence, continue the analysis.continue the analysis.Step 2: Ask whether 1980’s consumption, (1, 2, 9), was Step 2: Ask whether 1980’s consumption, (1, 2, 9), was affordable in 2010? affordable in 2010? Answer: In 2010 you had incomeAnswer: In 2010 you had incomey = py = p11xx11 + p + p22xx22 + p + p33xx33 = = 2 × 2 + 2 × 2 + 2 × 2 = 122 × 2 + 2 × 2 + 2 × 2 = 12while the cost of 1980’s consumption would have beenwhile the cost of 1980’s consumption would have beenpp11xx11 + p + p22xx22 + p + p33xx33 = = 2 × 1 + 2 × 2 + 2 × 4 = 142 × 1 + 2 × 2 + 2 × 4 = 14Thus you could not have had 1980’s consumption in 2010. Thus you could not have had 1980’s consumption in 2010. Hence: Continue the analysis. Hence: Continue the analysis.

1980 2010





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Step 3: Ask whether 2010’s consumption, (2, 2, 2), was Step 3: Ask whether 2010’s consumption, (2, 2, 2), was affordable in 1980? affordable in 1980? Answer: In 1980 you had incomeAnswer: In 1980 you had incomey = py = p11xx11 + p + p22xx22 + p + p33xx33 = = 4 × 1 + 2 × 2 + 1 × 4 = 124 × 1 + 2 × 2 + 1 × 4 = 12while the cost of 1980’s consumption would have beenwhile the cost of 1980’s consumption would have beenpp11xx11 + p + p22xx22 + p + p33xx33 = = 4 × 2 + 2 × 2 + 1 × 2 = 144 × 2 + 2 × 2 + 1 × 2 = 14Thus you could not have had 2010’s consumption in 1980. Thus you could not have had 2010’s consumption in 1980. Hence, no preference is revealed. Hence, no preference is revealed.

1980 2010





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Follow the linkFollow the linkhttp://faculty.pepperdine.edu/jburke2/ba210/PowerP1/Set1Answers.pdffor review questions for Lessons I.1 and I.2 (next time) that practice these for review questions for Lessons I.1 and I.2 (next time) that practice these skills: skills: Identify and compute opportunity costs.Identify and compute opportunity costs.Use marginal analysis to make a decision by comparing the marginal benefit Use marginal analysis to make a decision by comparing the marginal benefit to the marginal cost: increase quantity as long as the marginal benefit is to the marginal cost: increase quantity as long as the marginal benefit is greater than marginal cost.greater than marginal cost.Describe how a voluntary trade makes a rational person better off (happier, Describe how a voluntary trade makes a rational person better off (happier, more satisfied, …)more satisfied, …)Describe trade when one party is relatively better at producing Good X than Describe trade when one party is relatively better at producing Good X than another party, and relatively worse at producing Good Y.another party, and relatively worse at producing Good Y. Describe and identify an equilibrium as a rest point, or stationary point.Describe and identify an equilibrium as a rest point, or stationary point.Describe and identify efficiency as when all opportunities for improvement Describe and identify efficiency as when all opportunities for improvement without hurt are exhausted.without hurt are exhausted. Show how incentives affect decisions.Show how incentives affect decisions. Describe how incentives can restore efficiency.Describe how incentives can restore efficiency.

http://faculty.pepperdine.edu/jburke2/ba210/PowerP1/Set1Answers.pdf

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End of Lesson I.1End of Lesson I.1


BA 210 Introduction to BA 210 Introduction to MicroeconomicsMicroeconomics

ba 210 introduction to microeconomics

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