MicroeconomicsCourse E

John Hey

An overview

• ...of the first two parts of the course...

• ...of the most important points.

Economics – why?

• “People Are Different”

Part 1: Economies without Production

• 2: Gains from exchange• 3: Discrete goods: Reservation prices, Demand,

Supply and Surpluses• 4: Perfectly divisible goods: Reservation prices,

Demand, Supply and Surpluses• 5: Preferences• 6: Demand and supply with income in the form

of an endowment• 7: Demand with income in money• 8: Exchange• 9: (welfare economics)

Chapter 2 Gains from trade

• Important concepts:• Reservation price for a buyer.• Reservation price for a seller.• Buyer’s surplus.• Seller’s surplus.

Chapter 2

• In the competitive equilibrium the total surplus is maximised.

Chapter 3Discrete Goods

• An indifference curve... ...the locus of points for which an

individual is indifferent.

• Quasi-Linear preferences...• ... parallel indifference curves for which we

have an unambiguous measure of how much better off is the individual.

Chapter 3Discrete goods

• The demand curve is a stair with a step at every reservation price.

• The supply curve is a stair with a step at every reservation price.

Chapter 3Discrete goods

• The surplus of a buyer is the area between the demand curve and the price paid.

• The surplus of a seller is the area between the supply curve and the price paid.

Chapter 4Perfectly divisible goods

• Quasi-linear preferences• The same concepts and the same

results as in Chapter 3.

Chapter 5 Preferences

• Quasi-linear.• Perfect substitutes 1 to a.• Perfect complements 1 with a.• Cobb-Douglas with parameter a.• Stone-Geary with levels of

subsistence s1 s2 and parameter a.

Chapter 7Demand with money income

• Demand depends on preferences.• If we know the preferences we can

deduce the demands.• If we know the demands we can infer

the preferences.

Chapter 7Demand with money income

• Perfect substitutes 1:a

if p1/p2 < a then q1 = m/p1 q2 = 0

if p1/p2 = a then....

if p1/p2 >a then q1 = 0 q2 = m/p2

• Perfect complements 1 with a

q1=m/(p1 + ap2) and q2 =am/(p1 + ap2)• Cobb-Douglas with parameter a

q1 = am/p1 and q2 = (1-a)m/p2

• Stone-Geary with parameters s1, s2 and a

q1 = s1 + a(m-p1s1-p2s2)/p1 and

q2 = s2 + (1-a)(m-p1s1-p2s2)/ /p2

Chapter 6Demand and supply with income in

the form of endowments

• The same kind of results as in Chapter 7.

Chapter 6 – results

• Cobb-Douglas with parameter a

q1=a(p1e1+p2e2)/p1 and q2=(1-a)(p1e1+p2e2)/ /p2

• Perfect substitutes 1:a

if p1/p2 < a then q1 = (p1e1+p2e2)/p1 q2 = 0

if p1/p2 = a then....

if p1/p2 >a then q1 = 0 q2 = (p1e1+p2e2)/p2

• Perfect complements 1 with a

q1= (p1e1+p2e2)/(p1 + ap2) and

q2 =a(p1e1+p2e2)/(p1 + ap2)

Chapter 8Exchange

• The most beautiful Chapter ...

... the most important in the course

... The Edgeworth Box.

• To show exchange between two individuals.

• We look for an efficient exchange and ask whether there is a just one.

Chapter 8Exchange

• The contract curve is ...

... The locus of points efficient in the sense of Pareto.

• A point off the contract curve is inefficient.

• A point on the contract curve is efficient.

Chapter 9Welfare

• …• …• …

Part 2 Economies with production

• Chapter 10: Technology.

• Chapter 11: Minimisation of costs and factor demands.

• Chapter 12: Cost curves.

• Chapter 13: Firm’s supply and profit/surplus.

• Chapter 14: The production possibility frontier.

• Chapter 15: Production and exchange.

• (Chapter 16: Empirical analysis of demand, supply and surpluses)

Chapter 10Firms and technology

• Isoquants

• In the space of the inputs (q1,q2) teh locus of points for which output is constant

• (note the parallel: an indifference curve is the locus of points for which the individual is indifferent.)

Chapter 5 Chapter 10

• Individuals• Buy goods and

‘produce’ utility…• …depends on the

preferences…• …which we can

represent with indifference curves..

• …in the space (q1,q2)

• Firms• Buy inputs and

produce output…• …depends on the

technology…• …which we can

represent with isoquants ..

• …in the space (q1,q2)

Two dimensions

• The shape of the isoquants: depends on the substitution between the two inputs.

• The way in which the output changes form one isoquant to another – depends on the returns to scale.

Perfect Substitutes 1:a

• an isoquant: q1 + q2/a = constant

• y = A(q1 + q2/a) constant returns to scale

• y = A(q1 + q2/a)b returns to scale decreasing (b<1) increasing (b>1)

Perfect Complements 1 with a

• an isoquant: min(q1,q2/a) = constant

• y = A min(q1,q2/a) constant returns to scale

• y = A[min(q1,q2/a)]b returns to scale decreasing (b<1) increasing (b>1)

Cobb-Douglas with parameters a and b

• an isoquant: q1a

q2b = constant

• y = A q1a

q2b

• a+b<1 decreasing returns to scale

• a+b=1 constant returns to scale

• a+b>1 increasing returns to scale

Chapter 11Minimisation of costs and the

demand for inputs

• Demand depends on the technology.

• If we know the technology we can deduce the demand.

• If we know the demand we can infer the technology.

Chapter 12Cost curves

• The total cost curve...• ... the form depends on the

Returns to Scale:• Convex with decreasing RtS• Linear with constant RtS• Concave with increasing RtS.

Chapter 12Cost curves

• The LONG run ... ... in which the firm can vary both

inputs.• The SHORT run... ... in which the quantity of one of

the two inputs is fixed.

Chapter 12

• The marginal cost curve ...• ...is the slope of the total cost

curve.• The average cost curve...• ...is the slope of a line from the

origin to the total cost curve.

Chapter 13The supply curve of a competitive

firm• The condition for optimal output:

• p = marginal cost...

• ... where the marginal cost is rising.

• The supply curve is thus the marginal cost curve.

• The profit of the firm is the area between the supply curve and the price.

Chapter 14

• Production possibility frontiers.

• Case 1: linear technology ... two people.

• Case 2: non-linear technology ... two firms and two inputs.

Chapter 15

• A difficult chapter• The rate of trasformation (the slope of the

ppf of society) is equal to the marginal rates of substitution of the two individuals (the slopes of their indifference curves).

• (You will recall that the marginal rates of substitution of the two individuals must be equal in every competitive equilibrium.)

Chapter 16Empirical evidence

• Beautiful but difficult.

Overview

• In an economy without production demand and supply depend on preferences and endowments.

• Competitive exchange is efficient and depends on preferences and endowments.

• In an economy with production demand and supply depend on preferences and technology.

• Competitive exchange is efficient and depends on preferences and endowments.

The first two parts of the book

• Goodbye.