Chapter 12 Uncertainty :A contingent consumption plan: a specification of what will be consumed in each different (future) state of nature.

Utility functions and probabilities. Expected utility functions, or von Neumann-Morgenstern utility functions: EU = i piU(si), where pi is the probability the event si occurs. They are indifferent up to any positive affine transformation. Risk aversion and risk loving. Concave vs convex utility. The second derivative.

Diversification. Risk spreading. The stock market. Chapter 14 Consumers Surplus

Demand for a discrete good.

Reservation prices and consumers surplus.

Fig.

Producers surplus. Fig. Calculating gains and losses. The water-diamond paradox. Compensating and Equivalent Variations (coinciding if quasilinear utilities).

Chapter 15 Market Demand

One can think of the market demand as the demand of some representative consumer. Adding up demand curves: the horizontal summation principle. Fig. The price elasticity of demand: = (q / q ) / (p / p)= ( p / q ) / (p /q), or = (dq / q ) / (dp / p)= ( p / q ) / (dp /dq). It is normally negative. So, very often people turn to consider its absolute value ||. A commodity has an elastic ( inelastic, unit) demand if || > 1 ( || < 1 , || = 1 ). Elasticity and revenue. R = pq, dR = q dp + p dq, and then dR / dp = q [ 1 +(p) ] where ( p ) = ( p dq ) / (q dp). Fig.

Similarly, MR = dR / dq = p (q) [ 1 + 1 /(q) ] where ( q ) = ( p dq ) / (q dp). Strikes and profits. The Laffer curve.

Constant elasticity demands. Another way to express elasticity: = d ln q / d ln p. The income elasticity of demand . With p1 x1 + p2 x2 = m, we have dx2/dm = s11+s22, where si is the expenditure share of good i . The arc elasticity vs the point elasticity. 1 = p1 dx1/dm + p2

Chapter 16 Partial Equilibrium

The market supply curve. A competitive market. The equilibrium. Pareto efficiency. Fig. Market surplus and market shortage. Fig. Shortage is not scarcity. Figs.

Two special cases: of a vertical supply and of a horizontal supply.

Algebra of the equilibrium: D ( p ) = S ( p ). Comparative statics. Shifting both curves. Taxes. Distinguish Pp , the price paid by consumers, Pr , the price received by producers, Pl , the list price, and Po , the original price. The two ways to analyze the effect of a tax (imposed on demand or imposed on supply) are equivalent. Algebra of the equilibrium with a tax: D ( pp ) = S ( pr ), and pp = pr + T. Who bears the burden of a tax? The one with less elasticity shares more burden. Passing along a tax. The deadweight loss of a tax. A subsidy is the opposite of a tax. Chapter 18 Technology Figs.

These four chapters focus mainly on resource allocation insider firms. Inputs and outputs. Factors of production: land, labor, capital, raw materials, and so on. Financial capital and physical capital. Technological constraints. A production set: X = input(s) , Y = output. Example of one-input-one-output case: production function. Fig.

Examples of technology in two-inputs-one-output case (isoquants analysis): fixed proportions, perfect substitutes, Cobb-Douglas. Figs. Assumptions of technology: monotonic (free disposal), convex. The marginal product, The technical rate of substitution (TRS): with dy = 0, Fig.

TRS (x1, x2 ) = dx2 / dx1 = MP1 (x1, x2) / MP2 (x1, x2 ). Diminishing MP. Diminishing TRS. The long run (LR) and the short run (SR). Returns to scale: increasing, decreasing, and constant.

Chapter 19 Profit Maximization

The organization of firms. Proprietorships, partnerships, or corporations. Profits and stock market value. Fixed and variable factors. SR profit maximization: = py - w1x1 - w2x2, y = / p + w2x2 / p + w1x1 / p describes isoprofit lines, max x1 gives pMP1 = w1. Fig. Cobb-Douglas case. Optimum lies on the tangency of an isoprofit line and the production function. Fig.

Comparative statics: Increasing p increases x1 and then y. Increasing w1 reduces x1, and thus the factor demand curve follows. Figs.

w1

Low p x1

High p

High w1 x1

Low w1 x1

LR: both x1 and x2 are variable. Profit maximization and (constant) returns to scale. * Revealed profitability. Weak axiom of profit maximization WAPM gives py w 1x 1 w 2x 2 0. Exercise: Max xi based on production function y = f ( x1, x2 ) to derive factor demand xi = xi ( p, w1, w2 ), and then the firm supply function y = g ( p, w1, w2 ).

Chapter 20 Cost Minimization

Basic model: min x1, x2 w1 x1 + w2 x2 subject to f (x1 , x2 ) = y gives

c ( w1 , w2 , y ).

Isocost lines: x2 = C/w2 w1x1/w2. Tangency of an isocost line and an isoquant. MP1 (x1, x2) / MP2 (x1, x2 ) = TRS (x1, x2 ) = w 1 / w 2 or MP1 (x1, x2) / w 1 = MP2 (x1, x2 ) / w 2. Minimizing costs for y = min{ax1 , bx2}; y = ax1 + bx2; and y = x1a x2b. * Revealed cost minimization. Weak axiom of cost minimization WACM. x 2 0. Returns to scale and the cost function. Fixed and variable costs. Total, average, and marginal costs. FC, VC; TC, AC, MC, and AVC. MC > AC ( < AC) if and only if AC is increasing (decreasing). MC cuts AC (AVC) at ACs (AVCs) extreme. Long-run and short-run costs. w 1x 1 +w 2 Fig.

Fixed and quasi-fixed costs. Sunk costs are costs that are not recoverable. A special kink of fixed costs.

Chapter 21 Cost Curves

A misleading formula: AVC(1) = MC (1). The area under MC gives VC: MC = VC. Division of output among plants of a firm.

Should be MC(0) = AVC(0).

Fig.

Form MC based on mc1 and mc2 by horizontal summation. Typical cost curves. Example: c (y) = y 2 + 1. LR and SR cost curves.

Chapter 22 Supply of a competitive firm

These six chapters focus on the profit-maximizing output decision of firms. The technology description and the cost-minimization are already done with only cost functions left. With(y) = R(y) C(y), we have the following Basic Equation for firm supply decision: MC = MR. Its in fact FOC. SOC is (MC) = (MR).

Pure competition. Firm as a Price Taker. Thus R = py, and then MR = p. The supply decision. FOC: MC ( y* ) = p. SOC: MC ( y* ) 0. The demand curve facing a competitive firm. Fig.

The firms supply curve is the upward-sloping part of MC that lies above the AVC curve. The part of MC is also seen as the inverse supply function. Fig. Three equivalent ways to measure the producers surplus ( = R VC = + FC ). Example: c ( y ) = y 2 + 1. LR: p = MC ( y, k ( y ) ) vs SR: p = MC ( y, k ). LR supply curve is the part of LMC above LAC

Chapter 23 Industry Supply

Horizontal summation gives the industry supply. Entry and exit. The zero profit theorem. Free entry vs barriers to entry. Industry equilibrium with free entry, and the LR industry supply curves with free entry. Taxation in SR and in LR. Fixed factors and economic rent. Rent seeking. Energy policy: Two-tiered oil pricing; Price control; The entitlement program. Economists versus lobbyists.