Microeconomics

3070 Prof. Barham

Lecture 1: Introduction

Syllabus and Website

Website:
http://www.colorado.edu/ibs/hb/barham/courses/eco
n3070/
All assignments and solution keys will be posted on
the web site.
I will send you a notice when they are posted.
Syllabus

Outline
Cover chapter 1
What is microeconomics

Tools for microeconomics

Economic models
Constrained optimization
Marginal analysis
Equilibrium analysis
Comparative statics

Next class reviews calculus, may start Chapter 2

What is mircoeconomics
Can you buy all the clothing, vacations, sport
equipment, health care, food, beauty products,
yoga classes, seasons tickets to sport event,
donations to charity you want?
No
Mircoeconomics models our decision making process
on how much you decide to spent on what.

What You Will Focus On

How to make the market demand and
supply curves starting from assumptions
Price (P)
Doctors visit

P*

Qd: demand

Qs Supply

50

Equilibrium: Qd=Qs

Q1
.

10

Q2

Quantity (Q)
Number of appointments
per day

What is mircoeconomics
Official Definitions:
Microeconomics is the study of how individuals and
firms make themselves as well off as possible in a
world of scarcity and the consequences of those
individual decisions on the markets and the entire
economy.
Microeconomics is the study of the allocation of
scarce resources.
Mircoeconomics is also often called price theory.

This is to emphasize the important role that price plays.

Price not only thing studied think of health care market
think about quantity

What is mircoeconomics
Because we cant have everything, we need to make
trade-offs and microeconomics provides a way to
think about tradeoffs.
A society faces 3 key tradeoffs:
1.
Which goods and services to produce
2.
How to produce of them

How much labor and inputs should a firm use to

produce a car

Who gets the good and services (allocation)

3.

Based on price
Based on need (flu vaccine when a shortage)
Government

What is microeconomics

Workers need to choose how to allocate their time

between labor and leisure.
Firms need to choose how to allocate their
investment between human capital and machines.
Households need to choose how to allocate their
incomes between savings and expenditure, and
which expenditures

Micro versus Macroeconomics

What is the difference between micro and macro
economics?

Microeconomics: behavior of individual economic units

like consumers, producers, landowners, families, etc.
How and why do they make the decisions they make?

Macroeconomics: analyzes how the entire national

economy performs. It analyzes unemployment,
inflation, price levels, interest rates (many things we
take as given in microeconomics).

Economic Models
How do economists allocate resources?
They develop theoretical model.
Everything should be made as simple as possible but
not simpler Albert Einstein

Economic Models

The models are abstractions of the real world

Too complicated to take into consideration all factors

Without simplifications we would not be able to make
predictions.
Like a roadmap, does not give each house, but the bare
essentials i.e. major streets, highways and sometime main
attractions.

It may appear that the model makes heroic

abstractions (assumptions) from the complexities of
the real world.

Economic Models Example

Determinants of Poster Demand on Campus
You are advertising a big event for the freshman class how
many posters will you need?
Factors in your model:

Factors not in your model:

Price to make poster, size of freshman class

Content of poster, placement of poster, relative size of poster

Are there any constraints to this model?

the amount of budget you have to spend on poster advertising.

Types of Variables in a Model

Exogenous Variable: one whose value is taken as
given in a model.
Endogenous Variable: one whose value is
determined within the model being studied
Which factor(s) would have you taken as given in the
poster example?

Price, size of freshman class (exogenous)

Which factor(s) are determined by your model?

The quantity of posters needed (or demanded)

Tools of Microeconomic Analysis

1.

Constrained Maximization

2.

Equilibrium Analysis

3.

Comparative Statics

Constrained Optimization
Constrained optimization: an analytical tool used
when a decision maker seeks to make the best
(optimal) choice, taking into consideration possible
restrictions on the choice.

Constrained Optimization
This tool has two parts:
1.
Objective function: is the relationship the
decision maker seeks to optimize (maximize or
minimize).
2.
Constraint: limits or restrictions that are imposed
on the decision maker

Constrained Optimization
Examples
You want to maximize your happiness during your
second year at CU.
Objective function Utility (happiness):

Utility=f(days skied per month (s), beers per week(b)).

U=s*b
The thing you are maximizing or minimizing

Constraints: s.t. (subject to)

Income (I)=S*Ps+B*Pb, where P is price

Many max or min problems have some kind of a
constraint you have to work with

Writing Out Statement of

Constrained Optimization
Problem

MAXU s* b

Objective Function

s.t I s* Ps b* Pb

Constraint

s,b

Endogenous Variables

Marginal Analysis

Solution to a constrained optimization problem

depends on the marginal impact of the decision
variables on the value of the objective function.

But what is marginal?

The term marginal tells us how the value of the

objective function changes as a result of adding one
unit of a decision variable.

Marginal Analysis

How much do you spend on beer and skiing to

Maximize your happiness if you have 100 budget?
Happiness

Marginal Happiness

$
spent

From
beer

From
skiing

From
beer

From
skiing

0
25

0
80

0
4

80

50

90

10

10

75

92

15

100

94

20

Marginal Analysis

$100 on beer = 94 units of happiness

$75 beer plus $25 skiing = 96 units of happiness.
$50 on beer and $50 on skiing = 100 units of
happiness.

Yes a day of skiing with a nice apres ski makes you

very happy.

Marginal Analysis
You just did a constrained optimization problem

Optimize happiness (beer and skiing) subject to $100

weekly entertainment budget.

MAX H(b, s)
B,s

s.t. Ps*s + Pb*b=100

where

Objective Function
Constraint

b= quantity of beer; Pb=price beer

s=days of skiing; Ps=price skiing.

Equilibrium Analysis
Price (P)
Doctors visit

P*

Qd: demand

Qs Supply

50

Equilibrium: Qd=Qs

Q1
.

10

Q2

Quantity (Q)
Number of appointments
per day

Equilibrium Analysis

In a competitive market, equilibrium is achieved at a

price at which the market clears

price at which the quantity offered for sale = the

quantity demanded by consumers.

Since Qd = Qs at P*, there is no upward or

downward pressure on price. Hence, price could
stay at P* indefinitely.

Equilibrium Analysis
What if price is higher than P*?
Excess Supply or Demand

P
Price ($)
Doctors visit

Qd: demand

Qs Supply

Excess Supply
70
50

13

Quantity (Q)
Number appointments
per day

Equilibrium Analysis
What is price is lower than P*
P
Price ($)
Doctors visit

Qd: demand

Qs Supply

70
50
30
Excess Demand

13

Q Quantity
Number of appointments
per day per doctor

Comparative Statics

Examine how a change in an exogenous variable

will affect the level of an endogenous variable.

First, look at the value of the endogenous variable at

the initial level of the exogenous variable
Second, look at the value of the endogenous variable
at the new level of the exogenous variable.

Comparative Statics Example

Endogenous variable:
movement along curve
P
Price ($)
Doctors visit

P*

How do the exogenous

variables affect the graph?
S

Moves the curves

50
Endogenous variable:
movement along curve

10
Q*

Q
Number of appointments
per day per doctor

Comparative Statics Example

Suppose we are in China and there is an outburst of

the Avian Flu. A few weeks later there are some
new regulations put on doctors and they are
unhappy about it. So they do a rotating strike.

How will these factors affect our Supply and

Demand curve and the price?

Comparative Statics Example

P
Price ($)
Doctors visit

D1

Outbreak of avian flu,

D2
S1

Moves demand to the right,

but supply curve does not
change

P2

60

P1

50

10

13

Q1 Q2

Q
Number of appointments
per day per doctor

Comparative Statics Example

The rotating strike will lead to
P
Price ($)
Doctors visit

D1

D2

S2
S1

A reduction in supply
This is a shift to the left

P3

65

11
Q3

Q
Number of appointments
per day per doctor

See You Next Class