Economics 349 Intermediate Micro Theory

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Economics 349Intermediate Micro Theory

• Fall 2007
• Dr. Delemeester

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Course Essentials

• Course Web Page
• www.marietta.edu/delemeeg/econ349
• Grade
• Exams (60)
• Problem Sets (25)
• Spreadsheet Projects (15)

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Economic Roundtable

• to promote an interest in and to enlighten its
  members and others in the community on important
  governmental, economic, and social issues
• Business networking opportunity
• Student memberships 5

EconomicRoundtable.org
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The most important determinant of my success in
Economics 349 will be

• My interest in the material
• The amount of time I put into the class
• The instructors ability to inspire me
• My mathematical skills
• None of the above.

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• What Do Schoolteachers and Sumo Wrestlers Have in
  Common?
• How Is the Ku Klux Klan Like a Group of
  Real-Estate Agents?
• Why Do Drug Dealers Still Live with Their Moms?
• Where Have All the Criminals Gone?
• What Makes a Perfect Parent?
• Would a Roshanda by Any Other Name Smell as
  Sweet?

• Increasing Residual Wage Inequality Composition
  Effects, Noisy Data, or Rising Demand for Skill?
• Medium-Term Business Cycles
• Can Information Heterogeneity Explain the
  Exchange Rate Determination Puzzle?
• Media Frenzies in Markets for Financial
  Information
• An Efficient Dynamic Auction for Heterogeneous
  Commodities
• Matching and Price Competition
• Paying Not to Go to the Gym
• On the Simple Economics of Advertising,
  Marketing, and Product Design

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Introduction

• What are the key themes of microeconomics?
• What is a market?
• What is the difference between real and nominal
  prices?
• Why study microeconomics?

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Themes of Microeconomics

• Microeconomics deals with limits
• Limited budgets
• Limited time
• Limited ability to produce
• How do we make the most of limits?
• How do we allocate scarce resources?

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Themes of Microeconomics

• Workers, firms and consumers must make trade-offs
• Do I work or go on vacation?
• Do I purchase a new car or save my money?
• Do we hire more workers or buy new machinery?
• How are these trade-offs best made?

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Themes of Microeconomics

• Consumers
• Limited incomes
• Consumer theory describes how consumers
  maximize their well-being, using their
  preferences, to make decisions about trade-offs
• How do consumers make decisions about consumption
  and savings?

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Themes of Microeconomics

• Workers
• Individuals decide when and if to enter the
  workforce
• Trade-offs of working now or obtaining more
  education/training
• What choices do individuals make in terms of jobs
  or workplaces?
• How many hours do individuals choose to work?
• Trade-off of labor and leisure

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Themes of Microeconomics

• Firms
• What types of products do firms produce?
• Constraints on production capacity and financial
  resources create needs for trade-offs
• Theory of the Firm describes how these
  trade-offs are best made

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Themes of Microeconomics

• Prices
• Trade-offs are often based on prices faced by
  consumers and producers
• Workers make decisions based on prices for labor
  wages
• Firms make decisions based on wages and prices
  for inputs and on prices for the goods they
  produce

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Themes of Microeconomics

• Prices
• How are prices determined?
• Centrally planned economies governments control
  prices
• Market economies prices determined by
  interaction of market participants
• Markets collection of buyers and sellers whose
  interaction determines the prices of goods

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Theories and Models

• Economics is concerned with explanation of
  observed phenomena
• Theories are used to explain observed phenomena
  in terms of a set of basic rules and assumptions
• The Theory of the Firm
• The Theory of Consumer Behavior

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Theories and Models

• Theories are used to make predictions
• Economic models are created from theories
• Models are mathematical representations used to
  make quantitative predictions

Black-Scholes Option Pricing Model
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Theories and Models

• Validating a Theory
• The validity of a theory is determined by the
  quality of its prediction, given the assumptions
• Theories must be tested and refined
• Theories are invariably imperfect but gives
  much insight into observed phenomena

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Which of the following is a normative statement?

• Solar energy will be used increasingly over the
  next 100 years.
• Mergers between two companies should always be
  allowed.
• An increase in advertising by one major auto
  company will affect the sales of the other auto
  companies.
• If the US government lifts the current sugar
  quotas, the price of sugar will fall and the
  corny syrup industry will suffer.

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Positive Normative Analysis

• Positive Analysis statements that describe the
  relationship of cause and effect
• Questions that deal with explanation and
  prediction
• What will be the impact of an import quota on
  foreign cars?
• What will be the impact of an increase in the
  gasoline excise tax?

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Positive Normative Analysis

• Normative Analysis analysis examining questions
  of what ought to be
• Often supplemented by value judgments
• Should the government impose a larger gasoline
  tax?
• Should the government decrease the tariffs on
  imported cars?

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What is a Market?

• Markets
• Collection of buyers and sellers, through their
  actual or potential interaction, determine the
  prices of products
• Buyers consumers purchase goods, companies
  purchase labor and inputs
• Sellers consumers sell labor, resource owners
  sell inputs, firms sell goods

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What is a Market?

• Market Definition
• Determination of the buyers, sellers, and range
  of products that should be included in a
  particular market
• Arbitrage
• The practice of buying a product at a low price
  in one location and selling it for more in
  another location

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What is a Market?

• Defining the Market
• Many of the most interesting questions in
  economics concern the functioning of markets
• Why are there a lot of firms in some markets and
  not in others?
• Are consumers better off with many firms?
• Should the government intervene in markets?

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Which of the following markets do you think is
perfectly competitive?

• The market for local phone calls.
• The world soybean market.
• The world oil market.
• b) and c)
• a), b), and c)

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Market Model
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• Consider the demand for beer during the summer
  months. Let
• Qd 30 5P 0.01I 2R
• Where Q is measured in thousands of
  6-packs, P is the price per 6-pack in dollars, I
  is income, and R is the number of rainy days
  during the summer.
• Supply is given by Qs -100 20P
• Plot the supply and demand curves if I 20,000
  and
• R 15. What is the equilibrium price and
  quantity?
• b) If I 20,000 and R 10, plot the new demand
  curve and find the new equilibrium. Compare this
  to the original equilibrium. Does the movement
  in P and Q make sense with the decline in the
  number of rainy days?

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Real Versus Nominal Prices

• Comparing prices across time requires measuring
  prices relative to some overall price level
• Nominal price is the absolute or current dollar
  price of a good or service when it is sold
• Real price is the price relative to an aggregate
  measure of prices or constant dollar price

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Real Versus Nominal Prices

• Consumer Price Index (CPI) is often used as a
  measure of aggregate prices
• Records the prices of a large market basket of
  goods purchased by a typical consumer over time
• Percent changes in CPI measure the rate of
  inflation

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Real Versus Nominal Prices

• Calculating Real Prices

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Real Price of College
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You have been hired to examine whether
consumption of gasoline has been affected by
changes in the price of gasoline over time. To
complete the analysis, you need to adjust nominal
gasoline prices per gallon for changes in the
overall price level. Use the data below to
calculate the real price of gasoline for 1977 and
1989 using 1970 dollars.
0.37
0.34
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The Price of a College Education

• The real price of a college education rose 69
  percent from 1970 to 2006
• Increases in costs of modern classrooms and wages
  increased costs of production decrease in
  supply
• Due to a larger percentage of high school
  graduates attending college, demand increased

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Market for a College Education
New equilibrium was reached at 4,276 and a
quantity of 17.3 million students
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Price Elasticity of Demand

• Measures the sensitivity of quantity demanded to
  price changes
• It measures the percentage change in the quantity
  demanded of a good that results from a one
  percent change in price

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Price Elasticity of Demand

• Usually a negative number
• As price increases, quantity decreases
• As price decreases, quantity increases
• When EP gt 1, the good is price elastic
• ?Q gt ?P
• When EP lt 1, the good is price inelastic
• ?Q lt ?P

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Price Elasticity of Demand

• The primary determinant of price elasticity of
  demand is the availability of substitutes
• Many substitutes, demand is price elastic
• Can easily move to another good with price
  increases
• Few substitutes, demand is price inelastic

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Price Elasticity of Demand

• Looking at a linear demand curve, as we move
  along the curve ?Q/?P is constant, but P and Q
  will change
• Price elasticity of demand must therefore be
  measured at a particular point on the demand
  curve
• Elasticity will change along the demand curve in
  a particular way

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Price Elasticity of Demand
Demand Curve Q 8 2P
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Price Elasticity of Demand

• The steeper the demand curve, the more inelastic
  the demand for the good becomes
• The flatter the demand curve, the more elastic
  the the demand for the good becomes
• Two extreme cases of demand curves
• Completely inelastic demand vertical
• Infinitely elastic demand horizontal

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Infinitely Elastic Demand
EP ?
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Completely Inelastic Demand
D
EP 0
Q
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Other Demand Elasticities

• Income Elasticity of Demand
• Measures how much quantity demanded changes with
  a change in income

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Other Demand Elasticities

• Cross-Price Elasticity of Demand
• Measures the percentage change in the quantity
  demanded of one good that results from a one
  percent change in the price of another good

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Price Elasticity of Supply

• Measures the sensitivity of quantity supplied
  given a change in price
• Measures the percentage change in quantity
  supplied resulting from a 1 percent change in
  price

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Elasticity An Application

• During the 1980s and 1990s, the market for
  wheat went through changes that had great
  implications for American farmers and US
  agricultural policy
• Using the supply and demand curves for wheat, we
  can analyze what occurred in this market

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Elasticity An Application

• Supply QS 1800 240P
• Demand QD 3550 266P

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Elasticity An Application

• QD QS
• 1800 240P 3550 266P
• 506P 1750
• P 3.46 per bushel
• Q 1800 (240)(3.46) 2630 million bushels

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Elasticity An Application

• We can find the elasticities of demand and supply
  at these points

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Elasticity An Application

• Assume the price of wheat is 4.00/bushel due to
  decrease in supply