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AnalyzingEconomicProblems
Chapter One
Chapter One
Chapter One
Chapter One Overview
1. Defining Microeconomics
2. Who Should Study Microeconomics?
3. Microeconomic Modeling• Elements of Models• Solving the Models
4. The Types of Microeconomic Analysis
1. Defining Microeconomics
2. Who Should Study Microeconomics?
3. Microeconomic Modeling• Elements of Models• Solving the Models
4. The Types of Microeconomic Analysis
Microeconomics Defined
Microeconomics is the study of the economic behavior of individual economic decision-makers such as consumers, workers, firms or managers. This study involves both the behavior of these economic agents on their own and the way their behavior interacts to form larger units, such as markets.
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Who Should Study Microeconomics?
Example: The Railroad Industry in the US
74.9% of all freight, 1929 39.8% of all freight, 1970
1970’s:
• Poor profits, bankruptcies, and an inability to invest
1980’s:• Loosened regulation and union rules improved profitability
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Analysis of these issues requires Microeconomic tools and the key players below need to know something about Microeconomics.
Policy Makers
Managers
Union Leaders
Lenders
Business Owners
Who Should Study Microeconomics?
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Analysis of the impact of Global Warming on:
World Economic Stability
National Economic Policies
Consumer Spending
Economic Partnerships
Trade Agreements
Microeconomics and Global Warming
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Key Societal Questions
Societies must answer these questions that relate to microeconomics:
1. What goods and services will be produced and in what quantities
2. Who will produces these services and how will they produce them
3. Who will receive these goods and services and how will they get them
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Microeconomic ModelingChoice vs. Alternatives
Resemble Reality Be Understandable Be an Appropriate Scale
Models are like maps – using visual methods, they simply the process and facilitate understanding of complex concepts. Microeconomic models need to:
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Example: World-wide market for unprocessed coffee beans,
December, 1997
Example: World-wide market for unprocessed coffee beans,
December, 1997
PricePer
Pound
Quantity in Pounds
Supply (P,W)
Microeconomic ModelingChoice vs. Alternatives
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Demand (P,I)
Price Per Pound
Quantity in Pounds
Supply (P,W)
Example: World-wide market for unprocessed coffee beans,
December, 1997
Example: World-wide market for unprocessed coffee beans,
December, 1997
Microeconomic ModelingChoice vs. Alternatives
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Opportunity CostDependent on How One Specifies Alternatives
The Opportunity Cost of a resource is the value of that resource in its best alternative use.
Defined:
• $100 in facilities yields $800 Revenue• $100 in R&D yields $1000 revenue
• Opportunity cost of investing in facilities = $1000
• Opportunity cost if investing in R&D = $800
• $100 in facilities yields $800 Revenue• $100 in R&D yields $1000 revenue
• Opportunity cost of investing in facilities = $1000
• Opportunity cost if investing in R&D = $800
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The Objective FunctionDependent on How the Objective Function is Specified
The Objective Function specifies what the agent cares about.
Defined:
• Does manager care more about raising profits or increasing “power”?
• Does manager care more about raising profits or increasing “power”?
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The Constraints
Constrains are whatever limits is placed on the resources available to the agent.
Defined:
Time Budget Other Resources Technical Capabilities The Marketplace Rules, Regulations, and Laws
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The Constraint Optimization
Behavior can be modeled as optimizing the objective function, subject to various constraints.
• Facilities ( F ): N = budget / $30• R&D ( R ): N = budget / $100
• Max N• (F,R)• Subject to: expenditure < $100• Where: N is the number of workers
• Facilities ( F ): N = budget / $30• R&D ( R ): N = budget / $100
• Max N• (F,R)• Subject to: expenditure < $100• Where: N is the number of workers
Manager’s Investment Choice
Cost Per Unit of Time
• Facilities workers cost $30 • R&D workers cost $100
Cost Per Unit of Time
• Facilities workers cost $30 • R&D workers cost $100
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The Constraint Optimization
Consumer purchases
Food (F), Clothing ( C ), Income (I)Price of food (pf), price of clothing (pc)
Satisfaction from purchases: S = (FC)1/2
Max S(F,C) - subject to: pfF + pcC < I
Note: "as if modeling"
Consumer purchases
Food (F), Clothing ( C ), Income (I)Price of food (pf), price of clothing (pc)
Satisfaction from purchases: S = (FC)1/2
Max S(F,C) - subject to: pfF + pcC < I
Note: "as if modeling"
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PFF + PCC = I
F
C0
The Constraint OptimizationExample – Consumer Purchases
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PFF + PCC = I
F
C0
The Constraint OptimizationExample – Consumer Purchases
(FC)1/2 = S0
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PFF + PCC = I
F
C0
The Constraint OptimizationExample – Consumer Purchases
(FC)1/2 = S0
(FC)1/2 = S1
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PFF + PCC = I
F
C0
The Constraint OptimizationExample – Consumer Purchases
(FC)1/2 = S0
(FC)1/2 = S1
(FC)1/2 = S2
S2 > S1 > S0
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Exogenous & Endogenous Variables
Variables that have values taken as given in the analysis are exogenous variables. Variables that have values determined as a result of the model’s workings are endogenous variables.
Defined:
“How would a manager hire the most possible workers on a budget of $100?” vs. “How would a manager minimize the cost of hiring three workers?”
OR
“How much food and clothing should the consumer purchase in order to maximize satisfaction on a budget of I?”
vs.“What is the minimum level of expenditure that the consumer must receive in order to reach a subsistence level of satisfaction?”
“How would a manager hire the most possible workers on a budget of $100?” vs. “How would a manager minimize the cost of hiring three workers?”
OR
“How much food and clothing should the consumer purchase in order to maximize satisfaction on a budget of I?”
vs.“What is the minimum level of expenditure that the consumer must receive in order to reach a subsistence level of satisfaction?”
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Equilibrium
Defined: Equilibrium is defined as the point where demand just equals supply in this market (i.e., the point where the demand and supply curves cross).
Equilibrium analysis is an analysis of a system in a state that will continue indefinitely as long as the exogenous factors remain unchanged.
Equilibrium analysis is an analysis of a system in a state that will continue indefinitely as long as the exogenous factors remain unchanged.
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EquilibriumExample – Sale of Coffee Beans
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Demand (P,I)
•
EquilibriumExample – Sale of Coffee Beans
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Q*
P*
Demand (P,I)
•
EquilibriumExample – Sale of Coffee Beans
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Comparative Statics Analysis
A Comparative Statics Analysis compares the equilibrium state of a system before a change in the exogenous variables to the equilibrium state after the change.
Defined:
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Equilibrium
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Demand (P,I)
•
Equilibrium
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New Supply (P,W)
•
Demand (P,I)
•
Equilibrium
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New Supply (P,W)
•
Demand (P,I)
•
Equilibrium
Q*
P*
Q**
P**
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Consumer Choice Revisited
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Consumer Choice Revisited
(FC)1/2 = S0
•
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PFF + PCC = I1
(FC)1/2 = S0
•
Consumer Choice Revisited
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(FC)1/2 = S1•PFF + PCC = I1
(FC)1/2 = S0
•
Consumer Choice Revisited
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C** C*
F*
F** (FC)1/2 = S1•PFF + PCC = I1
(FC)1/2 = S0
•
Consumer Choice Revisited
S0 > S1
I0 > I1
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Defined:
Marginal Impact
The Marginal Impact of a change in the exogenous variable is the incremental impact of the last unit of the exogenous variable on the endogenous variable.
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Marginal ImpactAdvertising Example
Budget = $1M to allocate between TV ( T ) and radio ( R )
Problem: Max B(T,R) (T,R)
Subject to: pTT + pRR < $1m
where: B is "barrels“ and pT, pR are the prices of TV and radio advertising, respectively.
Budget = $1M to allocate between TV ( T ) and radio ( R )
Problem: Max B(T,R) (T,R)
Subject to: pTT + pRR < $1m
where: B is "barrels“ and pT, pR are the prices of TV and radio advertising, respectively.
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Marginal ImpactAdvertising Example
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Microeconomic AnalysisSome Types
Positive Analysis: • Can explain what has happened due to an economic policy or it can predict what might happen due to an economic policy.
Normative Analysis:• Is an analysis of what should be done
Positive Analysis: • Can explain what has happened due to an economic policy or it can predict what might happen due to an economic policy.
Normative Analysis:• Is an analysis of what should be done
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Microeconomic AnalysisSome Examples
Example: “Should we increase income equality rather than focus on economic efficiency?”
Example: “Should we impose a progressive income tax or a sales tax to increase income equality?”
Example: “Will a progressive income tax reduce aggregate hours worked?”
Example: “Should we increase income equality rather than focus on economic efficiency?”
Example: “Should we impose a progressive income tax or a sales tax to increase income equality?”
Example: “Will a progressive income tax reduce aggregate hours worked?”
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