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Microeconomics . Price Theory How much does Windows 7 sell for? How much does Linux sell for? If a negligent driver kills an 85 year old woman, how much money will the jury award the estate of the family? In a similar accident, but involving a 20 year old man, how much will the award be?

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  • Price Theory
    • How much does Windows 7 sell for?
    • How much does Linux sell for?
    • If a negligent driver kills an 85 year old woman, how much money will the jury award the estate of the family?
    • In a similar accident, but involving a 20 year old man, how much will the award be?
    • How much more money does a white male make compared with a white female make doing similar work?
    • How much more money can you expect to earn over your lifetime with a Master’s Degree from Chulalongkorn University compared with if you did not go to school?
supply demand
Supply & Demand
  • One of the most persuasive models in the business, social, and behavioral sciences.
  • Wide applications in fields such as
    • Economics
    • Finance
    • Labor
    • Statistics
    • Health
  • Major Goal: Price Determination.
the law of demand
The Law of Demand
  • An inverse relationship between a measure of price and a measure of the quantity demanded.
  • As the price of something goes up less of that something is demanded.
  • What is price?
  • What is demand?
  • In microeconomics a price is a ratio that represents terms of trade.
  • Prices, in micro, are real.
  • Opportunity costs represent real prices.
    • In order to get something you have to give something up.
  • We will use monetary units for convenience. Thus Baht or Dollars represent a medium of exchange…dollars per shirt or dollars per baht represent the price of shirts (in $’s) or the price of baht (in $’s).
a model
A Model
  • Maybe your first economic model was the PPF model…it represents prices in real terms:
  • In this model we see the terms of trade, i.e., how much Y we get (or give up) when we give up (or get) some amount of X.
  • Did you notice the curvature of the PPF? It doesn’t need to be this way, but the curve represents increasing marginal cost. That is a standard (and useful assumption):
    • As we get more X we have to give up increasing amounts of Y.
goods services
Goods & Services
  • Production is transformation.
  • It might be a physical transformation of resources.
  • It might be a spatial transformation of resources.
  • It might be a temporal transformation of resources.
the law of demand1
The Law of Demand
  • Intuitive.
  • Applicable to individual decision making.
  • Applicable to market activity.
  • Applicable to non-market activity:
    • Demand for drunk driving.
    • Demand for quality of life.
  • Demand exists in the output market.
    • For example: demand for automobiles.
  • Demand exists in the input market.
    • For example: demand for labor.
  • Some goods & services are both inputs and outputs.
    • For example: tomatoes.
market demand
Market Demand
  • Generated from individual demand.
    • For example, at a price of 10 baht
      • Miss Kawita wants 5 units
      • Mr Chayanin wants 4 units
      • Mr Satta does not want any units
      • Miss Utumporn wants 1 unit
    • At this price 10 units are demanded.
demand may be binary
Demand may be binary
  • At a price of Bt 3.95 million (Mercedes E220 CDI)
    • Richard has zero effective demand – is not in the market
    • Miss Ungkana has non-zero effective demand – is in the market (do not let BMW know this!)
  • Aggregation of many zeroes and ones leads to market demand
the law of demand2
The Law of Demand
  • Sometimes we can quantify Qd and P
  • We might model Qd
  • QdRichard = f(…,P,YRichard, …)
  • QdRichard = a + bP + cY
  • b might be -5
  • c might be .025
  • a represents other determinants
law of demand
Law of Demand
  • QdRichard = a + bP + cY
  • This is a linear model and looks like this:
linear demand
Linear Demand
  • If we examine our demand function holding Y constant (=1000) then we have
  • Qd = 35 – 5P
  • This is the same as
  • P = 7 – Qd/5
  • Graphing P against Q – Alfred Marshall
p 7 q d 5
P = 7 – Qd/5
  • Which Graphs as:
demand as willingness to pay
Demand as Willingness to Pay
  • The demand function for an individual represents the maximum amount of money that a person would be willing to pay to purchase a given quantity of a good or service.
  • The law of demand in this case is a reflection of diminishing marginal utility.
  • Marginal: incremental.
the supply function
The Supply Function
  • If I offered to buy all the chocolate chip cookies you brought to class on Saturday for Bt 1000 each, how many cookies would you bring?
  • If I offered to buy all of the cookies you brought for Bt 2 each, how many would you bring?
  • In this sense, the Supply Function represents the minimum amount of money a person would be willing to accept to provide a given quantity of a good or service.
supply preview
Supply Preview
  • Because of the profit motive there is a direct or positive relationship between the quantity supplied of a good or service and its price.
  • We might model this like:
    • Qs = f(…, P, …)
    • Qs = 10P, for example.
  • When we have a demand function (Qd) and a supply function (Qs) we can think about the price (P) which equilibrates Qd and Qs. This is Pe.
  • Typically when an observed price Po is greater than Pe we see excess supply and when Po < Pe we have excess demand. Does this make sense to you?
in labor economics
In Labor Economics
  • There is a demand for labor by firms and there is a supply of labor by households.
  • The price of labor is the wage.
  • The demand for labor depends on what sorts of things?
  • The supply of labor depends on what sorts of things?
wage determination
Wage Determination
  • As we will see, the demand for labor is called a derived demand. As more consumers want a particular good or service that creates demand for labor in the industry that produces that particular good or service.
  • What is We in a particular industry?
commodification of labor
Commodification of Labor
  • Note that it is theoretically easy to treat labor as we would any other classical input into production such as tomatoes, steel, seeds, or capital.
  • In the course of your studies you might want to think about this from time to time.
  • How mobile is labor?
  • Do prevailing wages adjust to excess supply or demand for labor?
  • Can certain kinds of labor easily be discriminated against?
  • What important institutions influence labor supply and/or labor demand decisions?
from here where
From Here Where?
  • Now that we have previewed some aspects of micro theory we will explore methods used to model demand and supply functions.
  • What goes on behind the demand function?
  • What goes on behind the supply function?
from here
From Here…
  • Price determination might be a reflection of optimal decision making by consumers and producers.
  • Micro theory can be used as a guide:
    • Descriptive models of behavior
    • Prescriptive models of behavior
      • Ethical Models
      • Optimal Models
step one
Step One
  • We build are skills by first looking at the demand function.
  • We will need a few mathematical tools to help us understand how the demand function expresses optimal consumer choice.
  • Consumers choose among baskets of commodities in order to maximize utility subject to budgetary constraints.
step two
Step Two
  • After we derive the demand function we will do similar exercises for the firm – to discover how the supply function represents maximal profit decision making.
  • The model is a bit asymmetrical, as we will see.
steps three four
Steps Three, Four, …
  • Once we are familiar with the basics of supply & demand
    • What are industries?
    • What is meant by economic welfare?
    • When do markets work and when do markets fail?
    • How would we measure failure?
    • When is their a role for government?
  • Derivatives measure the slopes of lines.
  • For example, curves do not have slopes, but lines tangent to curves do.
  • Notice something about curves that have peaks and troughs:
    • At the peaks and the troughs, the lines tangent at these points have zero slope.
first order conditions
First Order Conditions
  • Finding where the derivatives are equal to zero constitute the first order conditions for maxima and/or minima of functions.
second order conditions
Second Order Conditions
  • If we find a candidate for a maximum or a minimum, how do we tell?
  • SOC’s help us determine if we have found a max, a min, or something else.
  • Why are we doing this when we could just graph it?
    • Multiple dimensions
    • Econometric specification
  • Now watch this example…after the presentation we will slow down and learn how to use the rules of calculus. We will have many simple examples and lots of practice problems.
f x 3x 2 5x 31
f’(x) = 3x2 – .5x - 3
  • At x = 1.0868 f’(x) = 0
  • At x = -0.9201 f’(x) = 0
  • These are called the critical values of f(x).
  • Note that at 1.0868 , f(x) reaches what we call a local minimum.
  • At -0.9201, f(x) reaches a local maximum.
f x 6x 5
f’’(x) = 6x - .5
  • At x=1.08, f’’(x) = 6.0279 which is a positive number.
  • At x=-0.92, f’’(x) = - 6.0279, which is a negative number.
  • These are examples of FOC and SOC, finding a local min and a local max.
  • Note f(x) has no global max or min.
  • f(x) = k
  • f(x) = ax
  • f(x) = ax2 + bx + c
  • f(x) = g(x)*h(x)
  • f(x) = g(h(x))
  • f(x) = g(x)/h(x)
  • f(x) = ln(x)
  • f(x) = ex
  • f(x,y)
    • Now we have two derivatives
    • fx and fy which are called partial derivatives
  • f(x,y) = axy + by2 + c
  • fx = ay
  • fy = ax + 2by
  • FOC’s involve a simultaneous system of equations to solve:
    • fx = 0
    • fy = 0
f x y 3x 2 2y 21
f(x,y) = 3x2 + 2y2
  • Here, fx = 6x and fy = 4y
  • At the point (0,0) both of these equations are equal to zero.
  • Thus (0,0) is a critical value and we see that (0,0) is associated with a minimum value of our objective function
f x y 3x 2 2y 23
f(x,y) = 3x2 – 2y2
  • For this function there is one critical value, again at (x,y) = (0,0).
  • But note that this is not associated with a max or a min.
  • It is called a saddle point.
great news
Great News
  • In this class (and in other econ classes you will take) the functions you deal with will be nicely behaved.
  • By nicely behaved we mean that we can easily find critical values.
  • And these critical values will be associated with maximum or minimum values.
forest for trees
Forest for Trees
  • Let’s also remember something important. We do not want to get bogged down in the details of mathematics and forget why we are doing calculus in the first place!
  • At our level we want to come up with models of prescriptive (optimal) behavior and calculus is tool we use along the way.
  • Always remember … narrative reasoning is more convincing that equations.