1. Microeconomics A Anna Kukla-Gryz E-mail: akukla@wne.uw.edu.plakukla@wne.uw.edu.pl

2. Requirements for passing the course u Passing the course, two elements:  1st element: exam (70 % of the total points)  2nd element: grade from tutorials (30 % of the total points). To pass you need:  at least 50 % of the total points from the exam AND  at least 50 % of the total points from tutorials

3. Final test u The exam will be held on the exam period, u The exam – multiple choice test (five answers proposed to each question, only one is correct). u The test must be passed with a positive result (at least 50% of the total points). u It will be organized only once. Absence at the final test (on the required date) results in failing the course.

4. Exam Retake u In the retake exam period (in March) there will be only one final test organized, taking the same form as the normal final test. u All participants of the course are allowed to take the retake test, regardless of the result from the first approach. u Taking the retake exam cancels the result obtained from the first approach.

5. Other rules u All tests are organized according to the rules of "Zero tolerance for cheating". u There are no other possibilities (neither new dates nor rules) for passing the course.

6. Grades PointsGrade <0,50)2 <50,60)3 <60,70)3,5 <70,80)4 <80,90)4,5 5

7. Readings u Varian H. R., Intermediate Microeconomics: A Modern Approach, W. W. Norton & Co Ltd., New York, London, 2006 u Bergstrom T. C., Varian, H. R., Workouts in Intermediate Microeconomics, W. W. Norton & Co Ltd., New York, London, 2006 http://www.microeconomics.wne.uw.edu.pl/index.php?n=Main.A

8. Extra Reading u Besanko, D., Braeutigam, R. R., Microeconomics, John Wiley&Sons, 2008 u Browning, E. K., Zupan, M. A., Microeconomics: Theory and Applications, John Wiley&Sons, 2009 u Case, K. E., Fair, R. C., Principles of Microeconomics, Prentice Hall, 2006 u Hubbard, G., O'Brien, A. P., Microeconomics, Prentice Hall, 2007 u Jehle, G. A., Reny, P. J., Advanced Microeconomic Theory, Addison Wesley, 2000 u Mansfield E., Yohe G., Microeconomics: Theory and Applications, W. W. Norton & Co, 2004 u McConnell, C. R., Brue, S. L., Microeconomics, Irwin/McGraw- Hill, 2008

9. u Nicholson, W., Microeconomic Theory: Basic Principles and Extensions, South-Western College Pub, 2004 u O'Sullivan, A., Sheffrin, S., Perez, S., Microeconomics: Principles, Applications, and Tools, Prentice Hall, 2006 u Perloff, J. M., Microeconomics: Theory and Applications with Calculus, Addison-Wesley, 2007 u Pindyck, R. S., Rubinfeld, D. L., Microeconomics, Pearson Education, Inc., New Jersey, 2005 u Mas-Colell A., Whinston M. D., Green J., Microeconomic Theory, Oxford University Press, New York, Oxford 1995

10. Mathematics u Sydsaeter, K. P., Hammond, A., Essential Mathematics for Economic Analysis, Prentice Hall, 2008 u Sydsaeter, K. P., Hammond, A., Seierstad, A., Strom., A., Further Mathematics for Economic Analysis, Prentice Hall, 2008

11. ©2005 Pearson Education, Inc.Chapter 111 Introduction u What are the key themes of microeconomics? u Why study microeconomics?

12. ©2005 Pearson Education, Inc.Chapter 112 Themes of Microeconomics u Microeconomics deals with limits –Limited budgets –Limited time –Limited ability to produce u How do we allocate scarce resources?

13. ©2005 Pearson Education, Inc.Chapter 113 Themes of Microeconomics u 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? u How are these trade-offs best made?

14. ©2005 Pearson Education, Inc.Chapter 114 Themes of Microeconomics u 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?

15. ©2005 Pearson Education, Inc.Chapter 115 Themes of Microeconomics u Workers –Individuals decide when and if to enter the workforce v Trade-offs of working now or obtaining more education/training –How many hours do individuals choose to work? v Trade-off of labor and leisure

16. ©2005 Pearson Education, Inc.Chapter 116 Themes of Microeconomics u Firms –What types of products do firms produce? v Constraints on production capacity and financial resources create needs for trade-offs –Theory of the Firm – describes how these trade-offs are best made

17. ©2005 Pearson Education, Inc.Chapter 117 Themes of Microeconomics u 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

18. ©2005 Pearson Education, Inc.Chapter 118 Themes of Microeconomics u Prices –How are prices determined? v Centrally planned economies – governments control prices v Market economies – prices determined by interaction of market participants –Markets – collection of buyers and sellers whose interaction determines the prices of goods

19. ©2005 Pearson Education, Inc.Chapter 119 Theories and Models u 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: v The Theory of the Firm v The Theory of Consumer Behavior

20. ©2005 Pearson Education, Inc.Chapter 120 Theories and Models u Theories are used to make predictions –Economic models are created from theories –Models are mathematical representations used to make quantitative predictions

21. ©2005 Pearson Education, Inc.Chapter 121 Theories and Models Theories are invariably imperfect – but gives much insight into observed phenomena

22. ©2005 Pearson Education, Inc.Chapter 122 Positive & Normative Analysis u Positive Analysis – statements that describe the relationship of cause and effect –Questions that deal with explanation and prediction v What will be the impact of an import quota on foreign cars? v What will be the impact of an increase in the gasoline excise tax?

23. ©2005 Pearson Education, Inc.Chapter 123 Positive & Normative Analysis u Normative Analysis – analysis examining questions of what ought to be –Often supplemented by value judgments v Should the government impose a larger gasoline tax? v Should the government decrease the tariffs on imported cars?

24. Budgetary and Other Constraints on Choice Source: Hal R. Varian

25. Consumption Choice Sets u A consumption choice set is the collection of all consumption choices available to the consumer. u What constrains consumption choice? –Budgetary, time and other resource limitations.

26. Budget Constraints u A consumption bundle containing x 1 units of commodity 1, x 2 units of commodity 2 and so on up to x n units of commodity n is denoted by the vector (x 1, x 2, …, x n ). u Commodity prices are p 1, p 2, …, p n.

27. Budget Constraints u Q: When is a consumption bundle (x 1, …, x n ) affordable at given prices p 1, …, p n ?

28. Budget Constraints u Q: When is a bundle (x 1, …, x n ) affordable at prices p 1, …, p n ?  A: When p 1 x 1 + … + p n x n  m where m is the consumer’s (disposable) income.

29. Budget Constraints  The bundles that are only just affordable form the consumer’s budget constraint. This is the set { (x 1,…,x n ) | x 1  0, …, x n  and p 1 x 1 + … + p n x n  m }.

30. Budget Constraints  The consumer’s budget set is the set of all affordable bundles; B(p 1, …, p n, m) = { (x 1, …, x n ) | x 1  0, …, x n  0 and p 1 x 1 + … + p n x n  m } u The budget constraint is the upper boundary of the budget set.

31. Budget Set and Constraint for Two Commodities x2x2 x1x1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 m /p 2

32. Budget Set and Constraint for Two Commodities x2x2 x1x1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 2 m /p 1

33. Budget Set and Constraint for Two Commodities x2x2 x1x1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Just affordable m /p 2

34. Budget Set and Constraint for Two Commodities x2x2 x1x1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Just affordable Not affordable m /p 2

35. Budget Set and Constraint for Two Commodities x2x2 x1x1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Affordable Just affordable Not affordable m /p 2

36. Budget Set and Constraint for Two Commodities x2x2 x1x1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Budget Set the collection of all affordable bundles. m /p 2

37. Budget Set and Constraint for Two Commodities x2x2 x1x1 p 1 x 1 + p 2 x 2 = m is x 2 = -(p 1 /p 2 )x 1 + m/p 2 so slope is -p 1 /p 2. m /p 1 Budget Set m /p 2

38. Budget Constraints u If n = 3 what do the budget constraint and the budget set look like?

39. Budget Constraint for Three Commodities x2x2 x1x1 x3x3 m /p 2 m /p 1 m /p 3 p 1 x 1 + p 2 x 2 + p 3 x 3 = m

40. Budget Set for Three Commodities x2x2 x1x1 x3x3 m /p 2 m /p 1 m /p 3 { (x 1,x 2,x 3 ) | x 1  0, x 2  0, x 3   0 and p 1 x 1 + p 2 x 2 + p 3 x 3  m}

41. Budget Constraints u For n = 2 and x 1 on the horizontal axis, the constraint’s slope is -p 1 /p 2. What does it mean?

42. Budget Constraints u For n = 2 and x 1 on the horizontal axis, the constraint’s slope is -p 1 /p 2. What does it mean? u Increasing x 1 by 1 must reduce x 2 by p 1 /p 2.

43. Budget Constraints x2x2 x1x1 Slope is -p 1 /p 2 +1 -p 1 /p 2

44. Budget Constraints x2x2 x1x1 +1 -p 1 /p 2 Opp. cost of an extra unit of commodity 1 is p 1 /p 2 units foregone of commodity 2.

45. Budget Constraints x2x2 x1x1 Opp. cost of an extra unit of commodity 1 is p 1 /p 2 units foregone of commodity 2. And the opp. cost of an extra unit of commodity 2 is p 2 /p 1 units foregone of commodity 1. -p 2 /p 1 +1

46. Budget Sets & Constraints; Income and Price Changes u The budget constraint and budget set depend upon prices and income. What happens as prices or income change?

47. How do the budget set and budget constraint change as income m increases? Original budget set x2x2 x1x1

48. Higher income gives more choice Original budget set New affordable consumption choices x2x2 x1x1 Original and new budget constraints are parallel (same slope).

49. How do the budget set and budget constraint change as income m decreases? Original budget set x2x2 x1x1

50. How do the budget set and budget constraint change as income m decreases? x2x2 x1x1 New, smaller budget set Consumption bundles that are no longer affordable. Old and new constraints are parallel.

51. Budget Constraints - Income Changes u Increases in income m shift the constraint outward in a parallel manner, thereby enlarging the budget set and improving choice.

52. Budget Constraints - Income Changes u Increases in income m shift the constraint outward in a parallel manner, thereby enlarging the budget set and improving choice. u Decreases in income m shift the constraint inward in a parallel manner, thereby shrinking the budget set and reducing choice.

53. Budget Constraints - Income Changes u No original choice is lost and new choices are added when income increases, so higher income cannot make a consumer worse off. u An income decrease may (typically will) make the consumer worse off.

54. Budget Constraints - Price Changes u What happens if just one price decreases? u Suppose p 1 decreases.

55. How do the budget set and budget constraint change as p 1 decreases from p 1 ’ to p 1 ”? Original budget set x2x2 x1x1 m/p 2 m/p 1 ’ m/p 1 ” -p 1 ’/p 2

56. How do the budget set and budget constraint change as p 1 decreases from p 1 ’ to p 1 ”? Original budget set x2x2 x1x1 m/p 2 m/p 1 ’ m/p 1 ” New affordable choices -p 1 ’/p 2

57. How do the budget set and budget constraint change as p 1 decreases from p 1 ’ to p 1 ”? Original budget set x2x2 x1x1 m/p 2 m/p 1 ’ m/p 1 ” New affordable choices Budget constraint pivots; slope flattens from -p 1 ’/p 2 to -p 1 ”/p 2 -p 1 ’/p 2 -p 1 ”/p 2

58. Budget Constraints - Price Changes u Reducing the price of one commodity pivots the constraint outward. No old choice is lost and new choices are added, so reducing one price cannot make the consumer worse off.

59. Budget Constraints - Price Changes u Similarly, increasing one price pivots the constraint inwards, reduces choice and may (typically will) make the consumer worse off.

60. Uniform Ad Valorem Sales Taxes  An ad valorem sales tax levied at a rate of 5% increases all prices by 5%, from p to (1+0  05)p = 1  05p. u An ad valorem sales tax levied at a rate of t increases all prices by tp from p to (1+t)p. u A uniform sales tax is applied uniformly to all commodities.

61. Uniform Ad Valorem Sales Taxes u A uniform sales tax levied at rate t changes the constraint from p 1 x 1 + p 2 x 2 = m to (1+t)p 1 x 1 + (1+t)p 2 x 2 = m

62. Uniform Ad Valorem Sales Taxes u A uniform sales tax levied at rate t changes the constraint from p 1 x 1 + p 2 x 2 = m to (1+t)p 1 x 1 + (1+t)p 2 x 2 = m i.e. p 1 x 1 + p 2 x 2 = m/(1+t).

63. Uniform Ad Valorem Sales Taxes x2x2 x1x1 p 1 x 1 + p 2 x 2 = m

64. Uniform Ad Valorem Sales Taxes x2x2 x1x1 p 1 x 1 + p 2 x 2 = m p 1 x 1 + p 2 x 2 = m/(1+t)

65. Uniform Ad Valorem Sales Taxes x2x2 x1x1 Equivalent income loss is

66. Uniform Ad Valorem Sales Taxes x2x2 x1x1 A uniform ad valorem sales tax levied at rate t is equivalent to an income tax levied at rate

67. The Food Stamp Program u Food stamps are coupons that can be legally exchanged only for food. u How does a commodity-specific gift such as a food stamp alter a family’s budget constraint?

68. The Food Stamp Program u Suppose m = $100, p F = $1 and the price of “other goods” is p G = $1. u The budget constraint is then F + G =100.

69. The Food Stamp Program G F 100 F + G = 100; before stamps.

70. The Food Stamp Program G F 100 F + G = 100: before stamps.

71. The Food Stamp Program G F 100 F + G = 100: before stamps. Budget set after 40 food stamps issued. 14040

72. The Food Stamp Program G F 100 F + G = 100: before stamps. Budget set after 40 food stamps issued. 140 The family’s budget set is enlarged. 40

73. The Food Stamp Program u What if food stamps can be traded on a black market for $0.50 each?

74. The Food Stamp Program G F 100 F + G = 100: before stamps. Budget constraint after 40 food stamps issued. 140 120 Budget constraint with black market trading. 40

75. The Food Stamp Program G F 100 F + G = 100: before stamps. Budget constraint after 40 food stamps issued. 140 120 Black market trading makes the budget set larger again. 40