Frank Cowell: EC202 Microeconomics Revision Lecture 1 EC202: Microeconomic Principles II Frank Cowell May 2008

Frank Cowell: EC202 Microeconomics Objectives of the lecture A look back at Term 1 A look back at Term 1 Introduction to exam preparation Introduction to exam preparation Reference materials used (1) Reference materials used (1)  exam papers (and outline answers)  (c)  (c)  (a)  (a)  (a) Reference materials used (2) Reference materials used (2)  CfD presentations 2.9  related to past exam question  (...more to follow next week)

Frank Cowell: EC202 Microeconomics Principles Scope of exam material Scope of exam material  what’s covered in the lectures…  … is definitive for the exam Resit Resit  syllabus for 2007/8 is same as 2006/7  so resit candidates from last year get the same paper as new candidates Structure and format of paper Structure and format of paper  follows that of last three years  check out the rubric from, say, 2007 paper Mark scheme Mark scheme  40 marks for question 1 (8 marks for each of the five parts)  20 marks for each of the other three questions  multipart questions: except where it’s obvious, roughly equal marks across parts

Frank Cowell: EC202 Microeconomics Question Style – three types 1 Principles 1 Principles  reason on standard results and arguments  can use verbal and/or mathematical reasoning 2 Model solving 2 Model solving  a standard framework  you just turn the wheels 3 Model building 3 Model building  usually get guidance in the question  longer question sometimes easier? One type not necessarily “easier” or “harder” than another One type not necessarily “easier” or “harder” than another  get you to display different skills  part A (question 1) usually gets you to do both types 1 and 2  type 3 usually only in parts B and C of paper Examples from past question 1

Frank Cowell: EC202 Microeconomics (c) Straightforward “principles” question Straightforward “principles” question Just say what you need to say Just say what you need to say

Frank Cowell: EC202 Microeconomics (a) Straight “principles” Straight “principles” Note contrast between firm and consumer Note contrast between firm and consumer Be sure to give your reasons Be sure to give your reasons

Frank Cowell: EC202 Microeconomics (a) Principles again Principles again But format of question gives you a hint… But format of question gives you a hint… …write out decomposition formula …write out decomposition formula Then read off results Then read off results

Frank Cowell: EC202 Microeconomics (c) A model-solving question A model-solving question (i) just set E(  ) = 0 and twiddle (i) just set E(  ) = 0 and twiddle (ii) check what happens to E if you change  (ii) check what happens to E if you change  (iii) draw diagram and reason (iii) draw diagram and reason

Frank Cowell: EC202 Microeconomics (a) – question and approach A “hybrid” question A “hybrid” question Mainly model- solving Mainly model- solving But there’s an important principle But there’s an important principle will a solution even exist? What’s the solution to the monopolist’s problem? What’s the solution to the monopolist’s problem? Approach: Approach:  Find the expression for profits  Then try to maximise…

Frank Cowell: EC202 Microeconomics (a) – main answer To get profits we need demand function To get profits we need demand function You could just jump to last line You could just jump to last line Now write down profit expression Now write down profit expression Note wording in last line Note wording in last line

Frank Cowell: EC202 Microeconomics (a) – finishing off answer Use knowledge of basic principles Use knowledge of basic principles Effectively the competitive case Effectively the competitive case No solution! No solution! (we covered this in lectures) (we covered this in lectures)

Frank Cowell: EC202 Microeconomics Long questions Let’s look at an example Let’s look at an example  taken from exercise in the book  but of “exam type” difficulty  covered in CfD Illustrates type 2 question Illustrates type 2 question  Ex 2.9 is mainly model solving  next week: look at model building Look out for tips Look out for tips  Use simple principles to give you a shortcut to the answer  Use pictures where they help

Frank Cowell: EC202 Microeconomics Ex 2.9(1): Question purpose: demonstrate relationship between short and long run purpose: demonstrate relationship between short and long run method: Lagrangean approach to cost minimisation. First part can be solved by a “trick” method: Lagrangean approach to cost minimisation. First part can be solved by a “trick”

Frank Cowell: EC202 Microeconomics Ex 2.9(1): Long-run costs Production function is homogeneous of degree 1 Production function is homogeneous of degree 1  increase all inputs by a factor t > 0 (i.e. z → tz)…  …and output increases by the same factor (i.e. q → tq)  constant returns to scale in the long run CRTS implies constant average cost CRTS implies constant average cost  C(w, q) / q = A (a constant)  so C(w, q) = Aq  differentiating: C q (w, q) = A So LRMC = LRAC = constant So LRMC = LRAC = constant  Their graphs will be an identical straight line

Frank Cowell: EC202 Microeconomics Ex 2.9(2): Question method: Standard Lagrangean approach Standard Lagrangean approach

Frank Cowell: EC202 Microeconomics Ex 2.9(2): short-run Lagrangean In the short run amount of good 3 is fixed In the short run amount of good 3 is fixed  z 3 =  z 3 Could write the Lagrangean as Could write the Lagrangean as But it is more convenient to transform the problem thus But it is more convenient to transform the problem thus where where

Frank Cowell: EC202 Microeconomics z2z2 z1z1 Ex 2.9(2): Isoquants Sketch the isoquant map Sketch the isoquant map Isoquants do not touch the axes Isoquants do not touch the axes So maximum problem must have an interior solution So maximum problem must have an interior solution

Frank Cowell: EC202 Microeconomics Ex 2.9(2): short-run FOCs Differentiating Lagrangean, the FOCS are Differentiating Lagrangean, the FOCS are This implies This implies To find conditional demand function must solve for To find conditional demand function must solve for  use the above equations…  …and the production function

Frank Cowell: EC202 Microeconomics Ex 2.9(2): short-run FOCs (more) Using FOCs and the production function: Using FOCs and the production function: This implies This implies  where This will give us the short-run cost function This will give us the short-run cost function

Frank Cowell: EC202 Microeconomics Ex 2.9(2): short-run costs By definition, short-run costs are: By definition, short-run costs are: This becomes This becomes Substituting for k: Substituting for k: From this we get From this we get  SRAC:  SRMC:

Frank Cowell: EC202 Microeconomics q Ex 2.9(2): short-run MC and AC marginal cost average cost

Frank Cowell: EC202 Microeconomics Ex 2.9(3): Question method: Draw the standard supply-curve diagram Draw the standard supply-curve diagram Manipulate the relationship p = MC Manipulate the relationship p = MC

Frank Cowell: EC202 Microeconomics Ex 2.9(3): short-run supply curve   average cost curve   marginal cost curve   supply curve q p q p   minimum average cost

Frank Cowell: EC202 Microeconomics Use the expression for marginal cost: Use the expression for marginal cost: Set p = MC for p ≥ p Set p = MC for p ≥ p Rearrange to get supply curve Rearrange to get supply curve Differentiate last line to get supply elasticity Differentiate last line to get supply elasticity Ex 2.9(3): short-run supply elasticity

Frank Cowell: EC202 Microeconomics Ex 2.9: Points to remember Exploit CRTS to give you easy results Exploit CRTS to give you easy results Try transforming the Lagrangean to make it easier to manipulate Try transforming the Lagrangean to make it easier to manipulate Use MC curve to derive supply curve Use MC curve to derive supply curve

Frank Cowell: EC202 Microeconomics Next time Think more about method for long questions Think more about method for long questions Look at a few CfD Look at a few CfD  4.12, 4.13  5.1  7.8  9.6 See how they illustrate method See how they illustrate method Connect these to past exam questions Connect these to past exam questions