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ECB1MI
Microeconomics, Institutions and Welfare
Lecture 1
Prof. Dr. Stephanie Rosenkranz
Dr. Annette van den Berg
Drs Linda Keijzer
Drs Joyce Delnoij
Drs Sergei Hoxha
Drs Oke Onemu
11:11 1
Important information about the course
Schedule:
– one lecture per week (Monday)
– one test (45 Minutes) on MyLabsPlus per week
(Wednesday 6 PM until Sunday 11PM)
– two tutorials a week (Wednesday, Friday)
• but only one tutorial in week 47 (check schedule on WebCT!!)
11:11 2
Important information about the course
Material:
– Pindyck and Rubinfeld, 8th ed.
– Chapters 1- 4, 6 -14, 16 -18
– Book Chapter Institutional Economics
– Lecture notes (see course details)
– same book is used in course Intermediate Microeconomics
(remaining chapters + Game Theory)
– Problem sets
– MyLabsPlus (MLP)
11:11 3
Problem sets:
=> Treated in tutorials (see folders Course Content on
Blackboard)
• multiple choice questions
• open questions
=> Active participation counts
11:11 4
Look at sample exam
2 mid-term examinations (100% multiple choice,
see MLP) course week 4 and course week 7
end-term examination (100% open questions,
see tutorial questions) course week 9
Final grade: 30% Midterms (15% each), 70% final exam
11:11 5
1. MyLabsPlus
=> Log in (see folders Course Information on Blackboard)
• Username (login name): student number
• Password: student number
=> Code (comes with the book, can be bought via MLP)
=> Multiple choice questions • Have to be done in once
• Limited time
2. Active participation in class
Effort requirements
11:11 6
Blackboard
11:11 7
What is microeconomics about?
Scarcity → making choices = trade-offs
Strict assumptions
- rational, consistent choices (w.r.t information and preferences)
- optimizing behaviour → maximizing utility or maximizing profit/revenue
How do economic agents allocate scarce resources
• Consumers
• Workers
• Households
• Firms
• Politicians
• etc.
• time
• money
• production factors,
etc.
Markets
Interaction of economic agents on markets determine prices (demand and
supply) → Trade-offs are based on prices
11:11 8
Theories and Models
In economics, explanation and prediction are based on theories.
Theories are developed to explain observed phenomena in terms
of a set of basic rules and assumptions.
A model is a mathematical representation, based on economic
theory, of a firm, a market, or some other entity.
Theories and Models
11:11 10
Assume you are an alien on your first
visit to Earth
You see this animal and you are told it is called a ‘dog’.
11:11 11
Assume you are an alien on your first
visit to Earth Then you see these very different animals. Are these dogs?
Panda dogs are the new rage in China. Most are
chows that have undergone cosmetic primping to
have them appear as pandas.
11:11 12
Assume you are an alien on your first
visit to Earth Slowly but surely a dog-model emerges in your mind:
Does any individual case of a dog look like this? NO
Does it help you to define and identify dogs? YES
11:11 13
Theories and Models
11:11 14
Theories and Models
11:11 15
Positive versus Normative Analysis
positive analysis
Analysis describing relationships of cause and effect.
normative analysis
Analysis examining questions of what ought to be.
Agenda for today:
1. Introduction to demand and supply
→ what is a demand curve, what is a supply curve
→ the notion of equilibrium
2. Shifts in demand and supply
→ the effect on equilibrium
3. Elasticities, short term and long term
4. Government intervention
→ the effect on equilibrium
11:11 17
The Demand Curve
We can write this relationship between
quantity demanded and price as an equation:
QD = QD(P)
or
P = P(QD) (inverse demand function)
demand curve Relationship between the quantity of a
good that consumers are willing to buy and the price of the
good.
1. Introduction to demand and supply
(individual) Demand Curve
Q2
(Shift along the demand curve)
Note: downward sloping curve 11:11 19
Aggregate demand
4 7 11
4 8 12 24
0
Note: Aggregate demand is always less steep than individual demand 11:11 20
The Supply Curve
We can write this relationship between
quantity supplied and price as an equation:
QS = QS(P)
or
P = P(QS) (inverse supply function)
supply curve Relationship between the quantity of
a good that producers are willing to sell and the price
of the good.
Q2
(individual or market) Supply Curve
(Shift along the
supply curve)
Note 1: upward sloping curve
Note 2: derivation of aggregate supply is similar to derivation of aggregate demand
11:11 22
(Competitive) Market Equilibrium: Q`D(P) = QS(P)
Conditions:
1) Free entry/exit
2) Homogeneity
3) No market power
4) Transparency
One market price
results 11:11 23
Market mechanism leading to equilibrium
Now, suppose that originally
the price is above P0: surplus
→ P(QS) > P(QD)
→ underbidding
→ P(QS)
→ QS and QD
(shifts along the curves)
until QS = QD 11:11 24
2. Shifts in demand and supply
When a non-price determinant of demand (or supply) changes
the curve shifts.
These "other variables" are part of the demand (or supply)
function. They are "merely lumped into the intercept term of a
demand (or supply) function."
Thus a change in a non-price determinant of demand (or supply) is
reflected in a change in the x-intercept causing the curve to shift
along the x axis.
11:11 25
A shift of the (whole) demand curve
Due to one of the following changes ():
1) number of consumers
2) disposable income
3) taste and preferences
4) prices of related goods (substitutes and complements)
5) expectations
D’’
11:11 26
Effect of demand change on equilibrium
So, shift of demand curve
leads to shift along supply curve !
11:11 27
The Economist explains
11:11 28
Why it is cheaper to buy property in Berlin
than in other European capitals
Nov 6th 2014, 23:50
Property prices continue to climb in London
and in other major European cities, but Berlin
has defied the trend
Due to one of the following changes ():
1) number of suppliers (or magnitude of supply)
2) technology
3) production costs (and management skills)
4) government policies
A shift of the (whole) supply curve
S”
11:11 29
Effect of supply change on equilibrium
So, shift of supply curve
leads to shift along demand curve !
11:11 30
3. Elasticities
Measuring effects of changes in prices or other
factors on demand or supply.
11:11 31
Elasticity Percentage change in one variable resulting from
a 1-percent increase in another.
Price elasticity of demand Percentage change in quantity
demanded of a good resulting from a 1- percent increase in
its price.
(2.1)
The importance of elasticities
The importance of elasticities
In other words:
the elasticity measures the sensitivity to a price change
Hereafter:
1) Price elasticity of demand (most slides)
2) Price elasticity of supply (one slide)
3) Income elasticity (one slide)
4) Cross-price elasticity (one slide)
11:11 33
The importance of elasticities (II)
the degree in which a % price change
leads to a % change in the quantity demanded
Q
P P
Q
D
D
P0
P1
Q0 Q1 Q0 Q1
Q is very small
= relatively inelastic demand Q is very big
= relatively elastic demand
In other words: the relationship between %P and %Q
P
34
The importance of elasticities (III)
the degree in which a % price change leads
to a % change in the quantity demanded (or supplied)
Q
P P
Q
D
D
P0
P1
Q0 Q1 Q0 Q1
10
8
20 22 20 30
(Q1-Q0)/Q0
(P1-P0)/P0
11:11 35
Task 2: calculate
the elasticities
at (P0, Q0) for both
functions.
The importance of elasticities (IV)
Q
P P
Q
D
D
P0
P1
Q0 Q1 Q0 Q1
10
8
20 22 20 30
(Q1-Q0)/Q0
(P1-P0)/P0
11:11 36
the degree in which a % price change leads
to a % change in the quantity demanded (or supplied)
The importance of elasticities (V)
Relatively elastic: if E < –1 or: if E > 1
Relatively inelastic: if –1 < E < 0 or: if 0 < E < 1
→ turning point is at E = –1 (unit elasticity)
What does it mean if E = –1?
→ When a price rises with, say, 10%, demand decreases with 10%
What does it mean if E = –0.5?
→ When a price rises with, say, 10%, demand decreases with only 5%
What does it mean if E = –2.5?
→ When a price rises with, say, 10%, demand decreases with 25% 11:11
37
The importance of elasticities (VI)
Q
P = first derivative
(slope) of (demand)
function
E = -2 * 2/4 = -1
1
6
-2 * 1/6 = -1/3 E =
11:11 38
The importance of elasticities (VII)
Elastic part of the (linear) demand curve: E < –1
Inelastic part of the demand curve: –1 < E < 0
Note: Each point on a linear,
downward sloping curve gives
a different value for E
and each linear curve,
irrespective of its steepness, has
elastic and inelastic points 11:11 39
The importance of elasticities (VIII)
4 8
With linear demand curves, we see a
steady relationship between
E(lasticity) and TR (total revenue):
TR
Q 0
8
2 6
4
6
3.5
(TR = P*Q)
2
3
6
1
●
● ●
● ●
1. If E is elastic, a decrease in the
price leads to rising revenue
2. If E is inelastic, a decrease in the
price leads to declining revenue
→ policy implications! 11:11 40
Two extremes:
The importance of elasticities (IX)
Infinitely Elastic Completely Inelastic (the slope is infinite) (the slope is 0)
(i.e. demand is very sensitive to P) (i.e. demand does not react to P at all)
Examples?? Perfectly elastic demand: good has a large number of very close (that is, perfect) substitutes-
in-consumption readily available.
Perfectly inelastic demand: good has absolutely no substitutes-in-consumption.
41
Market for gasoline Market for automobiles
The importance of elasticities (X)
Short-term (SR) versus Long-term (LR) elasticities
P P
Q (SR) < Q (LR) Q (SR) > Q (LR)
11:11 42
the degree in which a price change
leads to a change in the quantity supplied
Price elasticity of supply
(Q1-Q0)/Q0
(P1-P0)/P0 EP =
Suppose P1 = 10
P3 = 12
Q1 = 10
Q3 = 14
→ Calculate EP
→ EP = +40%/+20% = 2
→ if EP > 1 → elastic supply; if 0 < EP < 1 inelastic supply 43
Income elasticity and cross-price elasticity
(formulas are in the book, p. 35) Recall: Demand curve may shift due to:
1) number of consumers
2) income
3) preferences
4) price substitution goods
price complementary goods
Income elasticity:
the degree in which
a % income change leads
to a % change in the
quantity demanded
Cross-price elasticity: the degree in which a % price
change in a substitution good or
complementary good leads to a
change in the quantity demanded
of another good
Substitution goods show
a positive sign for E;
Complementary goods show
a negative sign for E.
11:11 44
4. Effects of government interventions
Price controls are governmental impositions on the prices
charged for goods and services in a market.
A “price ceiling” is a government-imposed limit on the price
charged for a product. Governments often impose price ceilings
to protect consumers from conditions that could make
necessary commodities unattainable.
A “price floor” is a government-imposed limit on how low a
price can be charged for a product.
Price ceiling
Government intervention → the effect on equilibrium I
Introduction of maximum price
Interference with free market leads to a trade-off decision:
Some people gain and some lose from price controls. 11:11 46
Government intervention → the effect on equilibrium II
Introduction of minimum price
Pmin
Price floor
Excess supply ?
Only in combination
with price support! 11:11 48
Thank you for
your attention
and see you next
week!
11:11 49
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