Microeconomics (MSc)
Notes for (Beem101 Microeconomics) students; overview
Reading and using this web-book
Focus and style of this module
Level of this module
Readings and resources
Other relevant resources
About this web-book: the Governing Resource
‘Markers’, abbreviations, and callouts/boxes
Leaving comments and asking questions
within this book
using Hypothes.is
Some more cool things about this book
Tech details of this book (‘do I call this ’collophon’?)
Welcome and introduction videos outlined
Aside: A bit about me (Dr. David Reinstein), contact info
Me
Office hours: (TBD; see ELE)
Contact information
How to do well in this module
See also:
Outline and description of module
Briefly
Motivation with puppets
Planned syllabus, coverage (detailed)
Overview of module & rules, discussion/background,
Economic models (& maths tools), ‘empirical’ evidence
(
\(\frac{1}{2}\)
week)
Sec. @ref(pref-util-choice):
Preferences and utility; Choice
(1.5 weeks)
Sec. @ref(uncertainty)
Preferences under uncertainty (and over time)
(1 week)
Consumer preferences, indifference curves/sets
(0.5 weeks)
Consumer behavior/Individual (and market) demand functions and their properties
(1 week)
Noting a major “skip”
‘Monopolies and pricing of profit-maximizing price-setting firms’ (especially monopolies)
;
price discrimination/market segmentation
(1.5 weeks)
Notes: Mid-term examination, and a major “skip”
Strategic interactions: Game theory
(and evidence) (2 weeks)
0.0.1
Project, discussion of research
(1 week)
Supplement (optional):
Behavioural economics: Selected further concepts
Supplement (optional): Asymmetric information (Moral hazard, adverse selection, signaling) and applications
Scheduled lectures/tutorials, rules for assesment: see ELE page and module descriptor
1
Models, maths, fundamentals
Key goals of this chunk:
1.1
Empirics, maths revision
1.2
What is Economics?
What is Microeconomics?
1.2.1
So why learn these models, if they are not realistic?
1.3
Economic Models
1.3.1
Differing views about models
1.3.2
The PPF: a ‘model’ and a way of seeing things
“Supply and demand functions”, the “Marshallian cross”, “equilibrium effects”
Models applied in the context of “returns to university education”
How to evaluate, asses, and test models?
1.4
Aside: Empirical work/econometrics
Models: Interactive exercises (‘problem set’):
2
Preferences, Utility and Choice
2.1
Key goals of this chunk
2.2
Reading
Readings: ‘real research papers’
2.2.1
Interactive exercises (‘problem set’)
2.2.2
Content
2.3
Preferences
2.3.1
Preamble
2.3.2
A ‘motivating’ exercise
2.3.3
Preferences: Notation, definition, explanation
2.3.4
Properties
of preferences (some standard assumptions; aka ‘axioms’)
2.3.5
Possible preferences .. “Preference formation”
2.4
Utility functions
2.4.1
When can utility functions ‘represent preferences’?
2.4.2
An increasing function of a (‘regular’*) utility function represents the same preferences
2.5
Choice
2.5.1
Choice and rational choice
2.5.2
Rationalizing choice
2.5.3
Satisficing
2.5.4
The ‘Money pump’ argument
2.5.5
Framing and ‘decoy options’
Exercises: Preferences, utility and choice (‘problem set’):
Exercises: Preferences and utility
(Highly optional): Properties of binary relations - O-R problem 1a.
Shepard Scale and Penrose stairs (O-R problem 6)
Representations with additive utility [O-R 9b]
2.5.6
Some easier exercises (from Varian’s intermediate text)
Exercises: Choice
2.5.7
OR chapter 2 Exercise 6 “Caring up to a limit”
2.5.8
OR chapter 2 Exercise 8 “Money pump”
2.5.9
O-R ex. 2.3
2.5.10
Exercise: Decoy effect (Attraction effect)
3
Preferences under uncertainty (and over time)
3.1
Introduction
Main Readings
3.2
Probability concepts and notation (including sums and integrals): a quick review
3.2.1
Discrete Random Variables
3.2.2
Continuous Random Variables
3.3
“Lotteries”
3.3.1
Formal definition of Lotteries (from O-R), explanation
3.4
Preferences over lotteries
3.5
Properties of preferences (over uncertainties) (O-R 3.2.1)
3.6
Expected utility
3.7
Risk preferences
Risk preferences and EU
3.7.1
Risk attitude: O-R formal depiction
Further intuition and discussion
Intuition for ‘risk aversion iff concave value function
\(v(\cdot)\)
’
Graphical illustration of “risk aversion
\(\leftrightarrow\)
the value function
\(v(\cdot)\)
is concave”
3.8
Allais paradox; considering other (non-EU) frameworks
Simple depiction of Allais paradox
3.9
Experimental measures of risk attitudes
3.10
Applications (esp. to finance):
Benefits of diversification
Asset pricing and the CAPM (basic characterization)
Options contracts
moved to supplement
3.11
Measures of risk preferences, further characterizations
3.11.1
‘Certainty equivalent’ of a gamble, ‘Risk premium’
Local measures of risk-aversion
‘Prudence’
Food for thought: risk preferences across domains
3.12
Time preferences and discounting
Exercises - uncertainty, finance, time preferences (‘problem set’)
Some questions from previous exams (somewhat easier questions)
3.13
From O-R
4
Consumer preferences, constraints and choice, demand functions
4.1
Consumer preferences, indifference curves/sets (0.5 weeks)
4.1.1
“Bundles of goods” (O-R 4.1)
4.1.2
Preferences over bundles, indifference sets (indifference curves) (O-R 4.2 and supplements)
4.1.3
Examples of preferences (over 2 goods)
4.1.4
Properties: Monotonicity
4.1.5
Properties: continuity - discussed
in a previous section
4.1.6
Properties: Convexity (skipping the proofs)
(Differentiability: mainly skip)
4.1.7
Applications: Product positioning, marketing
4.2
Consumer behavior/Individual (and market) demand functions and their properties (1 week)
4.2.1
Choices are subject to constraints
4.2.2
Individual (consumer) demand functions (Marshallian demand) - first pass
4.2.3
Rational consumer and his/her optimisation problem
4.2.4
Marginal rates of substitution
Very simple example, for intuition
More insight into MRS
4.2.5
Note on ‘corner solutions’
4.2.6
Overview: Solution to consumer’s problem
4.2.7
Some ‘popular’ forms for utility functions, and their properties; computation
4.2.8
Rationalizing a demand function (Skip O-R section 5.5) {#}
4.2.9
(Weak axiom of) Revealed Preference
4.3
Properties of (Marshallian) demand functions
Homogeneity
4.3.1
Response to income changes
4.3.2
Response to (own) price changes (limited coverage)
4.3.3
Complements/substitutes; response to (other) price changes (limited coverage)
4.4
Consumer surplus (brief and incomplete treatment)
4.5
Market demand (function) (brief and incomplete treatment)
4.6
Elasticities
Elasticities more precisely
4.6.1
Price elasticity of demand
Examples from the headlines
4.6.2
Properties of price elasticity of demand
4.7
Income elasticity of demand; Normal, luxury, and inferior goods
Some real-world discussion of this
4.8
More formal statements of properties of Marshallian demand
4.9
Adding-up (‘aggregation’) etc
4.10
Enrichment, further material to consider
Further doctoral-prep concepts
Exercises: Consumer preferences and behavior/demand (‘problem set’)
5
(Monopoly) Firms’ optimization and pricing, price-discrimination
Readings:
Textbook reading
Price discrimination in the media and public debate
Material from data science and industry pricing practice
Peer-reviewed academic work
5.1
Why study the monopoly?
5.2
Monopoly profit-maximisation: simple (undergraduate-level) take:
5.2.1
Graphically: Monopoly profit-max
5.2.2
‘There is no supply curve for a monopoly!’
5.3
Monopolistic market, profit-maximization: O-R formal depiction and advanced insights
5.3.1
Profit maximization and marginal revenue
5.3.2
“Lerner markup rule” – an additional insight
5.4
Monopolies and ‘allocative inefficiency’
5.4.1
The deadweight loss of monopoly: simple discussion
Aside: Types of inefficiency; simple definitions
5.4.2
Other potential social costs and benefits of monopoly
5.5
Barriers to entry
5.6
Price discrimination/market segmentation
5.6.1
The basics
The three types of price discrimination
5.7
First-degree and/or ‘perfect’ price discrimination
5.8
Third-degree price discrimination (3dpd) / Market separation
Pricing under 3dpd/market separation (calculations/graphical depiction)
5.8.1
O-R: Formal treatment of the (monopoly) ‘pricing in multiple markets/segments’ problem
5.9
Who benefits from 3DPD?
Why is the benefit uncertain?
5.10
Arbitrage … can foil price discrimination
5.11
‘Second-degree price discrimination’, i.e., ‘self-selection’, i.e., ‘implicit discrimination’
The ‘self-selection’ problem
5.11.1
Formal characterisation (O-R)
5.11.2
Two consumer ‘Monopolistic market with a menu’ (O-R Prop 7.3)
5.11.3
Two consumer self-selection: a simpler parametric example
5.12
How do firms
actually
price? (this section is a work in progress)
Exercises: Pricing/monopoly/price-discrimination (simpler)
5.13
OR 7.1: Double Margins (all parts)
5.14
Welfare loss of monopoly: Discussion question from a prior exam
Monopoly pricing: Examples using R
5.15
Simulating willingness to pay and considering ‘optimal pricing’
5.16
Estimating demand and optimal profit based on ‘historical data’ (presuming random firm ‘price experimentation’)
Exercises: Price discrimination and segmentation, ‘pricing mechanisms’; intro to strategic interaction
Strategic interactions: Game theory; discussion and overview
5.17
Some video lectures covering much of the material in the next sections, but less formally
5.18
Suggested readings
5.19
Introduction
5.19.1
Basic concepts (strategic interaction, elements of a game))
5.19.2
Some examples
What game theory can do (wet blanket)
6
Strategic games
Elements of a game
6.1
‘Individual optimization considerations’; best responses, ‘rationalizability’
6.1.1
Common knowledge
6.1.2
Dominant, dominated strategies and rationalizability
6.1.3
Rationalisability/ Iterated strict dominance
6.2
Nash equilibrium
6.2.1
NE: Simple definition and discussion
6.2.2
NE: Formal depiction
6.2.3
Note on O-R characterization of ‘Nash equilibrium’
6.3
Examples of strategic games
6.4
Mixed strategy (Nash) equilibrium of strategic games
6.4.1
Simple presentation
Matching pennies: mixed strategies
Battle of sexes: mixed strategies
What’s all this rot?
Computing payoffs with mixing
6.4.2
Mixed Strategy: More formal presentation
Example: War of attrition *
6.5
Supplement: Finding NE in continuous games; example – the ‘Tragedy of the commons’
6.5.1
Tragedy of the Commons example
6.5.2
Again – “Strategic complements” and “strategic substitutes”
6.6
Supplement: Prisoners’ Dillemma in Normal and extensive form
6.6.1
The Prisoners’ Dilemma: Extensive form
6.7
How do you solve a problem like multiple-equilibria?
In-class experiment: BOS & coordination; need 2 volunteers
Multiple equilibrium and refinements
Is there a focal point?
7
Extensive form games (and sequential games)
7.1
Extensive form and subgame perfection: simple depiction
7.2
‘Repeated games’ … a form of sequential games (simple depiction)
Definite time horizon
7.2.1
Trigger strategies
7.2.2
Repeated Games: Indefinite or infinite time horizon
7.3
Extensive games (formal, following O-R)
7.3.1
Formal: ‘Regular’ Nash Equilibrium for the Extensive game
7.3.2
Formal: Subgame perfect equilibrium
7.3.3
Bargaining
8
Incomplete/Imperfect information (time permitting)
8.1
Information sets (and ‘partitions’)
8.1.1
Examples in tree form
8.2
Bayesian games (incomplete information, informal)
8.2.1
Bayesian Nash equilibrium (BNE; informal definition)
8.2.2
Example: Asymmetric information Cournot
8.2.3
Example: ‘fight or yield’/simultaneous entry
8.3
Sequential Games with Imperfect information
8.3.1
Definitions: Beliefs, sequential equilibrium, assessments
8.3.2
Equilibrium Concept: Weak sequential equilibrium
8.3.3
Consistency of Beliefs with Strategies (Requirement 2 of WSE)
8.3.4
Sequential games with ‘nature’
8.3.5
Most famous case: the
(Spence
1973
)
signaling model
Suggested exercises
8.4
Strategic games
1. Centipede game …
3. War of attrition
5. Guessing two-thirds of the average
6. “Cheap talk”
8. All pay auction
9. Another version of the location game
11. Contribution game
15. Hawk or dove
8.5
Extensive games
OR-1: Trust game
OR-4: Comparative statics
OR-5: Auctions
OR-6: Solomon’s mechanism
OR-8: Race
OR-10: Implementation
Beem101: Project, discussion of research
8.6
Description from ELE page:
8.7
Option 1: Game Theory: Characterization and analysis of a real-world situation/problem/issue
8.8
Option 2: Asymmetric information/agency theory/mechanism design: Characterization and analysis of a real-world situation/problem/issue
8.9
Option 3: Application of economic theory to (observational) empirical work (econometric/statistical analysis)
8.10
Option 4: Comparison of ‘Economic experiment’ designs (lab or field experiments) guided by Microeconomic theory
8.11
Option 5: Explanation of another ‘advanced concept’ in Microeconomic theory (not covered in midterm), application to a real-world situation/problem/issue (or a deep theoretical question involving human values and behavior)
8.12
Option 6: Real-world pricing and segmentation (or other forms of price discrimination) behavior asessed in light of economic theory
8.13
Other options: You can propose another project that doesn’t exactly fit into the categories above. BUT …
9
Supplement - Behavioural economics: Selected further concepts
9.1
Neoclassical versus Behavioural economics (simple discussion)
9.1.1
Classical economists are not naïve
9.1.2
Behavioural Economics
9.1.3
Modern consensus/entente
9.2
Limits to Human Decision Making: An Overview
9.2.1
Limited cognitive ability
9.3
Limited willpower and ‘hyperbolic discounting’
9.4
Limited self-interest … e.g, altruism and fairness
9.4.1
Converting from ‘material payoffs’ to ‘psychological payoffs’
9.4.2
Supplemental (reading): Evidence on the Ultimatum Game
9.4.3
Ultimatum game: theoretical predictions
9.5
Application: Give-if-you-win (EU vs. Prospect theory)
Field experiment
9.6
Behavioral Economics: further exercises and examples
Sources of evidence and discussion
9.7
Inconsistent preferences; examples considering decisions under uncertainty (simple treatment)
9.7.1
Allais paradox - what could be the explanation?
Kahneman and Tversky scenariae
9.7.2
Explaining the above paradoxes with prospect theory
Prospect theory – loss aversion (LA) part
Standard and loss-averse utility
KT experiment with prospect theory (loss aversion)
Allais redux: loose prospect theory (Loss Aversion) explanation
10
Supplements/appendix
10.1
Supplement: Fortune Cookie Wisdom
10.2
Supplement: market imperfections can suggest business opportunities
10.3
Supplement: is Microeconomics applicable to nature… outside of humans?
10.4
Supplement: Empirical research
10.4.1
Empirical meta-example
10.4.2
Ceteris paribus
10.4.3
Exogenous and endogenous variables
10.4.4
More advanced material on causal inference
10.5
Supplement: Gains to voluntary trade
10.6
Supplement: Quasiconcavity (of utility function/preferences)
10.7
Supplement: Constrained optimization (with many goods), Lagrangian method
10.8
Supplement: Primal and dual of demand (max and min), Hicksian demand, Identities, Slutskly equation
10.8.1
Primal and dual – functions and relationships (doctoral prep):
Expenditure and Indirect utility identities
Hicksian (compensated) and Marshallian (regular) identities
10.9
Intuition from the ‘Slutsky equation’
10.10
Supplement: options contracts
Price of options determined by
References
11
Supplement: Asymmetric information (optional)
11.1
Principal-Agent Problem
11.2
Moral hazard: Basic principles
11.3
Lemons problem
11.4
To learn this material fully (and to be prepared to answer an exam question), please also read:
11.5
Supplement: Hidden information: adapted full presentation
11.5.1
Introduction: Adverse Selection (Hidden information) and screening
11.5.2
A Basic parametric model (two types)
11.5.3
Full information/first-best case
11.5.4
Incomplete
information contracts
11.5.5
Overall results (Important!)
Published with bookdown
Microeconomics (MSc)
Exercises: Price discrimination and segmentation, ‘pricing mechanisms’; intro to strategic interaction
Exeter BEEM101 students: These will be covered
after
the midterm