Class 1: A review of basic

microeconomics

Microeconomics
Study of firms, consumers & markets
(As opposed to macroeconomics).
How do individual agents behave?
How do individual agents interact in
markets?

Basic idea: a market.

A place where agents buy or sell.
Product markets.
Factor or input markets.
Hypothesis: buyers & sellers behave to
rationally optimise their benefit.

Demand (buying)
Consider a group of individual buyers
(consumers).
Define the reservation price of a buyer as
the maximum they will pay.
Then market demand shows purchases in
a market at any reservation price.

Demand is a function:

Qd = Qd(p)
So quantity demanded Qd depends on
price p.
As price increases less will be purchased.

Graphing demand in a market:

Price p

As price goes up
people buy less

Quantity demanded Qd

Supply (selling)
Consider a group of vendors (sellers)
Define a vendors willingness-to-sell as the
minimum price they need to be offered to
supply.
Then market supply shows how much is
supplied at any price.

Supply is a function:
Qs = Qs(p)
So the quantity demanded Qs depends on
price p.
As price increases more will be offered for
sale.

Graphing supply in a market:

Price p

As price increases more is

offered for sale

Quantity supplied Qs

What determines supply?

Basically technology & costs.
If a firm takes prices given it produces to
the point where its extra costs (its marginal
costs) equal price.
Hence firm supply is its MC curve.

Market equilibrium: Putting supply

and demand together:
Now have a simple model:
Qd = Qd(p)
Qs = Qs(p)

This is indeterminate 3 variables

Qs, Qd & p but only 2 equations. Help!!!!!!!!

One way of closing the model:

Impose the equilibrium condition:
Qs=Qd.
Why?
Think about excess demands Qd>Qs and excess
supplies Qs > Qd.
These states cannot be an equilibrium.

market price pe, purchases & sales

Qs

pe

Qd

Qd(pe)=Qs(pe)

Qd , Qs

Explains market price pe, purchases Qd(pe)

& sales Qs(pe) as solution to:
Qd = Qd(p)
Qs = Qs(p)
Qs = Qd
An equilibrium since it persists.

At pe actions of buyers & sellers consistent.

Its only a model!

Lots of markets are almost never in
equilibrium (e.g. labour market).
Other markets may involve buyer or seller
power does not arise in competitive
setting.

But the competitive model is the basis of

much microeconomics.

Comparative statics
Endogenous variables are explained by a model
(here pe, Qd(pe), Qs(pe) ).
Exogenous variables have values taken as
given in a model (tastes, technologies,
incomes.)

Comparative statics studies how exogenous

variables affect endogenous variables.

Increased consumer income

p
Qs

pe

Qdnew
Qd
Qd(pe)=Qs(pe)

Qd , Qs

A technology improvement
p
Qs

Qsnew
pe

Qd

Qd(pe)=Qs(pe)

Qd , Qs

These graphical techniques are

used a lot.
One is comparing equilibria hence
comparative.
The transition path is ignored hence
statics.

Efficiency
Supply & demand drive an equilibrium that
is efficient.
Definition: If no one can be made betteroff without someone being worse off then
Pareto efficiency or simply efficiency
prevails.

Idea of efficiency
Suppose a group trade among themselves
without restriction anyone can trade whatever
they want without restriction.
The resulting allocation is efficient - if any 2
people could have made themselves better-off
they would have.
An all powerful being (a government) could
make someone better off but only by making
someone else worse off.

Proposition: Market equilibrium is efficient

Proof (intuitive)
If no constraints are placed on buyers or sellers
efficiency must obtain. If there were options for
groups to make themselves better-off with trade
they would be exploited.

Market outcomes (though efficient) may be

unfair in the sense that the rich get most of the
resources.

But competitive market outcomes are efficient in

the sense of being non-wasteful.
We characterise many environmental problems
as inefficiencies.

Main points of this class:

Microeconomics

Market equilibrium

Markets

Excess demand excess

supply

Buyers and sellers

Comparative statics
Demand & WTP

Pareto efficiency.
Supply & WT sell
Marginal cost.

End of class 1