Module title: Introduction to Economics

Module code: SOCS1008A

Module leader: Dr Hedvig Horvath
Time and Venue:

Lecture: Wed 9-11am, 20 Bedford Way Room

Seminars: 1. Fri 11-12pm, 27 Woburns Square TCRU Library

2. Fri 11-12pm, 18 Woburn Square SSRU Seminar Room

3. Fri 1-2pm, 18 Woburn Square SSRU Seminar Room

4. Fri 2-3pm, 18 Woburn Square SSRU Seminar Room

Date: weeks 6-10 and 12-16 (5th of Oct. to 16th of Dec. 2016)

Regulations, policies and procedures can be found here:

http://www.ucl.ac.uk/srs/academic-manual/c8/ioe

Regulations on undergraduate assessment can be found here:

http://www.ucl.ac.uk/srs/academic-manual/documents/ioe-2016-17/UCL-IOE-Assessment-
Regulations-2016-17.pdf
0
Top tips
1. Read the module handbook. It has all the information you need about the module and
assignments.

2. 70 per cent attendance at taught sessions is required or you will be unable to enter for
module assessment.

3. Make sure you do some reading every week. Use the module handbook to guide you.

4. Use the UCL and IOE libraries and other libraries nearby to access materials that you
cannot access online.

5. Use Moodle to download material and to participate in discussions with other students.

6. Read the criteria for grading of assignments in the course handbook and on Moodle. It is
there to help you.

7. Stick to the assignment deadlines as this is how you get feedback on AND credit for your
work! This is an important part of the teaching and learning process and will help you get
better grades.

If you have any study-related difficulties do contact the Module Leader or your Personal
Tutor, earlier rather than later.

If you have a disability-related query please contact the Student Support Centre on level 4 of
the main building on 20 Bedford Way (http://www.ucl.ac.uk/disability/ioe-students) or call
020 7612 6641.

1
Contents
Contact details ...................................................................................................................3

Module summary...............................................................................................................6

Teaching approach...........................................................................................................7

General reading and resources .....................................................................................8

Week 1: Introduction; Consumer’s Problem .............................................................9

Week 2: Substitution and Income Effects; Market Demand ............................... 11

Week 3: Firm’s Problem; Competitive Supply ....................................................... 12

Week 4: Market Equilibrium; Distortionary Policies ............................................. 15

Week 5: Monopoly ......................................................................................................... 17

Week 6: Introduction to Game Theory; Oligopolies and Monopsony ............. 19

Week 7: Public Goods; Externalities ........................................................................ 21

Week 8: Uncertainty and Risk; Savings and Capital Markets ............................ 23

Week 9: Introduction to Asymmetric Information ................................................. 26

Week 10: Catch-up and Conclusion; A Teaser: Research in Applied

Microeconomics ............................................................................................................. 28

Assessment 2016-17 ..................................................................................................... 31

Deadlines.......................................................................................................................... 32

Submission details, deadlines, and forms .............................................................. 33

2
Contact details

Module leader: h.horvath@ucl.ac.uk

Module administrator: [tbc]

Please note that our postal address is:

Department of Social Science
UCL Institute of Education
20 Bedford Way
London WC1H 0AL

3
Lectures
All lectures are held by Dr Hedvig Horvath.

Week 1 Introduction
Consumer’s Problem

Seminar: Optimization Practice

Week 2 Substitution and Income Effects

Market Demand

Seminar Title – Substitution and Income Effects; Aggregation

Week 3 Firm’s Problem and Competitive Supply

Seminar Title – same as lecture

Week 4 Market Equilibrium and Distortionary Policies

Seminar Title – Welfare Analysis Practice

Week 5 Monopoly

Seminar Title – same as lecture

Reading week (no teaching) – week commencing 7th November 2016

Week 6 Introduction to Game Theory

Oligopolies and Monopsony

Seminar Title – Nash equilibrium Practice

Week 7 Public Goods

Externalities

Seminar Title – same as lecture

Week 8 Uncertainty and Risk

Savings and Capital Markets

Seminar Title – same as lecture

Week 9 Introduction to Asymmetric Information

4
 Seminar Title – Simple Asymmetric Information Games

Week 10 Catch-Up and Conclusion

A teaser: Research in Applied Microeconomics

Seminar: Discussion of Short Projects

5
Module summary

This module is a first year core course that prepares students for the second year,
intermediate core module, “Economics of Public Policy.” It is both an introduction to the
economic way of thinking, as well as a basic microeconomic theory course. It demonstrates
how market-level phenomena are built up from individual decisions of economic agents,
discusses when market forces work and when they fail. All topics will be covered with a strong
policy focus and no advanced mathematics will be used.
This module is targeted towards students in the BSc Programme in Social Sciences with
Quantitative Methods, although interested students from other areas at UCL are welcome if
space permits. It does NOT aim to be an in-depth course in general economics as that is
offered over several terms at the Department of Economics at UCL.

Module aims
 to familiarize students with basic concepts and principles of how economic thinking
builds market-level phenomena from individual decisions of economic agents ;
 to teach students a solid understanding of a basic microeconomic toolkit to address
how markets work or fail, and how public policies may affect economic outcomes ;
 to enable students to analyze simple versions of, for instance, commodity and income
tax policies, antitrust regulations or insurance markets;
 to introduce students to how economists analyze (“model”) the real-world;
 to give a flavor of how microeconomics is used in public policy debates.

Learning outcomes
After completing the module students should be able to:
 understand basic concepts in economic thinking such as opportunity cost,
optimization, trade-offs, equilibrium, strategic behaviour, etc., and apply them in
reasoning to applied topics;
 understand verbal and graphical representation of economic ideas and analysis,
including the relationship between them;
 articulate, communicate and present economic arguments to non-specialist
audiences.
More specifically:
 understand graphical techniques underlying unconstrained and constrained
optimization;
 understand assumptions underlying the First Welfare Theorem and be able to
recognize simple phenomena of market failures;
 perform simple welfare analysis at the market level, and analyze equilibrium effects
of distortionary policies.

6
Teaching approach

Teaching on the module takes place through ten weekly lectures and seminars, each on a
different topic in microeconomics. There are readings and activities that you will need to
participate in before and after the classroom time each week:

Please make sure you read the two key readings listed below before the lecture every week.

At the lecture:
The two-hour session will be formal but interactive lecturing. It is advised that you read the
assigned textbook chapters beforehand, so you can ask and clarify what you were unsure
about and take more out of classroom time. We will take a short, 5-minute break in the middle
of the lecture if necessary.

At the seminar:
The one-hour session will mostly be about problem solving, with the exercises assigned from
the textbook’s end-of-chapter exercises. The exact format is up to the seminar leader but it is
recommended that students work on the assigned problems in groups first, and then the
whole class discusses the solutions together, guided by the seminar leader. Ask about and
clarify everything you do not understand! The problems assigned are very much like those
showing up in the problem sets and in the final exam!

Moodle
Moodle is a virtual learning environment that we will be using throughout this module. You
will be registered to use Moodle once you have registered for the module. You can log on to
Moodle, using your UCL computer name and password, here.

7
General reading and resources

You will need to read extensively to successfully complete the module assignments. All
readings are available from one of six sources:

1. Libraries. Many books and journals are physically located in the IOE and UCL libraries.

2. Electronic libraries. Most journals are available electronically via the UCL library’s on-line
catalogue. Search for the journal name, and see whether it gives you a URL option. There
are also various e-books now available.

3. Moodle. Some readings are available in digitised form on Moodle. Go to the relevant
seminar topic to find the article you are looking for.

4. Websites. We sometimes recommend that you read working papers or government

reports; in these cases a web link will be provided.

Recommended textbook
Nechyba, T. J.: Microeconomics: An Intuitive Approach, Cengage, 2011
You can buy the textbook at an exemption price at Blackwell’s University Bookshop at the
Logan Hall, UCL Institute of Education (20 Bedford Way entrance).

Suggested background reading

1. Dasgupta, P.: Economics – A Very Short Introduction, Oxford Univ. Press, 2007
2. Levitt, S. D., Dubner, S. J.: Freakonomics – A Rogue Economist Explores the Hidden
Side of Everything, Penguin, 2007
3. CORE Econ e-book – An online economics textbook created by inter-university
cooperation, including UCL Economics Faculty. You can create a free account and read
online at http://www.core-econ.org/ebook/.
4. Mankiew, N. G.: Principles of Economics, Cengage, 2012
5. Mankiew, N. G.: Principles of Microeconomics, Cengage, 2012
6. Olney, M.: Microeconomics as a Second Language, Wiley, 2009
7. A useful, multi-purpose resource for students in economics about what economics is,
recent issues, career paths, etc. can be found at the website of the American Economic
Association: https://www.aeaweb.org/students/index.php.

8
Week 1 (5th Oct.): Introduction; Consumer’s Problem

This lecture gives a brief overview about what economics, especially microeconomics, is and
what economists do. We will talk through examples illustrating the “study of individual
decision-making about how to allocate scarce resources” and the “study of incentives.” We
will put economics in the perspective of other social sciences and discuss what “positive”
economics means, as opposed to “normative” economics.

The bulk of the lecture and the seminar is about optimization, “doing the best we can given
the circumstances”, the most important principle in economics. We will break down
optimization into elements: (i) utility functions and indifference curves, including their special
types, to help formalize the “best”, and (ii) budget sets to formalize the “circumstances.” In
the lecture, we will go over how to solve optimization problems without advanced math, and
we will work through practical examples in the seminar.

We will discuss two key optimization settings: (i) 2-good consumption problem, when an
individual decides how much to buy from each of two goods, and (ii) the labour supply
problem, when an individual decides how much to work.

We will cover a lot of ground during this first week, but don’t worry if you don’t fully
understand it all at first as we will be revisiting and continuously using these ideas throughout
the module.

After completing the work for this lecture and seminar you should:

 have an overview of the content and rationale of the module and of the administrative
matters related to your study of it;
 have an idea about what questions economics discusses and what methods it uses to
answer these questions;
 have a basic knowledge of what utility functions, indifference curves and budget sets
are;
 understand what is meant by the optimization principle in economics;
 be able to solve simple 2-good consumption and labour supply problems.

9
Key concepts
positive vs. normative economics
utility function
indifference curves and special types (linear, Leontieff, Cobb-Douglas, quasi-linear)
budget set
opportunity cost
optimization principle

Required readings
 Nechyba 1, 2, 3A.1, 6
 recent media pieces related to the topic:
1. “What Is Economics Good For?” by Alex Rosenberg and Tyler Curtain, The New
York Times, August 25th 2013
2. “Yes, Economics Is a Science: Commentary,” by Raj Chetty, The New York Times,
Oct. 20th 2013

Other readings
 Nechyba 4, 5
 CORE Econ e-book, Ch. 3.0, 3.2-3.3
 Becker, G. S. (1992): “The Economic Way of Looking at Life”, Nobel Prize Lecture
(download:http://www.nobelprize.org/nobel_prizes/economic-
sciences/laureates/1992/beckerlecture.pdf)
 Stigler, G. A. and Becker, G. S. (1977): "De Gustibus Non Est Disputandum", The
American Economic Review vol. 67(2): 76–90.

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

10
Week 2 (12th Oct.): Substitution and Income Effects; Market Demand

When individuals face a change in their income or experience a price change, they may change
the amount they buy from each good. This week we use the graphical optimization framework
from last week to analyse such changes in their consumption. We will do this in 3 steps:

1. Only income changes, resulting in a pure income effect;

2. Price changes with a special case of preferences, resulting in a pure substitution effect;
3. Prices changes in general, resulting in both substitution and income effects.

These mechanisms are extremely important for policy. For instance, when the income tax
increases, net income falls so leisure time becomes more expensive. If I continue to work the
same number of hours, I can spend less. This makes me want to work more
(mechanical/income effect). On the other hand, leisure time becomes cheaper (because I lose
less by not working), which, in turn, makes me want to work less (substitution
effect/behavioural response). The two effects in this case go against each other, so how much
revenue the government can collect from such a tax increase depends on the relative sizes of
the two effects (the shape of the “Laffer curve”)! Policy evaluations often balance these two
effects to see the overall success/failure of an intervention. Ignoring either of them may lead
to wrong conclusions about the impact of the policy.

As we go, we will also learn what normal/inferior goods and regular/Giffen goods are. These
labels are often used in economic discussions.

So far, we have focussed on individuals’ choices. In the second (shorter) part of the lecture,
we will see how individual demands can be aggregated to form the demand in the whole
market. After all, microeconomics studies the market consequences of individual choices!

After completing the work for this lecture and seminar you should:

 be able to graphically pinpoint and determine the sign of income and substitution
effects;
 be familiar with the definition of normal/inferior and regular/Giffen goods;
 know what relationship the Laffer curve describes;
 be able to aggregate individual demands into market demand both graphically and in
the equation form for the linear case.

11
Key concepts
normal/inferior good
regular/Giffen good
substitution effect
income effect
Laffer curve
individual demand
market demand

Required readings
 Nechyba 7, 8A1-2., 9A.1-2.
 recent media piece related to the topic:
“Higher Local Minimum Wages: Early Results from Seattle,” by Timothy Taylor
(http://conversableeconomist.blogspot.co.uk/2016/08/higher-local-minimum-
wages-early.html)

Other readings
 CORE Econ e-book, Ch. 3.7
 Boskin, Michael J. (2005). “Causes and Consequences of Bias in the Consumer Price
Index as a Measure of the Cost of Living”, Atlantic Economic Journal, Vol. 33(1): 1-13.
 Eissa, N., and H. Hoynes. 2006. “Behavioural Responses to Taxes: Lessons from the
EITC and Labour Supply.” In Tax Policy and the Economy, vol. 20, ed. J. M. Poterba.
Cambridge, Mass: MIT Press: 74-110.

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

12
Week 3 (19th Oct.): Firm’s Problem; Competitive Supply

This week we turn to the other side of the economy: firms who provide the supply of goods.
The key insight lies again in optimization, as firms choose to the “best” production plan given
their “circumstances.” We will again break down a firm’s problem into 2 steps: (i) cost
minimization, and (ii) profit maximization. Then we will talk about the elements of cost
minimization in more details: technology and isoquants, and isocost curves. In the lecture, we
will go over how to solve the firm’s problem without advanced math, and in the seminar
students will go through practical examples. We will thoroughly go over the most important
idea and insight of this material, the zero-profit condition.

We will discuss two settings: (i) the production problem with one input only, and (ii) two
inputs. The former is simpler, while the latter is the standard in economics, with the two
inputs being capital and labour.

We will show that a firm’s supply curve is the upward sloping part of its marginal cost curve.
Therefore, by aggregating over competitive firms’ marginal cost curves, we can get the
industry’s supply curve.

After completing the work for this lecture and seminar you should:

 have a basic knowledge of what technology, production function, returns to scale,

isoquants and isocost curves are;
 understand what is meant by the zero-profit condition;
 understand the difference between marginal and average costs;
 be able to solve simple 1 and 2-input profit maximization problems;
 understand the relationship between a competitive firm’s supply and marginal cost
curves;
 be able to aggregate firm-level supply curves into market supply both graphically and in
the equation form for the linear case.

13
Key concepts
Technology and isoquants
returns to scale
isocost curves
zero-profit condition
marginal cost and supply curve
average cost
shut-down and exit points of the firm

Required readings
 Nechyba 11, 12, 13.1
 recent media piece related to the topic:
“Bubble-lus ions – Why most real-estate agents aren't getting rich.” by Austan
Goolsbee, Slate magazine, August 2005
(http://www.slate.com/articles/business/the_dismal_science/2005/08/bubblelusion
s.html)

Other readings
 Nechyba rest of 13
 CORE Econ e-book, Ch. 6.0-6.3, 7.0-7.5
 Coase, R. H. (1937): “The Nature of the Firm”, Economica, Vol. 4(16): 386-405.
 Williamson, O. E. (2009): “Transaction Cost Economics: The Natural Progression”,
Nobel Prize Lecture (download:
http://www.nobelprize.org/nobel_prizes/economicsciences/laureates/2009/william
son_lecture.pdf)

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

14
Week 4 (26th Oct.): Market Equilibrium; Distortionary Policies

Probably the densest and one of the most important parts of the course!

During the last 3 weeks, we built up market demand and supply. This week we put the two
together and define market equilibrium price and quantity as the intersection of the two. We
will go over some comparative statistics, that is, how to shift the two curves and what the
new equilibrium will be if certain things change (e.g. income of individuals, price of an input,
etc.)

We will discuss the First Welfare Theorem (FWT), which states that under some very
important assumptions the market equilibrium is efficient. (We will define efficiency more
precisely.) We will go over the assumptions in a little more detail, as during the rest of the
course, we will relax these one by one. We will say that when at least one assumption is not
satisfied, a market failure occurs.

In the second part of this week’s lecture, we relax one assumption, and will analyse the effects
of government interventions, such as taxes, subsidies (and more if time permits), on
consumers, producers and the efficiency of the market. We will call the loss of efficiency as
the result of these interventions (or later in the course, of the relaxation of other FWT
assumptions) deadweight loss.

After completing the work for this lecture and seminar you should:

 be able to graphically determine market equilibrium and perform comparative statistics

involving shifting or moving along the demand and supply curves;
 understand the First Welfare Theorem and the underlying assumptions ;
 understand the difference between the statutory and economic incidence of taxes ;
 understand that economic incidence is determined by the demand and supply
elasticities;
 be able to show graphically the effect of government interventions we discussed in class
on consumer and producer surplus and deadweight loss.

15
Key concepts
Competitive market
market equilibrium
efficiency
First Welfare Theorem
market failure
statutory vs. economic incidence
deadweight loss

Required readings
 Nechyba 10, 15, 18, 19, 20
 recent media piece related to the topic:
“Is Christmas a deadweight loss?” The Economist, Dec. 20 th 2001

Other readings
 CORE Econ e-book, Ch. 7.7-7.8, Ch. 8, Ch. 9.6
 “The Power of the Market”, episode 1 of the 10-part video series, “Free to Choose”
featuring the author of the book with the same title, Milton Friedman.
o In print: Friedman, M. and R. Friedman (1980): “Free to Choose: A Personal
Statement”, Harcourt Brace Jovanovich, New York, Ch. 1, pp. 9-37.
o Video: https://www.youtube.com/watch?v=D3N2sNnGwa4

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

16
Week 5 (2nd Nov.): Monopoly and Monopsony

During the next two weeks, we relax the “no market power” assumption of the First Welfare
Theorem. First, we look at the most extreme case of market power, monopoly, where there
is one single producer in the market. This means that this single producer has all the power
to set prices in the market. We will show that this price setting power leads to a “supply
point”, as opposed to a supply curve in case of competitive firms, and that monopolies only
operate on the elastic part of the demand curve. The result is higher (“marked up”) prices and
lower production, so some loss of efficiency, compared to a competitive industry.

Next, we turn to some everyday examples of price discrimination, when a monopoly can set
multiple prices for different consumers.

Finally, we discuss natural monopolies, in which case if a second firm entered the industry,
production costs would increase (“technological barriers to entry”). We will also discuss the
role of regulatory authorities in such circumstances .

After completing the work for this lecture and seminar you should:

 be able to graphically determine equilibrium in a monopolistic industry;

 be able to show consumer and producer surplus, deadweight loss and price mark-up in
a graph for a monopolistic industry;
 be familiar with types of price discrimination;
 understand when natural monopolies may arise and what a government can do to
regulate such an industry.

17
Key concepts
monopoly
supply “point” of monopoly
price mark-up
price discrimination
natural monopolies
monopsony

Required readings
 Nechyba 23
 recent media piece related to the topic:
“The Guardian view on broadband Britain: take internet infrastructure away from BT,”
Editorial, The Guardian, July 19th 2016

Other readings
 “It’s Complicated,” The Economist, Oct. 18th 2014
 Evans, A. E. (1991): “Are Urban Bus Services Natural Monopolies?”, Transportation,
Vol. 18(2): 131-150.

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

18
Week 6 (16th Nov.): Introduction to Game Theory; Oligopolies

This week we continue to relax the “no market power” assumption of the First Welfare
Theorem, but this time we are visiting a less extreme case, namely, when there are more than
one but few firms producing in a market. We call such a market structure oligopoly. Although
none of these firms are able to unilaterally set prices, they have some power as they are large
enough relative to the full supply in the market. Therefore, the equilibrium in such a market
will be less efficient than in a competitive market but more so than with a monopoly. Before
we delve into more details, we need some basic tools from game theory.
Game theory is the methodological toolkit to analyse strategic interactions. Up to this point
in the course, the utility/profit/payoff of one agent in the market did not depend on what
other agents did. Now, for oligopolists, their profits do depend on what quantity other firms
produce or what price they set. When maximizing profit, firms will try to strategically take
into account other firms’ actions. We introduce the concept of Nash equilibrium in simple but
famous games such as the Prisoner’s Dilemma or the Chicken Game. Then we turn to
analysing different types of duopolies, Cournot and Bertrand (and Stackelberg if time
permits). We also discuss the case when Cournot oligopolists collude.
Finally, we will look at what happens if market power is on the demand side of the market,
something we call monopsony or oligopsony. We will discuss a notable application of this
setting: introducing a minimum wage into an oligopsonic (as opposed to a competitive) labour
market, employment may increase!
After completing the work for this lecture and seminar you should:

 understand the relationship between the efficiency of

competitive/monopolistic/oligopsonistic markets;
 be able to derive the Nash equilibrium in a Prisoner’s Dilemma or Chicken Game;
 be able to graph/explain the Nash equilibrium in a Cournot and Bertrand duopoly;
 understand that collusion in a Cournot duopoly leads to the same equilibrium as with a
monopoly;
 be able to graphically explain why introducing a minimum wage in a competitive labour
market decrease employment, while in an oligopsonic one it may increase employment.

19
Key concepts
oligopoly
strategic behaviour
Nash equilibrium
Prisoner’s Dilemma
Cournot and Bertrand duopolies
MAYBE: product differentiation and monopolistic competition – see media piece..
oligopsony

Required readings
 Nechyba 24, 25
 recent media piece related to the topic:
“Competition Is For Losers” by Peter Thiel, Wall Street Journal, Sept. 12 th 2014

Other readings
 Nechyba 26
 CORE Econ e-book, Ch. 7.9
 Eckard Jr., E. W. (1991): “Competition and the Cigarette TV Advertising Ban”,
Economic Inquiry, Vol. 29(1): 119-133.
 Manning, A. (2003): “Monopsony in Motion”, Princeton Univ. Press, Ch. 1:
Introduction, pp. 3-28. (source: http://press.princeton.edu/chapters/s7522.pdf)
 Ransom, M. R. and D. P. Sims (2010): “Estimating the firm’s labour supply curve in a
'new monopsony' framework: Schoolteachers in Missouri”, Journal of Labour
Economics, Vol. 28(2): 331-355.
 Staiger, D., J. Spetz, and C. Phibbs (2010): “Is there monopsony in the labour market?
Evidence from a natural experiment”, Journal of Labour Economics, Vol. 28(2): 211-
236.

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

20
Week 7 (23rd Nov.): Public Goods; Externalities

This week we relax the “no externalities” assumptions of the First Welfare Theorem. As we
will see, the benefit or the cost of an individual’s action will depend on other agents’ actions.
For instance, the services we get in exchange for our taxes will also depend on how much
others pay in tax. Also, how much we enjoy the River Thames also depends on how much
pollution other people or firms pollute it.
We introduce the concept of public goods, compare it to private goods and discuss policy
relevant examples such taxation. We show that if left to the market, individuals invest less
than would be efficient in public goods – a phenomenon we call free-riding. Next we define
externalities. The economic problem is similar in nature: when taking an action, individuals
only take into account their own benefits/costs and ignore the benefits/costs caused to the
rest of society. Therefore, goods with externalities may not be produced efficiently.
Finally, we discuss the policies governments can introduce to improve the efficiency of the
production of goods with externalities. Such policies include Pigouvian taxes and cap&trade
policies.
After completing the work for this lecture and seminar you should:

 understand the economic difference between private and public goods ;

 be able to explain how the free-riding problem arises in the public good context;
 be able to give examples of externalities, explaining (i) what the main good is that brings
about the externality, (ii) what the private and social benefits/costs are to the
production;
 understand the basics of Pigouvian taxes and cap&trade policies , and how they can
increase the efficiency with which goods with externalities are produced.

21
Key concepts
public vs. private goods
free-riding
externalities
Pigouvian taxes
cap&trade policies

Required readings
 Nechyba 21, 27
 recent media piece related to the topic:
“Not Vaccinating Is the Greater Risk,” by Jane E. Brody, New York Times, Aug. 11th
2015

Other readings
 Fehr, E. and S. Gächter (2000): “Cooperation and Punishment in Public Goods
Experiments”, American Economic Review, Vol. 90(4): 980-994.
 Hardin, G. (1968): “The Tragedy of Commons”, Science, Vol. 162(3859): 1243-1248.

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

22
Week 8 (30th Nov.): Uncertainty and Risk; Savings and Capital

Markets

Before relaxing the last assumption of the First Welfare Theorem, we need to tech ourselves
up with tools to treat uncertainty and risk in economics.

So far, we have mostly been talking about consumption, however, savings and investments
are equally important in economics (and our everyday lives). To talk about savings, we need
at least 2 periods, present and future, and we need to link the two somehow. This link is
discounting, and we begin our discussion by introducing the concept of discounting: the
method to calculate how much £1 today is worth tomorrow, and how much £1 tomorrow is
worth today. Then we go over the savings (or intertemporal consumption) problem, which is
analogous to the consumer’s problem with the two goods being present and future
consumption, and the prices depending on the interest rate.

Then we move on to introduce the von Neumann-Morgenstern utility and risk preferences,
and then discuss one of the most important applications: the insurance problem. We show
that a risk averse person chooses to fully insure herself against all the risk. If time permits, we
might briefly talk about two other applications of uncertainty: the value of statistical life and
portfolio choice.

After completing the work for this lecture and seminar you should:

 understand discounting, be able to compute discounted present value and future value;
 understand the graphics of the savings (intertemporal consumption) problem;
 understand the link between regular utility functions and von Neumann-Morgenstern
utilities;
 understand the relationship between risk preferences and von Neumann-Morgenstern
utilities;
 be able to derive graphically that a risk averse person chooses to fully insure herself.

23
Key concepts
discount factor
discounted present value
future value
von Neumann-Morgenstern utility
risk averse/neutral/loving
insurance

Required readings
 Nechyba 3A.2, 8A.3, 17
 recent media piece related to the topic:
“Guardian: 'Oil reserves will soon be worth NOTHING!' (A bit like their stock tips,
really),” by Tim Worstall, The Register, March 22nd 2015
(http://www.theregister.co.uk/2015/03/22/guardian_oil_reserves_will_soon_be_wo
rth_nothing_a_bit_like_their_stock_tips_really/)

Other readings
• Eisner, R. and R. H. Strotz (1961): “Flight Insurance and the Theory of Choice”, Journal
of Political Economy, Vol. 69(4): 355-368.
• Halek, M. and J. G. Eisenhauer (2001): “Demography of Risk Aversion”, Journal of Risk
and Insurance, Vol. 68(1): 1-24.
• Viscusi, W. K. and J. E. Aldy (2003): “The Value of a Statistical Life: A Critical Review of
Market Estimates Throughout the World”, Journal of Risk and Uncertainty, Vol. 27(1):
5-76.
• Chetty, R. (2006): "A New Method of Estimating Risk Aversion", American Economic
Review, Vol. 96(5): 1821-1834.
• Press Release: The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred
Nobel 1990 (Harry M. Markowitz, Merton H. Miller, William F. Sharpe), source:
http://www.nobelprize.org/nobel_prizes/economic-
sciences/laureates/1990/press.html
• “Trendspotting in asset markets”, Popular information about The Sveriges Riksbank
Prize in Economic Sciences in Memory of Alfred Nobel 2013, download:
http://www.nobelprize.org/nobel_prizes/economic-
sciences/laureates/2013/popular-economicsciences2013.pdf

Seminar Activities
24
Selected end-of-chapter exercises from Nechyba.

25
Week 9 (7th Dec.): Introduction to Asymmetric Information

This week we relax the fourth, “no asymmetric information,” assumption of the First Welfare
Theorem, and discuss basic versions of asymmetric information models.
First, we define what asymmetric information means, and state that it can stem from some
characteristics of economic agents not observed by others (hidden types) or from action of
the agents not observed by others (hidden action). The classic problem highlighting how
hidden types may cause inefficiencies in the market is adverse selection. We will discuss this
following Akerlof’s (1971) simple but Nobel Prize winning paper. Then we turn to two
“solutions”, through which agents can mitigate inefficiencies caused by hidden types:
signalling and screening. After sketching up why adverse selection arises in each case, we
discuss signalling in the context of education, and screening in the context of public
procurement (and price discrimination in the seminar).
Then we will discuss the hidden action (“moral hazard”) problem and its significance in the
context of (any kind of) insurance.
After completing the work for this lecture and seminar you should:

 understand what asymmetric information means in economics and what forms it can
take;
 have a solid understanding of the intuition of adverse selection, signalling, screening
and moral hazard;
 be able to replicate the stylized models of adverse selection, signalling, screening and
moral hazard we go over in class;
 be able to come up with your own examples for these asymmetric information
phenomena from everyday life.

26
Key concepts
asymmetric information
adverse selection
signalling
screening
second-degree price discrimination
moral hazard

Required readings
 Nechyba 22

 “'Ban the Box' campaign asks employers to give ex-offenders a chance,” by Stephen
Howard, The Guardian, Oct. 17th 2013

Other readings
• “Secrets and Agents,” The Economist, July 23rd 2016
• Advanced information on the 2001 Bank of Sweden Prize in Economic Sciences in
Memory of Alfred Nobel, the Royal Swedish Academy of Sciences. (download:
http://www.nobelprize.org/nobel_prizes/economic-
sciences/laureates/2001/advanced-economicsciences2001.pdf)
• Riley, J. (2001), "Silver Signals: Twenty-Five Years of Screening and Signaling", Journal
of Economic Literature, Vol. 39(2): 432-478.
• Akerlof, G. (1970), "The Market for Lemons: Quality Uncertainty and the Market
Mechanism", Quarterly Journal of Economics, Vol. 84(3): 488-500.
• Rothschild, M. and J. Stiglitz (1976), "Equilibrium in Competitive Insurance Markets:
An Essay on the Economics of Imperfect Information", Quarterly Journal of Economics,
Vo. 90(4): 629-649.
• Spence, M. (1973), "Job Market Signaling", Quarterly Journal of Economics, Vol. 87(3):
355-374.

Seminar Activities
Selected end-of-chapter exercises from Nechyba.

27
Week 10 (14th Dec.): Catch-up and Conclusion; A Teaser: Research in

Applied Microeconomics

We finish up material from Nechyba and conclude the module by overviewing the structure
of the course. Review questions are welcome!

If we have time left, we will do a teaser of research in applied microeconomics. This is a broad
field of economics that works with micro level data (individuals, firms or other
microstructures of the society) and answers questions concerning labour, education, health,
social insurance, etc. Based on interest of the students, we will touch upon some (depending
on time how many) topics out of those offered below. We will discuss the main idea and
method of 1-2 key papers in the topic, written about UK or global policies.

In the final exam, the material in this teaser will NOT be assessed!

After completing the work for this lecture and seminar you should:

 have a clean idea about the structure of the module and the key insights of
microeconomics.
However, there will be NO questions on the teaser in the final exam, ideally, you will also:

 know the difference between randomized and natural (quasi-) experiments;

 have a basic understanding of the main idea behind randomized experiments,
difference-in differences and regression discontinuity designs;
 be able to summarize the required paper in each of the 3 topics eventually discussed
in class in a couple sentences. Your summary would include answers for the following:
o what is the paper’s research question?
o why is that interesting?
o What data do the authors use?
o What method/research design do the authors use?
o What do they conclude?

28
Key concepts
Research design
Randomized experiment
Quasi-experiment/Natural experiment
Difference-in-differences
Regression discontinuity

Required readings (we will pick 3 topics in the previous lecture; you are only
required to do the readings for the chosen topics)
• Health care: advantages of randomization when resources are scarce;
identifying adverse selection

o Allen et al. (2013): The Oregon Health Insurance Experiment: When

Limited Policy Resources Provide Research Opportunities, Journal of
Health Politics, Policy and Law, Vol. 38(6): 1183-1192. (download:
http://jhppl.dukejournals.org.libproxy.ucl.ac.uk/content/38/6/1183.f
ull.pdf)
o Allen et al. (2010): What The Oregon Health Study Can Tell Us About
Expanding Medicaid, Health Affairs, Vol. 29(8): 1498-1506. (download:
http://content.healthaffairs.org/content/29/8/1498.full.pdf)
• Minimum wage and its effects on employment and firm-level outcomes
o Card and Krueger (1994): Minimum Wages and Employment: A Case
Study of the Fast-Food Industry in New Jersey and Pennsylvania,
American Economic Review, Vol. 84(4): 772-793. (download:
http://davidcard.berkeley.edu/papers/min-wage-ff-nj.pdf)
• Unemployment and unemployment insurance (liquidity vs. moral hazard)
o Gruber (1997): “The Consumption Smoothing Benefits of
Unemployment Insurance”, American Economic Review, Vol. 87(1):
192–205.
o Card, Chetty and Weber (2007): "Cash-on-Hand and Competing Models
of Intertemporal Behaviour: New Evidence from the Labour Market”,
Quarterly Journal of Economics, Vol. 122(4): 1511-1560.
• Student loans in higher education

o Dearden et al. (2014): Money for nothing: Estimating the impact of

student aid on participation in higher education, Economics of
Education Review, Vol. 43(6): 66–78. (download:
http://www.sciencedirect.com/science/article/pii/S02727757140009
10)
29
 • If student interest is such, other potential topics may include: taxation, other
social insurance (e.g. disability), antitrust

Other readings
• Minimum wage and its effects on employment and firm-level outcomes
o Harasztosi and Lindner (2015): Who Pays for the Minimum Wage?
Dept. of Economics, UCL, manuscript (download:
https://www.dropbox.com/s/4wdvae5oo68v8mo/HungaryMW_wpFi
nal.pdf?dl=0)
• Unemployment and unemployment insurance (liquidity vs. moral hazard)
o Meyer (1990): “Unemployment Insurance and Unemployment Spells”,
Econometrica, Vol. 58(4): 757–782.

• Student loans in higher education

o Solis (forthcoming): Credit Access and College Enrollment, Journal of
Political Economy (download:
http://alexsolis.webs.com/CreditAccessSolis_July2015.pdf)

Seminar Activities
Discussion of short projects.

30
Assessment 2016-17

The assessment for this module consists of 3 summative parts:

1. 5 bi-weekly problem sets (10% of final mark)

These will contain mostly graphical and numerical problem solving, indicative of the
final exam. Students are encouraged to work in groups, however, everyone has to
write out and submit their own solutions. Problem sets are an essential part of the
course, both to get a good grade on the final and to grasp a solid and long-lasting
understanding of the material. Problem sets will be graded after submission, so
students will get continuous feedback on their work during the term.

2. a short project (10% of final mark)

This will be a short economic analysis essay. Students will pick a newspaper/magazine
(Guardian, Time, Economist, New York Times, etc.) article about a microeconomics
related issue, present it in a framework discussed in the course, and add their blog
post-like opinion/ideas to it. You should make sure that your essay is logically
structured. This means that each paragraph deals with a major issue or idea and that
these ideas are developed in a logical sequence.
The recommended length of the project is 1000 words and may not be more than 2
pages. It can be completed and submitted anytime during the term, until the
beginning of the last lecture. Some articles, labelled as “current media pieces” earlier
in this module handbook, will be assigned readings throughout the course, and
students are welcome to pick one of those. The short project will be graded by the
autumn term exam paper marking deadline (usually a couple of days before
Christmas).

3. a 2-hour final exam (80% of final mark)

This will take place during the centrally determined exam period across UCL (usually
from late April to late May each academic year). During the final exam, students will
have to solve problems very similar to those assigned for the problem sets. Students
will be allowed to use offline calculators but will be responsible for bringing one if they
need it. The “Teaser in Applied Microeconomics Research” from Lecture 10 will NOT
be assessed at the final exam.

31
Deadlines

Problem sets may be hand-written, and the hard-copy should be handed in at the BEGINNING
of lecture on the due date.

The short project will need to be submitted via Moodle (provide information relating to term
week and date) and a hard copy handed in at the BEGINNING of the last lecture of the term.

32
Submission details, deadlines, and forms

The short project should be word-processed and presented in the style and format set out in
the guidance for writing assignments, which can be found in the Programme Handbook.

You must keep to the word length specified in the assessment instructions ; going over or
under the specified length will incur a penalty. For details, see here:
http://www.ucl.ac.uk/srs/academic-manual/c4/ug-assessment/penalties#top.

The word length is counted including tables and figures. Footnotes, which must appear as end
notes at the end of the document, appendices and the references list are excluded from the
final count. Footnotes and appendices are not necessarily read by the assessor and are not
part of the assessed work.

Your course work should be in font size 12, on A4 paper, 1.5 lines spacing, with page numbers ,
reasonable margins and printed on one side of the paper. You must paginate your
coursework.

Deadlines for submission of final coursework are binding. Missing a deadline without prior
approval will incur a penalty. For details, see here: http://www.ucl.ac.uk/srs/academic -
manual/c4/ug-assessment/penalties#top

The front page of your coursework should be set out as in the template shown below. You
should download the electronic version from Moodle.

The word length must be stated on the title page.

For formative essays – please provide your full name and student number
For summative essays – please provide your student number only

UCL

Department of Social Science

Name of module

Title of coursework

Name of candidate / Student no.

Number of words:

33
Date submitted:

BSc Social Sciences

34
Coursework submission form - An electronic version is available on Moodle

Department of Social Science

BSc course work submission form

Module Title and Code ________________________________________________________

Student’s name ______________________________________________________________

Date of submission ___________________________________________________________

Title of assignment: Report / Dissertation / Essay (Please circle)

___________________________________________________________________________

___________________________________________________________________________

Word count ________________________________________________________________

Declaration of own work: I confirm that I have read and understood the UCL Guidelines on
Plagiarism. I confirm that this assignment is all my own work except where otherwise
indicated. This assignment has not been submitted on another occasion.

Sign here:_________________________________________________

……………………………………….……………….………...........................................

To the student – retain this as your record of submission

Received from …………………………………………. Date ……......….………….

Module title ………………………..………………………..............................………

Signed ………………………………..…......................... (Programme administrator)

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